Published on July 13, 2009
Rising to the Top: Finding the Best Liquidity in Dark Pools Hitesh Mittal, Managing Director Investment Technology Group © 2009 Investment Technology Group, Inc. All rights reserved. Not to be reproduced or retransmitted without permission. Brokerdealer products and services offered by ITG Inc., member FINRA, SIPC. POSIT Marketplace accesses, among other destinations, the POSIT Now and POSIT Match ATSs. 04170940099
Dark Pools Are a ZERO SUM Game • Traditional dark pools invited likeminded participants • The objective was to minimize impact • Newer entrants tend to invite a wider variety of participants with different objectives: • Institutions – minimize impact • DMA flow – reduce cost • Market makers, prop desks, and high frequency funds – earn short term alpha • Dark pools are a ‘zero sum game’ by construction • The objectives of newer entrants make them less attractive to institutions 1
How to Extract Quality Liquidity 1 2 3 4 Optimally allocate to Understand Separate Measure performance minimize contratypes in contratypes in and contratypes Implementation dark pools dark pools in dark pools Shortfall 2
Understanding ContraTypes Minimizes Institutional Impact Block Order May Support Stocks Institutional Market Bound No Spread Savings High Frequency Adverse Selection Market Makers Gaming Gamers *Based on internal ITG research: “Are You Playing in a Toxic Dark Pool? A Guide to Preventing Information Leakage,” Hitesh Mittal, Journal of Trading, Summer 2008. 3
Separating ContraTypes ITG’s Liquidity Filter technology uses this logic to interact intelligently against each type of liquidity Uses minimum size on orders Uses order type Peg Passive without min size Large Client Order Shuts down IOIs by sending small aggressive orders Avoids gamers by not allowing orders to get pinged 4
Understanding Implementation Shortfall Example: Buy 100k ABC Executed shares: 35k Unexecuted shares: 65k 7 bps Opportunity Cost IS of Executed Opportunity Total Shares Cost Implementation Shortfall 3bps 7bps 5.6bps 3bps IS of executed shares Total Implementation Shortfall = execution cost vs. arrival + potential cost of executing the residual order based on the current stock price 5
How to Measure Performance of a Dark Pool • Implementation Shortfall of executed shares • Fill rate • Adverse selection • Opportunity Cost: the cost of trading unexecuted shares • Implementation Shortfall + Opportunity Cost 6
Looking at Fill Rates Alone is Not Enough 15 bps Example: 6 Buy Orders 10 bps § Fill rate: 50% Great!! § IS cost on fills: Negative Great!! 5 bps Price § Opportunity Cost: High Not Great Time § Total IS cost: 5 bps (IS Cost + Opportunity Cost) High Not Great 10 bps 15 bps 7
Looking at Fill Rates Alone is Not Enough • Fill rate: 25% OK • IS cost on fills: 0 OK Price Time • Opportunity Cost: 0 Great!! • Total IS Cost: (IS Cost + Opportunity Cost) 0 Great!! Higher adverse selection = Higher opportunity cost 8
9 140 120 100 80 60 40 20 0 20 40 60 5 0 5 30 25 20 15 10 10 15 ATS 1 ATS 1 ATS 2 ATS 2 ATS 3 ATS 3 ATS 4 ATS 4 ATS 5 ATS 5 ATS 6 ATS 6 ATS 7 ATS 7 ATS 8 ATS 8 ATS 9 ATS 9 ATS 10 ATS 10 ATS 11 ATS 11 ATS 12 ATS 12 ATS 13 ATS 13 ATS 14 ATS 14 ATS 15 ATS 15 ATS 16 ATS 16 ATS 17 ATS 17 Adverse Selection End Time +1 min ATS 18 ATS 18 Adverse Selection End Time +15 min ATS 19 ATS 19 ATS 20 Adverse Selection Across Dark Pools ATS 20 ATS 21 ATS 21 ATS 22 ATS 22 ATS 23 ATS 23 ATS 24 ATS 24 ATS 25 ATS 25
Optimally Allocate for Best Performance • Spreading orders across multiple pools leads to more information leakage • Higher information leakage = Higher IS cost • Allocation should be adjusted based on • Adverse selection • Average impact in each pool • Average fill rate in each pool 10
Introducing POSIT Marketplace SM 11
ITG’s Liquidity Filter SM At the Core of POSIT Marketplace Separate toxic and Measure the nontoxic contras performance of each in dark pools dark pool and contra Measure total IS of Allocate first to orders and adjust highest quality dark allocation pools and contras 12
Disclaimer These materials do not provide any form of advice (investment, tax or legal). Neither Investment Technology Group, Inc. nor ITG Inc. is a registered investment adviser and they do not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy. The screen shots provided in this presentation represent examples of certain products available from ITG. They contain sample data and are provided for informational purposes only. All functionality and delivery estimates described herein are subject to change without notice. These materials are highly confidential and are not to be copied, displayed or transmitted in any form without the prior written permission of ITG. 13
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