As institutions hunt for liquidity during regular hours, ConvergEx Group launched a new pre-market algorithm earlier this week to help buy and sell side customers source liquidity outside of traditional market hours.
The move is sign that off hours trading in the pre-market session could become a new focal point for buy-side institutions if they are provided with tools that fit into their workflow.
ConvergEx said it was the first firm to develop an algorithm for pre-market trading. This comes on the heels of a decision by Nasdaq OMX to pre-market trading session to 4 a.m. eastern time, from the current 7 a.m.
“With liquidity shrinking any extra hours that we could offer to them would help them accomplish their goals,” said Scott Daspin managing director in the Global Electronic Execution group at ConvergEx.
Premarket trading is more complicated than regular hours because it’s a very volatile time of day and trading tends to come in spurts, explained Gary Ardell, head of the financial engineering and advanced trading solutions group at ConvergEx.
Premarket trading is important when there is news out or earnings, or there is a decision made by the portfolio manager, which would lead the traders to enter or exist a position before or after market hours, said Ardell.
Until now, operating in the pre-market session has been manual task at a point in the day where traders were pressed to speak with analysts and figure out the direction of the market. Now they have a more intelligent tool to automate what was a labor-intensive process, which allows them to trade in the pre-market the same way they trade during market hours, said Ardell.
Because this is a volatile time of day, the algo intelligently knows when to participate with erratic pricing,” said Ardell.
Daspin said he came up with the idea for an algo when he visited clients before market hours and saw a few people on the trading desk using a calculator to figure out how many orders they wanted to slice in the market with direct market access. “It’s extraordinarily difficult,” said Daspin. The client asked if ConvergEx could come up with an algo. In addition some buy side clients want to give the algo to their brokers. “When they didn’t have time to use a calculator they had to route the trade to a traditional cash desk,” related Daspin. For some traders, the algo is a workflow solution so they can get a piece of the trade done before the market opens, which helps them get a sense of the direction of the trade, said Ardell.
The algorithm was developed using ConvergEx’s Automated Testing Facility, which was rigorously back-tested over 20,000 different trading scenarios using years of pre-market trading data.
To be successful, an algo has to be aware of the idiosyncratic nature of pre-market trading, said Ardell. He compared pre-market trading in the U.S. to global trading in Asian markets. “There’s no predictable pattern,” said Ardell. “You see flashes of activity and then you see it go down.”
The move by ConvergEx follows an announcement last month by Nasdaq OMX that it plans to extend its premarket trading session to 4 a.m., three hours earlier than the current 7 a.m. Nasdaq plans to offer the 4 a.m. trading session no later than March 18, pending regulatory approval by the Securities and Exchange Commission. This would enable Nasdaq to compete with NYSE Euronext whose Arca Edge offers a premarket trading at 4 a.m. since 2005.
[For more on Will Traders Reset Their Alarms for Nasdaq’s 4 A.M>Pre-Market Session?, see Ivy Schmerken’s related story.]
Exchanges see the pre-market trading session as an opportunity to capture order flow, especially since rival dark pools are not allowed to trade in the pre-market, according to Daspin. “Exchanges would love to be relevant to Europe and they would love to trade when they are just the only game in town,” said Ardell.
The rules are that dark pools execute trades based on derived prices, (so the prices are not reliable. There’s so much volatility that regulators don’t feel the dark pools are safe during the premarket time, suggests Daspin.
Nasdaq, NYSE Arca, BATS and Direct Edge are already open for premarket trading beginning at 7 a.m. Ardell says that ConvergEx has not taken advantage of going way back to 4 a.m, as the firm hasn’t seen a demand for it from clients. Their algo is focused on trading from 7:30 a.m. to 9:29 a.m.
ConvergEx has done a lot of research during both trading and non-trading hours where it’s best to post and take liquidity, depending on the stock spread, market cap and risk or volatility of the stock movement, and it uses any of the exchange routes, explained Ardell. In the pre-market, the machine has to be very clever about picking its spots and not to over trade. “It has to be opportunistic and when liquidity is there it has to get it. Otherwise, it will drive prices,” he said.