Even the Meanest HFT Algos Won’t Mess With Block TradesMichael P. Regan
If you’re a whale in the stock market, maybe it’s time to stop pretending you’re a guppy.
That’s basically the case being made these days by market researcher Larry Tabb, who argues that the time is right to revive the art of block trading for institutional investors.
The status quo among brokers currently is to slice and dice large trades into tiny orders in an effort to quickly access liquidity scattered across multiple exchanges and dark pools. Much of the song and dance performed by computer algorithms is an effort to buy or sell large chunks of stock without throwing off a scent to high-frequency trading computers trying to sniff out big buyers and sellers in the market.
But here’s the thing: HFT firms won’t go near a huge offer to buy or sell that is thrown into the market all at once. Big block trades are too risky for HFT and go against the very nature of their strategies, which is to make a few pennies from many trades rather than many dollars from a few trades.
Block trades are often defined as at least 10,000 shares at a time. But Tabb, head of the namesake Tabb Group LLC, and analyst Valerie Bogard define their size as 20 percent of a security’s average daily volume. Block trading slid from 39 percent of volume in 2001 to 17 percent in 2013, Tabb’s report shows.
Part of the decline is a result of imperfect benchmark measurements for transaction costs, according to Tabb. Broker algorithms often aim to trade a big order at the stock’s volume-weighted average price, or VWAP. That’s calculated by tallying the dollar amount of every trade over a certain time period and dividing by the number of shares that changed hands. Buy at or below VWAP, it’s believed you got a good deal.
VWAP became a standard for trading execution, in Tabb’s view, amid the proliferation of exchanges and alternative trading venues coupled with paranoia that super-fast computers will exploit “information leakage.” Also, the market volatility in the wake of the 2008 financial crisis made it too risky to place a big order at a single price point and wait patiently for someone to take the other side.
But reliance on VWAP and other standard methods of analyzing transaction costs may be causing some brokers to miss chances to get better deals through block trades, Tabb said, especially now that market volatility has receded drastically.
Average executions should not be confused with best executions and technology now can better measure nuances in trading costs, according to Tabb, so investors and traders should embrace new standards. He compared clinging to the old benchmarks to keeping sweaters from the 1980s in hopes that they’ll come back in style.
The youngest traders may be most uncomfortable with the patience needed to trade blocks and the notion that faster is not always better, according to Tabb. The highest rated agency block-trading firm in a Tabb survey was JonesTrading Institutional Services LLC, which uses a “high-touch” method that relies on relationships between human traders instead of letting the computers do all the talking.
In other words, someone may need to teach those whippersnappers in the Cosby sweaters how to work a phone.