Every trader on Wall Street has heard of the Algo Wheel. But what the heck is it really?
And more importantly, why should you care?
There is a very loose understanding of the Algo Wheel in the marketplace. It’s some sort of broker ranking tool….or it picks the strategy for you….or it executes all its orders with the Wheel provider….and then generates some cryptic report.
Or something like that.
Every one of those observations is from real traders at real firms. (Ask me how I know this.) So, here’s a quick review for everyone’s edification. Don’t worry, there’s no sales-pitch at the end. The only goal here is education.
Murky
The Algo Wheel is one of the least understood electronic products on Wall Street. In a world of Big Data and A.I., that is saying something. Very few folks have a firm grasp on this thing, perhaps with good reason. In any case, the murky understanding can be traced to two factors:
1) a lack of a standardized product comparison and
2) a lack of a standardized usage.
Reason #1: Comparison
The first reason people are confused is because the Street lacks the means to assess all the “wheels” rolling around out there. So far, there has been no unbiased review from official, third-party firms. No one has yet compared and contrasted the various products claiming to be Algo Wheels. That will change soon. But for now, every vendor and non-bulge broker is spitting out their version. Some claim to be global when they are only live in one region. Others claim to have artificial intelligence embedded. All of them issue “report cards.” Most won’t share that methodology of calculation. And almost none will tell you the uncomfortable truth: that your own flow is insufficient as a data-set for statistically reliable conclusions….no matter HOW big you are.
Reason #2: Usage
The second reason people are confused is because of the regional differences in its application. In Europe, the Wheel is exactly what it was originally designed to be: an elegant solution to the requirements around best-execution. Yet outside of Europe, it is a wholly different beast performing a wholly different function. The European version is a graceful, flying Pegasus. But the American version is a sweaty Clydesdale workhorse. Allow me to explain.
Best-ex liability
European trading became much more dangerous for the Buyside trader under MIFID2. Because the updated rules suddenly made the Buyside directly liable for the quality of their fill prices. The trader sending the order must now answer to the Regulators as to where they traded….and why. Fill prices had always been an execution concern….but it had never been a Regulatory concern for the Buyside.
Now it is.
European pegasus
Enter the Algo Wheel.
Here is a simple desktop software that utilizes data to select the strategy and broker. Even better, it generates reports explaining itself. All this is sufficient to quell any Regulatory inquiry about what was traded where – and why. This makes European Buyside traders comfortable because it removes their direct liability for their execution quality. Instead, that now lies squarely on the Algo Wheel logic. Thus, the Algo Wheel magically flies the best-ex “problem” back to the Sellside broker.
American Clydesdale
In Asia and the Americas, the Wheel serves a wholly different function. Best Execution obligations in those regions have always been the Sellside’s problem. There, the broker is still viewed by the Regulators as the primary culprit regarding poor execution quality. Which means the Algo Wheel isn’t needed as a “CYA” for Buyside traders in the Americas.
Why then do they use it?
The American and Asian traders are using it to automate their orders’ decision-making process. The Wheel acts as something of a junior trader, enabling efficient management of broad order flows. So, the Algo Wheel has become a desk workhorse in strategizing the upcoming trade in a systematic fashion. This means the Wheel enables an “if/then” though-process to be implemented as a matter of procedure. For example, illiquid names can automatically route to your specified regional brokers whose algos tend to trade conservatively (as defined by you). Meanwhile, your more liquid names can automatically go to the bulge-brackets because (in your estimation) even they can’t screw up AMZN, GOOG and NFLX!
You need to pay your cash coverage with some high-touch orders? Good thing you have two “Cash Desk” Wheels! You’ve set up one Cash Wheel with your “mastermind” traders who stretch every order hours longer than necessary. But you’ve also got another Cash Wheel for those heavy-handed “bulls-in-a-china-shop.” You know….those old-timers that you golf with regularly.
Flow control
In the States, most traders don’t want the Algo Wheel to tell them how to trade. They want the Wheel to help them manage their flows among their brokers, after they’ve already decided how to trade it! Because the Wheel can be programmed to enforce almost any parameters, such as specified monthly commission payouts by broker, right down to the penny. Of course, your brokers don’t know where they sit in your pre-established payout schedule. They don’t even know if they’ll still be on your broker-list for the upcoming year. But their uncertainty created by being in a Wheel drives them to hustle for better execution. This applies to both your manual and electronic orders. That’s a good thing.
Flexible
The Algo Wheel can be programmed with features like your brokers’ risk-controls, your custom order-routes, your regional market-preferences, currency determinations and all the minutiae that guide your decision on how an order should be handled. Almost any pre-established workflow routine can be put into the logic of a Wheel. And this comprehensive flexibility is why it’s a completely different product in the New World versus the Old World. Europe uses it politely, just as it was intended. The rest of the world has turned MacGyver with the thing.
Practicality
Right now, you’re wondering if it would be of any use to your desk. So let’s address all those questions of practicality. The Algo Wheel can indeed be deployed alongside any OMS or EMS – even if the provider is hesitant to admit this. You should face no extra charges associated with the Wheel, beyond the standard FIX line costs attached to any algo connection. Implementation is simple, although it requires testing with each broker you add to your Wheel. But any broker can be added quickly because they ALL want a shot at your flow. But let’s forget what you see and think about that which you do not.
Differentiation
The REAL differentiation among Wheels is not the front-end GUI on the screen….it is the back-end data calculations that you don’t see. The data that compares and ranks your brokers matters greatly. And this is where the cream rises to the top. Unfortunately, this critical piece is the one area where all the questions that should be asked, are NOT being asked. So don’t keep yourself in the dark. Start digging into how this data is sorted and calculated. If the provider doesn’t know – or won’t say – then run the other way. Because that is the real guts of it and you need to understand it.
Pros & cons
The PROS of the wheel are flexibility, protection against best-ex inquiries and systemization of your trading process. The CONS are your time and effort involved in fine-tuning the tool to your exact preferences. The early conversations will be lengthy. But once your process has been created, the upkeep gets easier each month. More trade data always speeds reliability of broker-comparison. But all insights are helpful in that they open the door to better partnerships with your brokers through specific examples. The conversations you can have with your algo providers will accomplish two things: it will give you insight into their logic and it will enable them to better tweak their algos for your performance-improvement. That is a win-win.
Like all technology on Wall Street, it is not a fit for everyone. But you won’t know if it’s right for you until you ask the right questions. This will help you do that.
Because it’s all about the fit.
This article is by Marc Angelos for Traders Magazine and it was licensed by Bloomberg. It was originally published on BPS on Aug 6, 2018.