Date : June 2, 2005
Publication : The Financial Times

Human traders add more value than algorithms

Sir, Stories in praise of algorithmic trading are becoming more common and the FT has joined the chorus "Algorithms add up to affect quarter of US equity trades" (May 27).

We think the hosannas may be a little premature. While it is true that the early penetration rates are impressive, the actual utilisation rates are less so, according to a recent report by Financial Insights.

More importantly, because of the paucity of actual performance analysis available to date, the early experimentation in which most industry participants, including ourselves, feel compelled to take part, may peter out if the data do not support "best execution" responsibilities of brokers and money managers. Frankly, it is too early to tell, although we hear a mix of views from our customers and our own limited use thus far puts us in the camp of believing that while algorithms clearly add value on the efficiency front, their performance as yet cannot compare with the judgment of human traders.

The other issue, which your reporter Andrei Postelnicu wisely points out and is indeed a concern, is the potential abuse of algorithmic order flow by the proprietary trading firms offering them to their customers.

The "wolf in sheep's clothing" analogy may be unduly harsh and the likelihood of proprietary trading desks actually peeking at the order flow itself is probably low.

However, possessing the intimate knowledge of how these algorithms are designed and operate, may make it rather easy for these "prop" desks to reverse engineer the strategies being employed by customers and make educated guesses about how to trade against their order flow.

Our hope is that the number of studies analysing the benefits and costs of algorithms will soon catch up with the number of stories extolling their virtues and/or adoption rates, so that as an industry we can make sure we are fulfilling our duty to customers.

Joseph Gawronski, Chief Operating Officer, Rosenblatt Securities, New York, NY 10005, US

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