Algorithmic trading facts & fantasies

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LBMA/LPPM Precious Metals Conference

30/09/2013

Algorithmic trading facts & fantasies

J Scott Kerson

Head of Commodities AHL / Man Systematic Strategies, Man Group PLC

LBMA/LPPM Precious Metals Conference 2013

September 2013

For institutional/professional and/or qualified investor use only. Not for public distribution.

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Important notes

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What do systematic traders actually do?

Why do we use algorithmic execution?

An anecdotal history of systematic trading

Source: Man database and Wikipedia.

What do we do?

1954

: IBM introduces the 704, the world’s first mass-produced

computer with floating point hardware, index registers, and core

memory.

1956

: Mathematics PhD student Edward O. Thorp observes that

a deck of cards has “memory” – the conditional distribution of the

next card depends on the previous cards dealt. He uses the IBM

704 to bootstrap a systematic strategy for Black Jack. He doubles

his money in his first weekend.

1962

: Thorpe publishes his system in Beat The Dealer, becomes a

NY Times best-seller, and forces every casino in the world to alter

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LBMA/LPPM Precious Metals Conference

30/09/2013

Source: Man database

There is no guarantee of trading performance and past performance is no indication of current or future performance/results.

Estimating the composition of ‘the deck’

The empirical response function for FASTCOMM

B a si s p o in ts P n L

Standard deviation of signal

Simulation of the Man Commodities Fund systematic overlay and WTI Crude Oil in 2008

Sources: Man database and Bloomberg.

Sample period of backtrack data: 1 January 2008 to 31 December 2008. In this backtrack, which corresponds to a simulation of the Man Commodities Fund USD institutional share class. There is no guarantee of trading performance and past performance is no indication of current or future performance/results.

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Is it an advantage not to read newspapers?

“An ominous warning that

the rapid rise in oil prices

has only just begun”

(The Independent,

11 June 2008; Model remains

LONG, but starts to CUT)

“An ominous warning that

the rapid rise in oil prices

has only just begun”

(The Independent,

11 June 2008; Model remains

LONG, but starts to CUT)

“Will oil prices recover after

tanking in 2008?”

(The Telegraph,

29 December 2008; Model

remains SHORT)

“Will oil prices recover after

tanking in 2008?”

(The Telegraph,

29 December 2008; Model

remains SHORT)

“New ‘super-spike’ might

mean USD 200 a barrel oil”

(MarketWatch, 7 March 2008;

Model is LONG)

“New ‘super-spike’ might

mean USD 200 a barrel oil”

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What do systematic traders actually do?

Why do we use algorithmic execution?

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LBMA/LPPM Precious Metals Conference

30/09/2013

Coming soon to a market near you



At least 30% of all US equity market volumes are traded by machines, with some estimates suggesting 60% or more



In electronic commodities futures execution, we estimate that algo share has doubled in the last two years, from 20%

to 40%



‘High-touch’ or human-to-human rapidly going to zero for liquid futures

Sources: BloombergBusinessweek, 6 June 2013: How the Robots Lost: High-Frequency Trading's Rise and Fall. Marco Avellaneda, 2011: Algorithmic and High-frequency trading: an overview.

The rise of the machines

US Equities markets: percentage of orders generated by algorithms

Per c entage of equity volum e

Source: Man database.

The AHL approach: pitting humans against the machines

Explicit competition between Virtual Trader and The Desk

100% to machines 100% to desk Competitive band – 50/50 split Large trades Small trades

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AHL’s evidence on competitive execution

-2 -1 0 1 2 3 4

Cocoa (NY)Soy Oil Cocoa (London)Soy Beans Coffee (Robusta)Corn Rapeseed (Winnipeg)Platinum Wheat (Chicago)Palm Oil Sugar (London)Lean Hogs Copper (NY)Rubber Wheat (KC)Live Cattle Crude Oil (WTI)Heating Oil Gasoil Cotton Crude Oil (Brent)Soy Meal Gold Coffee (Arabica)Feeder Cattle Silver Wheat (Minneapolis)Palladium Crude Oil (ICE WTI)Natural Gas Gasoline Sugar (NY)

Algorithmic trading facts & fantasies

LBMA/LPPM Precious Metals Conference

30/09/2013