Futures Market Ripe for Algo Providers

Over the last 10 years—with the exception of one significant dip following the calamity of late-2008—trading volume in the futures market has steadily risen, and is expected to rise another 10 percent this year over last, according to the Futures Industry Association.

According to a new report from Tabb Group, US Futures Trading 2012: Buy-Side Demands in an Evolving Marketplace, by the end of 2012 it is estimated that 10 percent of order flow allocation in the hedge fund space will be done algorithmically, up from 3 percent just a year ago. This is a trend that is expected to continue over the years to come. "As futures become a more important part of overall strategies, the use of algorithms is expected to increase," states the report.

A more interesting statistic provided by Tabb is just how many survey respondents are already moving to algos for futures trading. In 2011, 38 percent of asset managers and 33 percent of hedge fund managers reported using futures algos. Those numbers have spiked to 62 and 60 percent, respectively.

This presents an opportunity for firms that can design faster, more sophisticated algos. But the Tabb report makes one important point: "Traders are easing into the use of futures algos, essentially testing their capabilities before expanding their adoption. In some cases, traders are even waiting for preferred broker counterparties to offer a more robust product as they are not convinced they need to add brokers or alternative front ends to have access to futures-specific algorithms."

The report points out that while high-volume buy-side firms have traditionally created their own algos, this may not be the case in the future as volumes and competition in the space potentially drive up the cost of building algos. Brokers that can provide better pricing decisions and the integration of prices from other instruments and asset classes will have a leg up on the competition, according to Tabb.

"There is really no reason anymore for us to try to build a better algo when the brokers have really good strategies that we can use," stated one large hedge fund.

My colleague Jake Thomases recently wrote a feature on how mid-tier broker-dealers have to make tough choices about which algorithms to white label and which ones to develop internally. Looking to the future, it will be interested to see if a gap is created in this space between the mid-tier and large-tier brokers, which have the scale and budget to create more specific algorithms.

If you have any thoughts on the matter, send me an email at anthony.malakian@incisivemedia.com, or give me a call at +1 646 490 3973.

Finally, Waters is pleased to welcome our newest staff reporters, Timothy Bourgaize Murray in the US and Steve Dew-Jones in the UK. Both will write for Waters magazine, Buy-Side Technology and Sell-Side Technology. Timothy can be reached at timothy.murray@incisivemedia.com or +1 646 490 3968. Steve can be reached at steve.dew-jones@incisivemedia.com or +44 207 316 9672.