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Discussion in 'Wall St. News' started by basis, Mar 21, 2007.

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    Chicago trio shakes up markets
    By Anuj Gangahar

    Published: March 19 2007 18:41 | Last updated: March 19 2007 18:41

    Three publicity-shy Chicago-based groups are emerging as a potent global force in trading across almost all asset classes.

    The trio use complex technology and mathematical models, often termed “blackbox trading”, to buy and sell in enormous volumes on a daily basis.

    The three outfits are Citadel, the hedge fund founded in his Harvard dormitory by Ken Griffin; DRW Trading, a 15-year-old company that started out as a Eurodollar options specialist; and Getco, acknowledged as one of the pioneers of electronic trading.

    Bill Cline, former head of the capital markets practice at Accenture and now managing partner of Acai Solutions, a capital markets consultancy, said the three Chicago groups were part of a broader trend in which hedge funds and proprietary trading outfits provide the market with order flow, liquidity and in some cases take equity stakes in exchanges, as well as trading huge volumes for themselves.

    “This, and similar moves by others, represent a challenge to the very concept of the exchange because increasingly, everyone can trade directly with everyone else. The hub-and-spoke network does not really stand up any longer,” Mr Cline says.

    Evidence of the growing influence of the Chicago trio came when they were recently among half a dozen hedge funds and non-bank traders that joined a group lobbying for membership of MTS, the dominant eurozone government bond trading platform.

    Their efforts have triggered unease among some investment banks, which have exclusive access to the platform and so dominate trading in the €4,000bn ($3,000bn) market. Citadel is perhaps the best known of the Chicago trio, although Mr Griffin himself rarely gives interviews.

    The fund is believed to account for at least 10 per cent of trading flows on eSpeed and BrokerTec, the electronic bond trading platforms. These two in turn are estimated to account for about two-thirds of trading flows in the most frequently traded Treasury instruments – which total about $300bn a day. In disclosures made late last year, Citadel revealed holdings of more than $30bn of government bonds.

    With a strategy based to a large extent on high-volume, frequent trading, Citadel is also believed to account for more than 5 per cent of all daily share trading volume on the NYSE and Tokyo Stock Exchanges.

    The DRW Trading Group describes itself on its website as “an aggressive, dedicated organisation engaged in many different aspects of the trading industry, including market making and proprietary trading”.

    The three groups are part of a wider movement that is using state of the art technology and applying complex mathematical procedures to dictate their trading patterns or respond to movements across the capital markets.

    Their ability to transact such large volumes of securities so quickly, which is key to the influence they wield, can be put down at least in part to their use of so-called “programme trading” (see box).

    Alongside their thriving proprietary trading businesses, Citadel, DRW and Getco also act to varying degrees as marketmakers in a host of instruments and have positioned themselves to take advantage of rapid global changes in market infrastructure by forming alliances with, or investing in, trading platforms and stock and derivatives exchanges.

    The global exchange landscape is going through unprecedented consolidation. Big deals such as the merger of the NYSE Group and Euronext, the pan-European exchange, have been accompanied by the entry of well-funded new players such as Bats trading and the Level automated trading system.

    Indeed, Getco is one of the market makers that has contributed to the success of the Bats system, which has been taking equity market share away from the Nasdaq and NYSE since it launched just over a year ago.

    Getco and Citadel last year signed up as early adopters of the joint venture between the Chicago Mercantile Exchange and Reuters, which aims to form the first centrally cleared foreign exchange marketplace. One Chicago-based fund of hedge funds manager says that as the lines between exchanges, broker-dealers, hedge funds and proprietary trading firms blur, it remains to be seen which firms and business models stand to benefit most. “It is not just a case of who will win, but a question of what constitutes winning,” he says.


    The term “program trading” applies to any type of strategy that uses quantitative analysis to identify mispricings of instruments such as stocks, bonds, indices or derivatives. The aim is to profit from exploiting these by trading in a highly automated, systematic fashion.

    An example is index arbitrage, which involves selling futures on an index while simultaneously buying back a basket of its component stocks when the index is worth more than its constituent parts. The relationship between the value of an index and its constituents is known as the basis and can be positive or negative.

    Statistical arbitrage involves a “capture” trade designed to take advantage of an unexpected divergence in the relationship between two or more securities that usually hold a steady correlation. Program trading differs from algorithmic trading, which is also widely used by Citadel, DRW and Getco.

    Algorithmic trading is any highly quantitative, automated method of implementing a trading strategy, be it to add a position on some instrument or merely to hedge individual stock risks in a portfolio.

    Some algorithms allow traders to buy or sell stock along with the prevailing trend in the market. This is the case with the most widely used form, known as volume-weighted average price, the VWAP. Others offer the ability to mask bids or offers and execute transactions only at pre-defined thresholds.