Shares are traded on ASX on a price and time priority basis.
If you are using an online broker, your order is routed directly to the market via your broker’s filters. This is called Direct Market Access (DMA) and it allows you a high level of control over your trading.
DMA enables brokers to enter your order into the market, via their IT systems and pre-trade filters.
Some professional traders also use DMA. However, instead of manually entering their orders into a computer, they rely on a set of trading rules (trading algorithms) which are entered into a computer. The computer then makes trading decisions for the professional trader based on these rules. Trading algorithms can be programmed to achieve different objectives – such as to minimise market impact costs and capture trading opportunities.
An algorithm is simply a set of instructions to complete a given task.
Algorithmic trading is a computerised, rule-based system responsible for executing orders to buy or sell a security.
Algorithmic trading activity on ASX has meant a;
- trade execution speed increase,
- daily transaction volume increase, and an
- average value reduction for each trade.
Many retail investors find algorithmic trading unusual because it can generate a lot of trades for very small numbers of shares. ASX closely monitors algorithmic trading patterns – as it does for all trading activity - and while the level of algorithmic trading has increased in recent years, it has not raised major issues for ASX. When ASX does uncover evidence of manipulative trading behaviour, however generated, a referral is made to ASIC, the regulator.
To better understand the effects of algorithmic trading, it is useful to understand what algorithms are seeking to achieve.
Execution algorithms were developed to minimise the market impact of large orders and therefore reduce the costs of trading. The most common of these is VWAP – an algorithm designed to ensure that the execution of a large order is done at the volume weighted average price of a security over a day.
Situational algorithms are more sophisticated algorithms, which seek to profit from changes in data, information and events. Whereas an execution algorithm is used to execute a pre-existing order in the most efficient manner, a situational algorithm seeks to take advantage of a particular situation – hence the name. It will create orders from a computer-generated algorithmic strategy as well as execute the orders as efficiently as possible.
Example of an execution algorithm undertaking a Volume Weighted Average Price strategy
The VWAP strategy is one of the most commonly used trading algorithms. The aim of the strategy is to achieve a steady price over the day, weighted by the volume (number of shares) traded. A VWAP order would typically be achieved by splitting the total order into multiples of smaller orders, with these smaller orders being executed during the day. The table below shows a typical course of sales from a VWAP strategy. There are two large orders then a series of small orders being executed as part of the VWAP algorithm.
Trade history/course of sales
ASX does not have system minimum limits on trade size for execution - however brokers may set limits on the volume and or value of the trades their clients can execute through their systems. Many stockbrokers will typically set a minimum order size of $500.