Program Trading Defined - Part I

Program trading has become a significant factor in the markets today, occasionally getting blamed for high volatility. On most days, however, program trades get very little attention. Despite the lack of focus in the media, program trades make up a large portion of the market's activity every day. Today we start a multiple-part series on program trading.

What Is Program Trading?

Program trading is loosely defined as any type of computerized trading methodology where the purchase or sales decision is determined by a computer program.

Real-time input of market data is analyzed and when certain pre-determined conditions are met, the computer program places a trade, automatically, to capture whatever value the algorithm has "found."

This loose definition of "program trading" has faded over the past decade, however, and is generally more accurately referred to today as "algorithmic trading."

Examples of such systems might include technical analysis of a single stock, momentum analysis of a single stock, arbitrage strategies of a single ETF index fund against its corresponding futures contract, and almost any other type of approach currently.

Firms Offering Algorithmic Trading

The algorithmic type of "program trading" is used by individuals and institutions alike. Furthermore, there are a wide variety of products now available that analyze and execute trades automatically.

Examples of firms offering this type of algorithmic trading software include:  

• 4^th Story www.4thstory.com
• Ninja Trader www.ninjatrader.com
• SmartQuant www.smartquant.com
• Strategy Runner www.strategyrunner.com

This list is not all inclusive; there are many firms offering software products today for automated, algorithm-based trading strategies.

An interesting, more comprehensive list of firms offering algorithm trading products and services can be seen at: http://wallstreetandtech.com/AdvancedTrading/directory/  

Note that some of these products require the use of the firm's trading platform and are therefore not "portable."

While this loose definition covers virtually all aspects of "automated trading," it is not what "program trading" refers to today.

Program Trading On The New York Stock Exchange

After the stock market crash in 1987, the New York Stock Exchange implemented Rule 80A, which required firms placing program trades to report such trades on a daily basis.

At the time, and up until September 30, 2007, program trading was defined by the New York Stock Exchange as follows:

Program trading is defined as a wide range of portfolio trading strategies involving the purchase or sale of 15 or more stocks having a total market value of $1 million or more.

Therefore, when "program trading" is discussed as a factor in the markets during the past 20 years, only those trades placed with a value of more than $1 million and involving a basket of more than 15 stocks is included.

The definition for the past twenty years did not require that the trades be placed automatically, by a computer. The strategy may have been determined by a computer program, but any trades that resulted from that strategy were reported as program trades, even if the trades were placed manually.

An automated trade placed by an algorithmic trading system (such as those listed above) that did not meet the criteria of 15 stocks and total value over $1 million would not have been considered to be a program trade.

The New Definition Of Program Trading

Beginning September 30, 2007, the NYSE changed the definition of program trading to eliminate the $1 million requirement.

The definition of program trading was also redefined to be more specifically focused on trades that are part of a larger "coordinated" strategy.

"Program trading" means either (A) index arbitrage or (B) any trading strategy
involving the related purchase or sale of a "basket" or group of 15 or more
stocks, provided, however, that the purchases or sales of stocks are part of a
coordinated trading strategy, even if the purchases or sales are neither entered
or executed contemporaneously, nor part of a trading strategy involving options
or futures contracts on an index stock group, or options on any such futures
contracts, or otherwise relating to a stock market index.

What the revised definition means is that many types of algorithmic trading strategies will not be considered "program trading." 

Trades that originate from an automated program analyzing real-time data are not "program trades" unless the trade "strategy" involves 15 or more stocks, regardless of whether the total value of the automated trade exceeds $1 million. In addition, the trades do not have to be simultaneously placed.

The primary determinant of when a trade is a "program trade" is whether the trade is part of a single "coordinated" strategy involving more than 15 stocks.

This means that automated trades of any size that might occur in a stock you are also trading will not be reported as a "program trade," unless that trade is part of a "coordinated strategy" involving 15 or more stocks.

Program Trade Reporting Requirements

On the NYSE, firms that place program trades are required to report them to the exchange.

Prior to September 30, 2007, firms were required to report these trades on a separate form filed within three days of the trade (T+2). 

With the recent changes, this definitive post-execution filing is eliminated. Firms are required to identify program trades at the time of execution, with a specific code identifying the type of trade and the principal involved.

The types of program trades now identified include the following:

• Non-algorithmic program trade
• Algorithmic program trade
• Index arbitrage

Firms placing program trades will also have to identify the origin of the trade:

• Proprietary (the NYSE member firm is trading its own account)
• Agency (the firm is placing the trade on behalf of a client)
• Agent (the firm is placing the trade on behalf of another NYSE member firm)

All of these changes were required to be implemented by NYSE firms by September 30, 2007, but many have been in compliance with the new Rule 80A for most of the summer.

NASDAQ Program Trading Requirements

NASDAQ has no requirements on firms to report program trades. The only reliable information on program trading in the market comes from the NYSE.

Conclusions - More To Come

Future installments in this series will look at the major firms executing program trades.  Later, we will examine how program trading volume is calculated.

Comments may be e-mailed to the author, Robert V. Green, at rvgreen@briefing.com