Algo Wheels Overview by Chris Chapman

Author: Chris Chapman, Liqueo Senior Consultant 

Although Algo Wheels haven’t been around for that long, comparatively speaking, they have made a significant impact on the Trading landscape, across multiple asset classes. But what is an Algo Wheel and why is it important in the modern trading world? This article will take a high-level look at the basic principle of Algo Wheels and how they can help to optimise Trader performance.

At base level, Algo Wheels are designed to take any favouritism out of Algo selection. All too often in the past, a Trader may well have overused a ‘favourite’ or ‘preferred’ Broker/Algo combination, either due to familiarity or for any number of other reasons. However, when an Order is sent to an Algo (or Broker) Wheel, the actual Order routing is made at random to one of a pre-determined panel of Brokers and to a specific Algo Strategy, based on a defined set of criteria. Over time, routing in the Wheel will even out according to Broker weighting to ensure fairness and may typically be based on overall notional value of the Orders submitted.

Other than the previously mentioned bias, other benefits of using a Wheel include speed and likelihood of Execution, reduced trading costs and improved analysis & reporting capabilities. The latter benefit is particularly important in the post-MiFID II world where being able to demonstrate Best Execution is paramount.

Speaking from an Equity perspective, an Order sent to a Wheel is generally known as a Low Touch Order but what defines an Order as Low Touch can be fairly fluid and vary from desk to desk. Broadly speaking though, it will be a relatively straightforward Order with a reasonably high degree of execution certainty. An example would be an Order below a certain value e.g. $5million with a share quantity below a certain percentage, say 5%, of either the Average Daily Volume (ADV) or the Remaining Daily Volume (RDV). It could be argued that RDV is a superior measure as this will reduce throughout the day, so what could be a Low Touch Order at the opening bell may not still be one approaching the Close. Other criteria, such as Market Cap or tradability may also be used depending on the complexity of the evaluation to be undertaken.

Orders of this ilk are more likely to be traded quickly and efficiently. This frees up the Trader to concentrate on Orders that require more care, market knowledge or interaction with a Broker - High Touch Orders. Related to this point, it is feasible to have a pseudo High Touch Wheel running in parallel, based on the same general premise as Low Touch, with Orders potentially being executed in the same way (Broker/Strategy) but excluded from any Low Touch analysis. Again, this can be seen as demonstrating a desire to eliminate Broker bias.

The initial evaluation of an Order to determine its potential to be traded via a Wheel is clearly critical but where should that evaluation take place? Should it be in the Order Management System (OMS) or in the Execution Management System (EMS)? Either approach is valid but as with most things, data is the key. Using the criteria example of ADV/RDV mentioned above, if this data point is not available in your OMS, then you aren’t going to be able to make that initial evaluation. Similarly, if you can’t export the decision information out to your EMS, then there is little point making the decision in the OMS. That said, if the data isn’t available in the EMS either, then the decision needs to be made using a different set of criteria.

It could be argued that OMS evaluation is more suitable if the Desk hierarchy is a defined by a clear Low Touch/High Touch split. Here, a Trader will be able to see that they should not take the Order and trade it if they can see that it is not meant for them. If a Desk is set up to trade by Sector, then the argument for making the decision on how to trade in the EMS becomes stronger but equally, it does not render the OMS evaluation invalid.

More recently, some of the traditional OMS offerings have evolved into Order Execution Management Systems (OEMS), in an attempt to bridge the gap between the two different systems and offer the best of both worlds. Ultimately, there is no ‘one size fits all’ solution and there are of course, many subtle differences between the different OMS and EMS systems available that see to that. 

Whilst Algo Wheels are not designed to replace a Trader, they certainly look as though they are here to stay and will probably evolve further to offer ever more complex solutions. Here at Liqueo, we have the knowledge and expertise to help clients work their way through the different options available.