Real-time Transaction Cost Analysis : Building Up the Buy-side Tool Kit


ITG’s Kevin O’Connor sorts the nuts and bolts of real-time TCA and discusses specific strategies with Steve Peterson of the Teacher Retirement System of Texas.
Monitoring and reporting on trading performance in real-time is not a new concept. Trading profit and loss (P&L) calculations and supporting transaction cost information has been available in most Execution Management System (EMS) and some Order Management System (OMS) platforms for a number of years. However, integrating the calculations and information into trading workflows presents a unique problem. Specifically, how do you design a monitoring and feedback system that is fast, easy to use and provides information that will help traders make smart strategy choices. Real-time monitoring can be broken down into three main categories:

  1. Transaction Cost Analysis
  2. Risk Monitoring
  3. Market Conditions (Prices, Volumes, etc.)

Transaction Cost Analysis (TCA)
In its simplest form, real-time TCA consists of comparing execution prices to various benchmarks, such as arrival price, interval volume weighted average price (VWAP) or previous close, and displaying this information back to users as a realized P&L number. In addition to realized P&L, unrealized P&L (which uses a proxy price for the unexecuted portion of orders) can be shown, providing a trader with a view as to the potential exposure remaining in their orders. When analyzing individual orders, real-time TCA tools plot actual executions against market prices to provide a visual representation of the execution “footprint”. When analyzing multiple orders, the tools focus on generating alerts or highlighting performance outliers.
Risk Monitoring
Risk monitoring tools analyze the risk characteristics of a residual tradelist. This typically includes metrics such as total risk, tracking error, beta and sector imbalances. Real-time risk monitoring is used by traders that are looking to minimize total risk while working a program or a list of securities. These tools are also used by portfolio managers and trading desk management to monitor the status of portfolio transitions.
Market Conditions
There are many ways for traders to monitor market conditions. The simplest metrics quantify actual market volume, prices and volatility. For volume monitoring, a comparison of current volume to historic volume is often provided. Order-by-order and aggregate participation rates are also generated, providing traders with a view of their total market participation. For market price monitoring, individual security prices can be compared to industry, sector and market movements. Volatility is another analytic that can be analyzed in real-time. Comparing realized volatility to historic volatility gives traders some perspective on the relative difficulty of the current market conditions.
To make this type of real-time monitoring most effective, it should be available for all electronic trading flow, not just the transactions staged through an EMS. By way of example, Investment Technology Group provides real-time monitoring capabilities for all transactions that flow through broker-neutral platforms. Traders can now get a consolidated view of their trading activity even if they don’t stage all transactions via a single EMS. Using the monitoring capabilities available, traders can quickly and easily monitor real-time market conditions and trading P&L for all of their electronic trading.
I recently spoke with Steve Peterson, Trader and Transaction Cost Analyst specialist at the Teacher Retirement System of Texas about his experience with real-time monitoring tools.
Kevin O’Connor: When did you start using real-time monitoring tools?
Steve Peterson: The Teacher Retirement System of Texas uses both internal and external managers, and there are portfolio transitions that occur from time to time. We decided that we would like to do some of the transition work internally, but that we also needed the tools that transition managers have to monitor the market, risk and trading P&L in real-time. We started using these tools over the last year, and we now consider them essential to our ability to monitor our transition activity, and important to our overall trading process.
Kevin O’Connor: How are the tools integrated with your trading workflow?
Steve Peterson: The tools we use are integrated directly with our EMS. We started using them to monitor our internal transition activity, focusing on risk monitoring and P&L monitoring. However, they are available for all trading, and since they are integrated with, but also separate from the blotter, we can have them running on the side while we trade. When we do trade, we tend to have a lot of activity, so the tools become an important part of our process. We usually run a quick, aggregate pre-trade snapshot as soon as the list is staged to the EMS. This pretrade report is sometimes sent to the portfolio managers so that they can get an expectation of implementation costs. After that, we typically break up our list and assign it to different traders. The tools are flexible enough to allow each trader to monitor their own orders and view a P&L for the activity they are responsible for. At the same time, all of the traders or trading management can look at the risk characteristics of the original trade list to make sure we are minimizing residual risk and/or sector imbalances as we are all trading.
Kevin O’Connor: How does real-time monitoring mix with your traditional, post-trade TCA reports? How is post-trade TCA different?
Steve Peterson: We recognize that post-trade reporting is about examining trends in costs over large time periods and peer group comparisons. The kind of process improvements we consider when looking at our post-trade data are more at the macro-level. When monitoring individual orders, we are focusing on what we can do tactically to minimize potential performance outliers by altering trading strategies. In theory, if we manage our dayto-day trading being sensitive to arrival-price benchmarks, we will see better performance over time in our post-trade analysis. Conversely, if we see trends in our post-trade analysis that highlight areas for improvement, we can monitor those types of transactions more closely.
Kevin O’Connor: Are you using the real-time monitoring tools to alter your trading strategies?
Steve Peterson: We have always used market information to inform our trading strategies. The challenge comes on busy days, when we have more names to trade than can be monitored individually. On those days, we look at our Summary P&L chart to see which names we need to focus on. We can drill into those names looking at both the volume monitor and trade progress charts to decide if a change in strategy is possible. We will examine real-time pricing and volumes for individual names, making decisions as to whether we should speed up or slow down. There may also be times where the algorithm selected is no longer the right choice, and we need to search for liquidity elsewhere.
Kevin O’Connor: What kinds of additional tools and metrics would you like to see from analytics vendors? 
Steve Peterson: I’d like to see more graphical representations of market conditions, including metrics that would help us determine when there is significant high-frequency trading in the names we are working. It would also be helpful to have metrics that analyze specific algorithms. A chart or graph that shows the algorithm’s market footprint (trade prices in relation to the bid/ask/mid) for a specific name would help users determine if the prints you are getting are of high quality.
I think there is room for improvement in pre-trade analysis as well. The ability to see a dynamic, evolving pretrade number, one that is adjusted by current market conditions (volatility,spread, volume), would be a great help to traders. A dynamic pre-trade estimate would allow traders to get a better feel for what their performance will be against post-trade benchmarks, which consider market impact and market conditions. Along those same lines, being able to see performance against a participationweighted price benchmark intraday would be helpful since that is one of the benchmarks we use post-trade.
One piece of information that ismissing right now in real-time monitoring is a view into the historic performance of specific destinations, given current market conditions. Adding this type of information would be another analytic that could be used to aid us in strategy and destination selection.
Kevin O’Connor: Do you think real-time monitoring tools will become a standard part of every trader’s workflow?
Steve Peterson: Absolutely. I think many traders are already comfortable with real-time P&L monitoring and basic market analytics. With more traders being exposed to posttrade TCA, they are also familiar with the metrics and benchmarks used in evaluating their aggregate performance. If the tools provided by vendors can cover all electronic flow and provide alerts and easy to understand graphics, traders will use them as part of their regular trading process. Anything that can provide traders with the information they need to analyze execution flow and perhaps avoid significant outliers is worth experimenting with.