Nerds on Wall Street: Math, Machines, and Wired Markets

3.3. Algos for the Buy Side: Transaction Cost Control

It didn't take long to notice that these new electronic trading techniques had something to offer to the buy side. Financial journals offered a stream of opinion, theory, and analysis of transaction costs. Firms like Wayne Wagner's Plexus Group—now part of Investment Technology Group, Inc. (ITG)—made persuasive, well-supported arguments about the importance of transaction costs. Pension plan sponsors, sitting at the top of the financial food chain, were convinced in large numbers.

Index managers did not have to be convinced. With no alpha considerations in the picture, they observed that it was possible to run either a lousy index fund or a particularly good one. The difference was the cost of trading. Those passive managers, on their way to becoming trillion-dollar behemoths, were high-value clients to brokers.

In addition to giving their high-value clients what they wanted, brokers had an additional incentive to adopt electronic trading. The end of fixed equity commissions spawned new competitive pressures. Electronic trading had the potential to cut costs dramatically, while improving quality of service.

The largest firms developed their own electronic order entry systems. Others bought from niche vendors. One of these was Davidge Data, headquartered in a loft a short walk from the financial center. Nick Davidge had many clients to support, and used bicycles to dispatch service people, mostly himself. In the course of this ...