The Practical Guide to Wall Street: Equities and Derivatives

CHAPTER 5

Program Trading

INTRODUCTION

Program trading¹ is unquestionably one of the most misunderstood and unfairly vilified businesses on Wall Street. The popular perception is of unsupervised decision making and high-velocity trading by computers using sophisticated models to pick the pockets of unsuspecting investors who just want to buy a few shares to tuck away something for retirement or their kids’ education.

It is certainly a colorful image but, fortunately, it is also wholly inaccurate. While there do exist so-called “statistical arbitrage” traders that use computer models to detect and profit from anomalous trading patterns in the market, they make up a small fraction of the total traded volume and, more importantly, have nothing whatsoever to do with the program trading business of a typical Wall Street investment bank.

The question then is, what exactly is program trading? At the risk of completely disappointing those readers who found the previous characterization of program trading appealing, we can use as a starting point the definition provided by the NYSE.

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.

—New York Stock Exchange, July 31, 2008

It is a remarkably simple definition—15 names and a million dollars—and, admittedly, not particularly useful. In practical terms, program trading is the simultaneous execution of a portfolio ...