Build and explain it and they will come.

That’s what Will Wall, head trader at Richmond, Virginia-based RiverFront Investment Group, told Markets Media when informed of a new algorithm aimed at sourcing liquidity in small-capitalization stocks. While not currently using an algo to get small-cap exposure, Wall was intrigued by the possibility of using Convergex’s newest electronic offering.

Small-cap stocks are less liquid, especially in block size. Wall currently gets his exposure to small-cap names via exchange-traded funds but said even there finding what he needs is tough. Bid-ask spreads still are wider compared with mid- or large-cap names and anything that helps him find liquidity in these small stocks and snag alpha is a good thing.

“Small-cap liquidity is not as plentiful as it is in mid- or large-cap,” Wall began. “This type of algorithm sounds like an interesting approach. Anything that improves small-cap trading is beneficial.”

But Wall said the devil is in the details and he wanted to know more about the algo and how it manages or gauges a particular dark pool’s toxicity. He added that having his orders rest in a potential toxic venue and having a predatory trader sniff out his intentions makes him wary.

So how does Convergex’s new small cap algo work?

According to Convergex’s Oliver Sung, the algo is brand new and designed to maximize liquidity in less liquid names while simultaneously minimizing market impact. It does this by placing resting hidden ‘child’ orders in over 15 ATSs. If an order cannot be executed in a dark venue, then the algo can route away to public exchanges. Furthermore, the algo has built-in logic that will prompt the algo to pull its orders when it senses that it is signaling its presence in a particular venue.

“The algorithm will then return to the market with orders when it determines that it is advisable to re‐engage,” Sung said. “Also, block executions are continuously analyzed for the potential execution of conditional orders.”

No resting orders are placed on exchanges.

The hallmark feature of this new algorithm is the so-called shot clock mechanism. This feature allows a buy-side trader to select a default amount of time (the clock) that the algorithm has to execute, or shoot, the orders out to be filled. Once the shot clock time expires, resting orders are automatically pulled and the trader can re-select the parameters of the shot clock and try again.

The shot clock is meant to strategically takes liquidity from lit and dark markets in an intelligent and impact minimizing manner. “In essence, the shot clock feature allows traders to have full control to replicate the manual workflow they are currently using to trade small cap stocks,” Sung said. “Traders get full control and this algo replaces the manual workflow most traders are using to execute small-cap trades.”

Buy-side traders can also set the pace in which the algorithm executes an order from three levels of aggression. Traders can set aggression levels according to their knowledge of the stock – not what Convergex or a computer model might suggest.

Also, in the case of when it looks like an execution by the algo will result in adverse price selection, the logic will automatically stop executions and withdraw from the market. “We’ve seen that many of our clients are spending more time in the small cap area, so this algo makes sense,” Sung said.

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