Trade Strategy and Execution Flashcards
trade motivation
(1) Profit seeking
(2) Risk management and hedging needs
(3) Cash Flow needs
(4) Corporate actions, margin calls, and index reconstitution
2 considerations of Profit seeking trading motivation
(1) Rate of alpha decay (higher rate -> shorter time frame -> trade urgency
(2) Minimize information leakage (alert the market to the security
mispricing through their trading activity)
kind of rate of alpha decay
(1) trade on daily news flow
–> higher alpha decay rate
–> higher trade urgency
(2) trade on long-term fundamentals
–> lower alpha decay rate
–> lower trade urgency
the aim of Risk management and hedging needs
(1) To maintain target risk exposure
(2) Rebalance after change in market conditions (targeted duration)
(3) Remove risk factor from a portfolio (hedge FX exposure)
Trading Strategy Inputs
- Order Characteristics
- Security Characteristics
- Market Conditions
- Individual risk aversion
Order characteristic
(1) Side (buy, sell, short buyback (cover), or short sell)
(2) Absolute size (quantity)
(3) Relative size (% of ADV)
alpha decay
Alpha decay is deterioration in alpha once an investment decision has been made.
TWAP
+ Time-weighted average price
+ TWAP ignores volume
+ appropriate for managers who wish to remove the impact of outliers
VWAP
+ Volume-weighted average price
+ average price of all trades, weighted by volume
+ use when they want to participate with volume patterns over a day
+ achieve the objective of using the cash received from sell orders to fund buy orders of the rebalancing
Arrival price
price of the security when the order is sent to the market for execution
Scheduled algorithms
execute trades using rules driven by historical volumes or specified time period
Charateristics:
+ High liquidity
+ Small order
+ low urgency
Include:
+ Percentage of volume algorithms
+ Time slicing algorithms
Liquidity-seeking algorithms
take advantage of favorable liquidity conditions when offered by the market
Charateristics:
+ low liquidity
+ High urgency
+ High size order
+ Infor leakage concern
Eg: wait large order appeared -> enter BUY
Arrival price algorithms
seek to trade close to market prices prevailing at the time the order is entered
Dark strategies/liquidity aggregators
+ execute trades in dark pools,
+ with aggregator algorithms attempting (aggregator algorithms: thuật toán tổng hợp)
+ optimize trading across multiple dark venues.
Smart order routers (SORs)
+ algorithms
+ determine the best destination (either lit or dark) to route an electronic order to lit/dark or both (the market must have both lit & dark)
+ get the best result
dark pool
+ is a privately exchange for trading securities.
+ allow institutional investors to trade without exposure until after the trade has been executed and reported
High-touch approach
+ involve high levels of human involvement
+ required for large trades (known as block trades)
+ Use in less liquid market
+ >< Electronic trading
+ 2 types of high-touch approach (base on who assumes the risk of trading the order):
* principal trades (broker take risks related exercute):
* agency trades (broker only lam trung gian)
direct market access (DMA)
+ allows buy-side portfolio managers/traders to access the order book of the exchange directly through a broker’s technology infrastructure.
+ used more for futures than for options
request for quote system
systems used by investors to request prices from dealers in less liquid quote-driven markets
VD: các lô TP rất lớn, khi bán thì request người mua trả giá trước rồi mới bán
opportunistic algorithms
= Liquidity-seeking algorithms
Dark strategies/liquidity aggregators
execute trades in dark pools, with aggregator algorithms attempting to optimize trading across multiple dark venues
Execution cost
Execution cost = ∑sjpj−∑sjpd = Trading cost + Delay cost
+ Delay cost = (Price at time PM decision - Arrival Price) x Volume
+ Trading cost = (Aver Price - Arrival cost) x Volume
implementation shortfall
IS = paper return − actual return
market-adjusted cost
arrival cost (bps) − β × index cost (bps)
arrival price
the price when the order is sent to the market for execution
principal trade
+ Include:
* Quote-driven market
* OTC Market
* Off-exchange market
* Request-for-quote market
+ Use in: gov bond, currency fx,…
+ Characteristics: the broker assume that the risk related trade pricing into her quoted spread.
execution risk
+ the risk of an adverse movement in a share price in the time it takes to execute an order
+ proxy: price volatility
+ reduce: use liquidity securities
Market impact
is the adverse movement in price caused by submitting an order to the market and forcing prices up as a buyer, or down as a seller
4 types of reference price
(1) Pretrade benchmarks (known before trading) include: decision price, arrival price, previous closing price, opening price
(2) Intraday benchmarks: price during trading period: include VWAP, TWAP
(3) Posttrade benchmark: determine after the trade complete
(4) Price target benchmark: use by profit seeking manager, earn short term alpha
5 types of trading strategy selection
(1) Short term alpha
+ Objective: ST alpha earning in liquidity market
+ Urgency: high
+ reference price: arrival price benchmark
+ execution method: Algorithm
(2) Long term alpha
+ Objective: trade in LT earning due to change in fundamental condition
+ urgency: low
+ reference price:
+ exe method: sell in gradually small part to avoid infor leakage
(3) Risk rebalance
+ Objective: rebalace or hedge risk exposure
+ Urgency: low
+ Refn price: TWAP
+ execution method: Algo
(4) Client redeemtion trade
+ Objective: liquidate to meet client redeemtion needs
+ urgency: at the end of day
+ ref price: closing price
+ Exe method: VWAP
(5) New trade mandate
+ Objective: invest new client fund
+ urgency: by client -> urgen
+ Ref price: closing price
+ exe method: immediate
3 types of trade implementation choices
(1) High-touch approaches: involve high levels of human involvement
(2) Electronic trading: involves trading via computer and is used in more liquid markets.
(3) Algorithmic trading: is the use of programmed rules to electronically trade orders
DMA appropriate for ?
(1) small trade (2) in liquid electronic markets
Decision price = 20 with size = 50.000
Arrive price = 20.1, purchase success with 40.000, average price = 20.34
close price = 20.55
Trading fee = 0.02
+ Delay cost = 40.000 x (20.1 - 20) = 4.000
+ Trading cost = 40.000 x (20.34 - 20.1) = 9.600
+ Oppotunity cost = 10.000 x (20.55 - 20) = 5.500
+ Fee: 40.000 x 0.02 = 800
added value of function
added value (bps) = arrival cost (bps) − estimated pretrade cost (bps)
what type of algorithm help trade:
+ minimize the trade’s market impact
+ avoid conveying information to market participants
Schedule Algorithm
Function of arrival cost (bps)
Arrival cost = Side x (Aver Price - Arrival Price)/ Arrival Price x 10.000
incentive to take risk (mock test)
Related to management fee
PM try to get more risk to enhance return to have more probability to get high return
Function of Opportunity cost
= The volume fail x (The plan profit before trading)
paper return
hypothetical return that the fund would have received
if the manager were able to transact all shares at the desired decision price and without any associated costs or fees
the trader receive the order from PM for 1,000 share at 10:00, when its price is $30
the trader request order in the market, calculate the delay cost in case of the price is $29.9 and $30.1
+ in 29.9, delay cost = 29.9 - 30.0 = -0.1
+ in 30.1, delay cost = 30.1 - 30.0 = 0.1
Delay cost: the reason and the solution ?
The reasons:
(1) The trader is not familiar with RLK and needs to review, include:
+ liquidity
+ volatility
+ intraday trading patterns
+ current market conditions
(2) The trader need to review the historical performance of brokers trading similar order sizes and trading characteristics
The solutions: by having proper trading practices in place to provide traders with all the information they need to make an immediate decision, such as pre-trade analysis and post-trade analysis
Opportunity cost: the reason and the solution ?
The reasons: insufficient market liquidity
The solutions: Opportunity cost can be reduced by knowing the order size and share quantity that is most likely to be executed in the market within a specified price range
Trading cost: the reason and the solution ?
The reasons: insufficient market liquidity
The solutions: selecting the proper price benchmarks and trading urgency
window dressing
manipulate financial statement
agency trade
+ the broker is engaged to find the other side of the trade but acts as an agent only
+ risk for trading the order remains with the buy-side portfolio manager or trader.
dark pool must not be report ?
A. correct
B. Incorrect
B. Incorrect because it must not be report before transaction, but must be report after transaction
Lit market must be report when ?
A. pretrade
B. After trade
A. Pretrade
