Trading strategies

CFA Level III Portfolio Management
#1

Brave ones,

Probably we don’t have straightforward answers to this theme but I would like to get your comments, if possible:

  1. large % of AVD // wide spread // urgent = BROKER

  2. large % of AVD // narrow spread // urgent = CROSSING

  3. small % of AVD // narrow spread // urgent = IMPLEMENTATION SHORTFALL

  4. small % of AVD // narrow spread // not urgent = BROKER/CROSSING

Extra ball) I do not understand the relation of a WIDE SPREAD and the choice to use CROSSING or BROKER. Can we use both?

many thanks once again,

#2

If liquidity is poor ( indicated by wide spread) AND your order is large compared to average daily volume, use broker who can locate liquidity through their contacts . X ing network won’t do leg work for you. also your trade may never get done on a Xing network if liquidity is poor

if liquidity is good ( narrow spread ) , do use a X ing network because you will get the trade sone at lower cost than a broker particularly for large %ADV . Why give up costs to a broker who doesn’t have to look far for liquidity.

Cost versus getting the job done

#3

what about small ADV, wide spread with high urgency?

#4

IMPLEMENTATION SHORTFALL, to minimize implicit costs with early trade?

#5

Implementation shortfall strategy reduces delay costs which are a portion of implicit costs.

Implimentation costs = Explicit costs (smaller portion) + Implicit costs (larger portion)

reducing the implicit costs has a greater affect on total implementation costs than increasing explicit costs

#6

Daily trade volume pattern is another factor?

Why not to use Implementation Shortfall for case 4)?

4) small % of AVD // narrow spread // not urgent = BROKER/CROSSING

#7

I believe you won’t need to fragment a trade with small % of AVD, risking some implicit costs (delay of full execution).

However, # 4 is identified in this way on CFAI

4) small % of AVD // narrow spread // not urgent = VWAP

#8

Yeah, I’d use VWAP algorithm for 4. The lack of urgency means that you afford to wait to squeeze costs.

#9

2008 AM session Ques 8-B

ans : CHA security chosen for VWAP

its has small % wrt ADV, low spread low urgency…but the characteristic which did not convince to choose it as a best for VWAP algorithm is trades HIGH AT THE END OF THE DAY.

Any views why was still chosen?

#10

my 2 cents,

VWAP is suitable to follow the predictable trading pattern of the security, so it’s a mirror strategy in the sense you just fragment your trade according to the expected volume profile, attempting to equal/outperform the VWAP ‘bench’

#11

what about this?

5) small % of AVD // wide spread // not urgent = ??? BROKER / CROSSING ???

#12
  1. Small % of AVD - Not urgent - wide spread

Crossing network will be prefered over broker. Basically both are useful when you have a block order to but given a choice Broker will be more costly

#13

does small % of AVD necessarily means block order?

or we can have a block order without having a large % of AVD?

or block order implies order fragmentation and then we would go directly to algorithmic trading strats?

now I am puzzled…thanks once again

#14

block order = an order to buy/sell in a quantity which is large relative to liquidity ordinarily available

#15

so a block order is necessarily linked with large % of AVD? can I infer this?

or can we have a ‘relative large to liquidity ordinarily available order’ and still be a small % of AVD?

tks

#16

large % of average daily volume ~ relative large to liquidity ordinarily available, I guess

#17

It’s difficult to say whether you would incur more costs with a broker (explicit costs -yes, but total costs - ?) Using a broker may allow them to find some liquidity in the market and lower the spread a little, hopefully covering their cost of finding it.

#18

I agree rahuls but you mentioned a block order with small % of AVD.

this trading strategies theme is so ambigous for me

#19

FinNinja, but it is a small order & not necessarily suitable for upstairs markets. I belive Brokers are mostly used for BLOCK txns.

It would be better to put this order in POSIT (crossing network) where all small order will be batched toghether & crossed at a specific time. Risk is that it may not be executed coz crossing doe not guratantee that trade will have an opposite match or may only be partially filled. But it a NOT URGENT one. Absense of dealer here will lower the commission.

Is in it?

#20

The choice of not using a broker could increase your delay costs though, this being a less liquid security. As you mentioned the risk of the crossing network is that there may not be an opposite match available.

I don’t know what the right answer is on this one, but I think you have a more guaranteed execution for a (possible) higher price with a broker. I would worry about not being able to execute the trade at all, or having it severly delayed - increasing those costs.

Tigas - are there actual answers to these questions?