Trading Strategies

Well, the CFA Level 3 exam is 2 weeks away, it’s my turn to write a blog article, and I am at a loss. I’m functioning at a fairly low level these days, with my main priorities being 1) attempt to maintain a semblance of normalcy, while 2) keeping a virtual encyclopedia of facts and formulas from seeping out of my brain. I’m not so sure I’m doing a good job of #1; as for #2, I could swear I lost at least 5 formulas when I sneezed this morning. Looks like I picked the wrong year to develop allergies.

Now that I’ve established the fact that my bandwidth is low, and lowered any expectations you may have regarding this article, I thought I would talk a bit about trading. The execution of a trade is a fairly simple matter – we have software that enables advisors to enter the desired trades in a client’s account, which are then transmitted to a trade blotter. Throughout the day, Mark Lewis and I (the designated traders) group all the trades together and send them out to get filled. For a typical trade, which might be a market order of a few hundred shares of a very liquid security, the trade is filled within seconds. Sometimes, though, we have block trades, when we sell the same security for many accounts. These trades can consist of several hundred thousand shares; depending on the average daily trading volume for a particular security, a trade that size could have considerable market impact which could negatively affect the fill price.

So what do we do? We work with the trade desks at the custodian (Schwab, Fidelity, etc.) to break the trade down into smaller pieces so that it is more easily absorbed into the market, to decrease price impact. There are several ways they can do this, but most of the time they use trading algorithms, which are automated based on quantitative rules. The ones we use most frequently are called simple logical participation strategies, such as VWAP and percentage-of-volume. VWAP (which stands for volume-weighted average price) strategies attempt to complete the order in a specified time period (anywhere from a few hours to the entire day), either at or better than the day’s VWAP for that security. Percentage-of-volume strategies break the block into smaller pieces equal to a certain percent of the trading volume (usually 5 to 20%) and feed those to the market until the trade is completed. Both strategies attempt to go along with market order flow, breaking a large order into smaller pieces to avoid detrimental price impact.

Sarah DerGarabedian, Research and Trading Associate

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