P. 1
Measuring Trade Difficulty

Measuring Trade Difficulty

|Views: 47|Likes:
Published by Wayne H Wagner

More info:

Published by: Wayne H Wagner on Sep 04, 2009
Copyright:Attribution Non-commercial


Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less





.ffi mtr -#* frs ffir

Wayne H. Wagner, Partner Edward C. Story, Partner


..F1* & ffit -&* Htr

LarryJ. Cuneo,Partner
Mark Edwards, Associate
Michael Keady, Associate Rosemary Tribulato, Associate

SERVICES PROVIDED TO Institutional Investors
Investment Managers

Institutional Traders


Plan Sponsors

June 1991
One of the mileposts of an advancing technology is the creation of a set of terminology to describe actions and phenomena not heretofore requiring names. At worst, this becomes jargon. At best, it becomes a way of seeing things that were previously invisible.

-+lexusmopmental work on its @fIlreafP:IURE service-lrasrequired us to define new concepts of implementation cost analysis. In the next few
commentaries,we will discuss four concepts in whichwe have advanced the state

of the art

difficulty, trade quality, opportunity/impacVtiming,


implementation shortfall.

We at Plexus are often asked "What is the optimal shares, size, timing, etc. given our management style?" We have found no easy
answer. Trades are not alike. They differ in the
ease or difficulty of execution.

arising from independently derived prospects or indMdual liquidity requirements. The supply (or demand) is likely to be thin and sporadic.

Again according to Loeb, a $5 million trade in a $200 million company might cost 2.5 times as
much as a $500,000trade.

Several factors combine to increase difficultv:

L. The size of the company. As companies get smaller or more obscure. the

Compahy SilC

number of

institutional shareholders

Anynews on the stockwill cause potentialbuyers and sellers to reassess the current positions. News or market price action -- a form of news in itself -- can wake up investors and increase the volume of potential trades.
The most surefire method of increasing supply is to attract sellers by raising the price in public markets. Some shareholders uninterested in selling at "a lower price:vill be drawa out by the higher price. David Whitcomb calls this gravitationalpull. Small stocks, however, may suffer from a lack of resiliency, the recovery to former levels once the


institutional holders, the more unlikely a comparable size order will appear on the other side. fte_qfrly-altCr'natiyss_arq to purchase f1s11 a broker at a significant premium or to assemble the position out of retail order flow. Assembling is usually a Iong and frequently self-defeating

also usually gets smaller. The smaller the number


According to Tom Loeb a $5 million order in a $200 million company might cost will cost 2.5 times as much as the same trade in a $2 billion

supply imbalance recedes. Twisting Fischer Black's insight, the trade may not make enough noise to wake up potential sellers.
Tom Loeb investigated the cost effects of the size of the company and the size of the order in his seminal work of 1988. However. these factors do not account for all differences in difficulty. We

.....l,,,,0idef .Si2C

order. To stand the effects of' size. think of flow
rates into the market. With no special news


The size of

the under-

have identified

two additional important

on a company, shares will come into the market randomly. Fischer Black calls this noise: orders

dimensions, market conditions and the desired speed of trading, which appear to lre of greater significance than company size and order size.

6061#ilsl"rir* *q:*ievarc{, $*ife 3tr*

l-l Sar:t*;Vl*nie*, e#ifurnla *S4.*f





i*l3} 394-6i3S



The direction of stock price movement at the time of desired execution.

or participate orders imply medium urgency. Limit or crossing orders signal low urgency. A manager willing to chance that a limit order
might not execute clearly isn't jumping on a hot
news item.

Stockprices rise when

the number of potential buyers
exceeds the number of potential sellers.

A buyer

moving into a crowd of buyers will face adverse trading conditions: the order is on the same side

as the crowd. The only way he or she can

To summarize, we have defined four factors whose combined effect will determine trade difficulty and expected cost of transacting. The current weights in use by Plexus are:

complete the trade and take the prize is to outbid

other potential buyers. fn contrast, a buyer moving into a crowd of sellers has the scarce goods. He or she can tantalize the most anxious seller to bid above rivals.

Plexus has measured the difference between trading in a market coming in and a market moving away to be 300 to 800 basis points. This factor dominates all other mst considerations, ittcluding size of comparry and size of ordcn It
suggests that implementation costs can be lowered

liquidity Discretion (working, principal, Momentum (individual stock) Capitalization

25Vo 30Vo

(shares desired/volume) etc.)


(shares outstanding X price)

The relative weightings of these factors are updated on the basis of observation, and the database is still buildins.

by earlier manager decisions, before momentum has been established. The implementation cost savings may well exceed the effects of loss of claritv of decision.



The urgency of the order. Orders that demand instant
liquidity call upon the market's facilities for


responding to

Our friends will be glad to know that we are now up to 16 clients and looking forward to a lot more!

immediate demand. The chance of a random seller arrMng at the market at the same instant as a buyer is negligible. A market that is not naturally liquid must be made liquid by a market maker. He is willing to do so only at an expected profit. Urgency may arise from the type of decision information (news, first call) used by the manager. It also may stem from the personality of the manager, who may be impatient to complete his trade once he has finalized his decision. Traders get very good at reading the manager's signals and gauging the probable cost of implementing
the typical decision.

with the level of insight

More importantly, we are pleased

information we have been able to deliver to our clients.


a$dition, David


formerly with Wilshire Associates, has joined Plexus Group and will be working with Larry Cuneo on client report production and technologl

Urgency strongly interacts with the market direction. Marathon runners never make up on the downhills what they Iose on the uphills.
Similarly, trading costs in adverse markets exceed the lowered costs of dealing in favorable trading

(e)1991,PLEXUS GROUP A General Partnership You are welcome to reprint quotationsor extracts

conditions. This is doubly important
conditions of urgency.


from this material with credit given to Plexus
Group, 606 Wilshire Boulevard, Suite 310, Santa Monica CA 90401. Tel. (213) 45L-5A75.

Often, the best place to observe urgency is in the order instructions. A principal or market trade implies high urgency. Market-not-held,working

You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->