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Wayne H. Wagner, Partner %##ffi%Wffi SERVICES PROVIDED TO

Edward C. Story, Partner w**tr}e-6p Institutional Investors
LarryJ. Cuneo,Partner Investment Managers
Mark Edwards, Associate Institutional Traders
Michael Keady, Associate Plan Sponsors
Rosemary Tribulato, Associate --

MEASURING TRADE DIFFICULTY

COMMENTARY #31
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, and
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.
Several factors combine to increase difficultv:
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.

L. The size of the Anynews on the stockwill cause potentialbuyers

company. As com- and sellers to reassess the current positions.
panies get smaller or Compahy SilC
News or market price action -- a form of news in
more obscure. the itself -- can wake up investors and increase the
number of insti- volume of potential trades.
tutional shareholders
also usually gets smaller. The smaller the number The most surefire method of increasing supply is
of institutional holders, the more unlikely a to attract sellers by raising the price in public
comparable size order will appear on the other markets. Some shareholders uninterested in
__ side. fte_qfrly-altCr'natiyss_arq to purchase f1s11 selling at "a lower price:vill be drawa out by the
a broker at a significant premium or to assemble higher price. David Whitcomb calls this
the position out of retail order flow. Assembling gravitationalpull.
is usually a Iong and frequently self-defeating
actMty. Small stocks, however, may suffer from a lack of
resiliency, the recovery to former levels once the
According to Tom Loeb a $5 million order in a supply imbalance recedes. Twisting Fischer
$200 million company might cost will cost 2.5 Black's insight, the trade may not make enough
times as much as the same trade in a $2 billion noise to wake up potential sellers.
company.
Tom Loeb investigated the cost effects of the size
2. The size of the of the company and the size of the order in his
.....l,,,,0idef .Si2C
order. To under- seminal work of 1988. However. these factors do
stand the effects of' not account for all differences in difficulty. We
size. think of flow have identified two additional important
rates into the market. dimensions, market conditions and the desired
With no special news speed of trading, which appear to lre of greater
on a company, shares will come into the market significance than company size and order size.
randomly. Fischer Black calls this noise: orders

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 3.The direction of or participate orders imply medium urgency.
stock price move- Limit or crossing orders signal low urgency. A
iiiii:i:ii:iStoek:Priice::i.i.l
ment at the time of manager willing to chance that a limit order
desired execution. might not execute clearly isn't jumping on a hot
:.llllllll*i...Iff"tl:l::::l Stockprices rise when news item.
the number of
potential buyers To summarize, we have defined four factors
exceeds the number of potential sellers. A buyer whose combined effect will determine trade
moving into a crowd of buyers will face adverse difficulty and expected cost of transacting. The
trading conditions: the order is on the same side current weights in use by Plexus are:
as the crowd. The only way he or she can
complete the trade and take the prize is to outbid liquidity
Relative 25Vo
other potential buyers. fn contrast, a buyer (shares desired/volume)
moving into a crowd of sellers has the scarce Discretion 30Vo
goods. He or she can tantalize the most anxious (working, principal, etc.)
seller to bid above rivals. Momentum 357o
(individual stock)
Plexus has measured the difference between Capitalization l$Vo
trading in a market coming in and a market (shares outstanding X price)
moving away to be 300 to 800 basis points. This
factor dominates all other mst considerations, The relative weightings of these factors are
ittcluding size of comparry and size of ordcn It updated on the basis of observation, and the
suggests that implementation costs can be lowered database is still buildins.
by earlier manager decisions, before momentum
has been established. The implementation cost -w.w.
savings may well exceed the effects of loss of
claritv of decision.

4, The urgency of NEWS OF PLEXUS

the order. Orders Uigency
that demand instant Our friends will be glad to know
liquidity call upon the that we are now up to 16 clients and
market's facilities for looking forward to a lot more!
responding to
immediate demand. The chance of a random More importantly, we are pleased
seller arrMng at the market at the same instant with the level of insight and
as a buyer is negligible. A market that is not information we have been able to
naturally liquid must be made liquid by a market deliver to our clients.
maker. He is willing to do so only at an expected
profit.
In a$dition, David Rismann,
formerly with Wilshire Associates,
Urgency may arise from the type of decision has joined Plexus Group and will be
information (news, first call) used by the manager. working with Larry Cuneo on client
It also may stem from the personality of the report production and technologl
manager, who may be impatient to complete his development.
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.

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
conditions. This is doubly important unde?
conditions of urgency.
Often, the best place to observe urgency is in the
order instructions. A principal or market trade
implies high urgency. Market-not-held,working
(e)1991,PLEXUS GROUP
A General Partnership
You are welcome to reprint quotationsor extracts
from this material with credit given to Plexus
Group, 606 Wilshire Boulevard, Suite 310, Santa
Monica CA 90401. Tel. (213) 45L-5A75.