30a Market orders vs.

Limit Orders

Compare market orders with limit orders, including the price and execution uncertainty of each

Why would I want to use a market order?

 If you absolutely have to get a trade done right away, you go with a market order.
 Let's say you want 10,000 shares of ABC at a price of $20/share.
 You might not get exactly the price that you would prefer (ie. you will likely pay above
$20/share).
 However, your order is almost certain to be filled (ie. you will likely get all 10,000 shares).

But, what if I care more about getting the price I want than I do about getting my whole order filled?

 In that case, you would want to do a limit order.

 You won't be forced to take a price you don't like (ie. you will not pay more than $20/share).
 However, the downside is that your order might not get filled - at least, not completely filled (ie.
you are less likely to get all 10,000 shares).
 Here is a nice summary table to help remember what I just told you:

Market Order Limit Order

Instructions Immediate execution at the best Trade at the best possible price, but only if it is at
possible price least as attractive as the limit price
Execution Start at lowest ask, then next Order is filled immediately in increments until
Procedure lowest... until filled completed
Top Priority Execution is the top priority Price is the top priority
Source of Price is a secondary concern, so Execution is a secondary concern, so execution
Uncertainty price uncertainty is a risk uncertainty is a risk

30b Effective spreads, quoted spreads and trading costs

Calculate and interpret the effective spread of a market order and contrast it to the quoted bid–ask
spread as a measure of trading cost

What can you tell me about the "quoted spread"?

 This is simply the difference between the bid and ask prices and is also know as the inside bid-
ask spread, inside spread, market bid-ask spread, and market spread.
 What you may not have know about before is that the halfway point between the bid and ask
prices is known as the "midquote".
So then, what is the "effective spread"?

 First, you need to realize that the bid/ask spread is a flawed measure because sales often take
place at prices above the bid price or below the ask price.
 To get the effective spread, simply take the difference between the execution price and the
midquote from just before the trade occurred and multiply by 2.

Multiply by 2?

 Yes, which means if you see two possible multiple choice answers, the one that is exactly double
the other one is probably correct.

What is the effective spread when an order is carried out at more than one execution price?

 In that case, us a weighted average is used to determine execution price.

And, what is the "average effective spread"?

 Typically, we would measure the effective spread for a single transaction.

 However, there's no rule that says it has to be limited to just one transaction.
 If you take the effective spreads observed over a series of transaction in a specific stock over a
day, or even a week or a month, you can average these up to get the "average effective spread"
for the relevant time period.

It sounds like you're saying that the effective spread is a better measure than the quoted spread.

 That's exactly what I'm saying.

 The effective spread is a better measure of market liquidity/trading costs than quoted spread
because it captures:
 1) Price improvement from quoted prices to actual transaction prices; and
 2) Market impact that large transaction sizes have on quoted vs. execution prices (see
30f and 30m).

So, how do I know if a market is providing price improvement?

 If the effective spread is lower than the quoted spread, that's what's happening.

30c Securities market structures

Compare alternative market structures and their relative advantages

What are the three main market structures?

 1. Brokered: Investors access the market via brokers (see 30d), who find counterparties.
2. Quote-driven: Trading and is determined by dealers (see 30d), who act as market makers and
provide liquidity (ie. make effective spreads lower than quoted spreads - see 30b).
3. Order-driven: Investors trade directly with each other (no intermediaries such as brokers or
dealers).

Is there more than one type of order-driven market?

 Actually, yes.

1. Electronic crossing networks: Investors place orders, which are then matched (or crossed) based
on averaged bid/ask prices at set intervals.
2. Auction markets: traders compete against each other to fulfill orders.
3. Automated auctions: Computerized auction markets (also known as electronic limit order
markets).

What are "hybrid markets"?

 This is just a name for market that have characteristics of more than one market type.

And, do you have a handy summary table?

 Yes. Here you go:

Market Type Advantages Disadvantages

Brokered ("upstairs market") - Anonymous;
- Better for illiquid markets;
- More important for countries
without well-developed capital
markets
Quote-driven (Dealer) - Execution is guaranteed,
- Dealers provide liquidity and
market continuity
Order-driven (Direct exchange) - Transparent bid/ask = price
discovery,
- Automatic rules match
counterparties
Order: ECN - Anonymity (which is important)
- Mostly for Institutional trades - Ability to accommodate large
orders
- NO market impact (by definition)
Order: Auction - Price discovery
- Can operate continuously, or only
transact at a single point each day
- Agency problems;
- Brokerage fees;
- Lack of transparency
- Lack of transparency
- Order may not be executed
(price is prioritized)
- No price discovery
- Partial order filling
- Poor liquidity (high opportunity
cost)
- Less partial order filling than
ECN, but still some
Order: Automated Auction - Price discovery
- Anonymity
- After-hours markets - Increased liquidity

- Computerized - Gaining popularity (see 30l)

because they are like ECNs, but also
- aka. "Electronic limit-order provide price discovery
markets":

30d Brokers and dealers

Compare the roles of brokers and dealers

Tell me what I need to know about brokers.

 Brokers are hired by the investor and work FOR the investor.
 In exchange for a commission, brokers provides the following services:

1. Representing the investor's orders to the market.

2. Finding counterparties for a trade.
3. Providing market intelligence to the investor.
4. Allowing the investor to remain anonymous.
5. Providing additional services to investors (such record keeping, cash management, etc.).

What about dealers?

 Dealers act AGAINST the investor by under-bidding when the investor wants to sell and over-
asking when the investor want to buy.
 Dealers are not agents, rather they are in business for themselves and receive compensation in
the form of trading gains.
 However, Dealers are not entirely bad because they do provide liquidity to the market.
 Also, you as a trader are more likely to want to buy or sell when you have an information
advantage over the Dealer (or think that you do). This means that the Dealer has "Adverse
Selection Risk".

So, someone is either a broker or a dealer, right?

 Not necessarily, there are also "broker/dealers", which is when a broker decides that it is more
likely to be successful if it participates in the transaction.
 In such a case, the broker effectively becomes your minority partner and captures some of the
upside in your deal (ie. they put up some of their own money and get more than just a
commission).

Sounds okay. Is there a downside to using a broker or dealer, or broker/dealer?

  Yes.
 First, with a broker, you are paying an agent to work on your behalf and are therefore subject to
agency problems.
 More importantly, whether you go with a broker or a dealer, once you start shopping your trade
around, information starts leaking out and the price is going to start moving away from where
you want it to be.
 If you really want anonymity, you should consider using a crossing network.

30e Market quality: liquidity, transparency and execution

Explain the criteria of market quality and evaluate the quality of a market when given a description of its
characteristics

What do I need to know about "the criteria of market quality"?

 Ideally, markets should posses the following qualities:

1) Liqidity

 Many active buyers and sellers

 Diveristy of opinions and investment needs
 Convenience
 Integrity and fair dealing
 Specific criteria for evaluating a market's liquidity include:
 Low bid/ask spreads: Otherwise you can't trade on information unless it is supremely
valuable.
 Resilience: Market prices stay near their intrinsic value.
 Market depth: The ability to accommodate large order sizes without moving prices too
far (price impact).

2) Transparency

 Investors can obtain pre- and post-trade information at a minimal cost

 A market that lacks transparency or is perceived to have rules that advantage certain investors
over others will soon lose investor trust

3) Execution (aka. Assurity and of completion)

 Investors need to have confidence that, when they make a trade, the counterparty will uphold
its obligations (ie. to pay or deliver)
 This is why, for example, clearing houses act as guarantors of performance.
Okay, that all seems pretty straightforward, how is this likely to show up on the exam?

 I see this as much more likely to show up in the afternoon session as part of a multiple choice
question set.
 Take a look at Example 3, where they give you an observation about what had happened to a
market in terms of its quoted spreads or quoted depths, or some such characteristic, and you
need to determine whether you think that this improves or deteriorates market quality.
 Also, while there are three characteristics mentioned in this LOS, the text devotes an entire page
to discussing liquidity, which is not particularly lengthy in the big picture, but transparency and
execution/assurity of completion are forced to share a small paragraph on the next page, so
chances are that you will need to know a) what characteristics make a market more or less
liquid, and b) liquidity is ALWAYS GOOD.

30f Execution costs: Explicit and implicit

Explain the components of execution costs, including explicit and implicit costs, and evaluate a trade in
terms of these costs

What exactly are the components of execution costs? Aren't these just transaction fees?

 No, there are more than just transaction fees to consider.

 In fact, there are actually four components of trading costs, starting with:

1) Explicit transaction fees

 These are easily quantifiable because they have a price tag (commissions, fees, taxes, etc.).

Wait. You just said that execution costs weren't about transaction fees.

 That's not actually what I said.

 Transaction fees are part of trading costs, but only a part.
 The other components are "implicit".

Which means?

 Which means that you don't actually get a bill for them, but they do exist.
 You just have to work through some annoying calculations in order to find them.
 These are discussed in 30g.

Annoying calculations? I'm going to not learn those and hope this doesn't show up on the exam.
  Not a wise move because these are pretty much the most important part of this Reading and
there's a good chance that it will show up on the exam.

Fine. So, what are these "implicit" execution costs?

2) Market impact costs

 These were discussed a little bit in the context of 30b.

 Basically, market impact costs occur whenever an order is executed at a price other than the
currently quoted bid or ask.

What would cause this to happen? Why can't people just buy at the ask or sell at the bid?

 There are a few reasons for this.

 First, a large order is more likely to have a market impact than a smaller order.
 Also, if traders believe that a prospective buyer/seller is more informed, they will not be willing
to meet this price for fear of being exploited.
 Interestingly, this is a case where having a reputation for being smart can actually work against
you.

I've never had that problem.

 No, I don't suppose you have.

And the other implicit execution costs are... Wait, what did you just say?

 Moving on.

3) Missed trade opportunity costs

 This is the gain that you miss out on (or loss you avoid) if your order does not get completely
filled.
 This typically happens with limit orders, which have execution uncertainty.
 This is measured using the difference between some closing price and the benchmark price,
which is the price at which the manager decided he wanted to buy it (or sell, but on the exam it
will almost certainly be a buying scenario).

"Some closing price"? That's not very specific.

 No it is not. That's the problem with this measure.

 How do you decide when to an opportunity ends?
 For example, you can regret an opportunity if the price goes up during the day and your order
gets cancelled, but you won't feel too bad about missing out if the price tanks three weeks later.
 Because of this ambiguity, they may tell you specifically which price to use, but a safe
assumption is the closing price on the day that the order is cancelled (aka. cancellation price).
What is the fourth component of execution costs?

4) Delay/Slippage costs

 These costs are a lot like missed opportunity trading costs in the sense that they arise when an
order cannot be completed immediately.
 The difference is that missed opportunity trading costs arise when an investor is holding out for
a specific price. It's not that she is prevented from trading, it's that she won't trade at a price
beyond her limit.
 In the case of delay/slippage costs, the market (rather than the investor) is the limiting factor
because it cannot provide sufficient liquidity to process the order.
 This typically arises when an order to particularly large and must be broken down into smaller
lots in order to be filled.
 Because this can take a while, information is leaking out to the market and the price starts to
move away from where it was when the investor made the initial decision to trade.

So, you said something about annoying calculations?

 Yes, we covered some very simple calculations in 30b.

 Another simple calculation is Volume-Weighted Average Price (or VWAP), which is simply the
weighted-average price at which a security was bought or sold.
 However, VWAP is flawed and the preferred method (Implementation Shortfall) is covered
in 30g.
 THAT is where we get into the more detailed (and annoying) calculations).
 But before we get there, if you want to estimate implicit costs, simply multiply the difference
between the trade price and the benchmark price by the number of shares traded.
 (Actual transaction price - Benchmark price) x # of shares traded

30g Execution Costs: Implementation shortfall

Calculate and discuss implementation shortfall as a measure of transaction costs

So, what is "Implementation shortfall"?

 It's basically of everything we discussed in 30f rolled into one number.

 Overall, you can think of it as the sum of a portfolio’s actual net value and the return that would
have been generated with no explicit or implicit trading costs.
 It is the most exact approach to transaction cost measurement. In other words, it is always
preferable to VWAP (see

30h) - at least, it is for exam purposes.

  But you also need to know its component parts, and to know those, you need to know a bunch
of prices.

What are the prices that we need to know to calculate implementation shortfall?

 Benchmark price (BP): The price that the manager sees and decides to buy/sell at (assume that
it's the closing price on the first day of a case/question set).
 Decision price (DP): This is the closing price on the day before any part of the order gets filled, so
it will be different for parts of the order that are filled on different days.

Wait, the "benchmark price" is the price that the manager sees and decides to buy/sell at, but the
"decision price" is something else?

 This is probably the most frustrating part of a very frustrating LOS.

 If you trade on Day 1, then DP = BP.
 But, think of DP as resetting every day, because the manager makes the decision to continue to
try and get his order filled.
 In the example that starts on page 24, the actually puts in a new order price, so that's a pretty
clear example of a new decision price being set.
 But the manager may just decide to keep the order open, in which case the decision price resets
without her putting in a new order price.

Whatever. If they try to pull crap like that on exam day, I'm going to start a riot. Anyway, what are the
other prices that we need to know to calculate implementation shortfall?

 Execution price (EP): The actual transaction price (for the portion of the order that actually gets
filled).
 Cancellation price (CP): The closing price on the day that the order is cancelled and the
remaining portion is unfilled.

Okay, what formulas do we use once we know these prices?

 The formulas below provide each component of implementation shortfall as a % of order, but
you may also be asked for these expressed in currency terms, which you can do by multiplying
the %s by the amount of the original order.

Explicit cost (Fee/share / BP) x total shares in order

Delay/Slippage cost [(DP - BP) / BP] x % of order filled
Realized profit/loss [(EP - DP) / BP] x % of order filled
Missed opportunity [(CP - BP) / BP] x % of order NOT filled
cost

These formulas are all different. Can you help me understand them a bit better?
  Start with the denominator, which is always the benchmark price.
 Next, note that delay costs and realized profit/loss are multiplied by the % of the order that is
actually filled - not the entire order size and not the % that goes unfilled.
 Missed opportunity costs are multiplied by only the % of the order that does NOT get filled,
which makes sense.
 Explicit costs, by contrast, are applied to the entire order - so $20 trading fee on an order for
1,000 shares is $0.02/share - even if the order does not get completely filled.
 Those are all logical, but the prices used in the numerator are trickier:
 Delay/Slippage costs start with DP - BP (think "Delay means use DP")
 Missed opportunity costs start with CP - BP, which makes sense because the you pretty
much admit you've lost the opportunity when you cancel the rest of your order
(although remember that there is no set rule on what actually is the "cancellation
price").
 Realized profit/loss starts with EC - DP, which actually makes sense - just remember that
the DP is used in the numerator, but it is still the BP that is used in the denominator.

Can you please provide me with an example of implementation shortfall?

 I'm not really feeling like putting in much of an effort today, so I'm basically just going to give
you the example from Section 3.1 with tiny changes.

Mon (close) Tues (close) Wed (intra-day) Wed (close)

$10.00 $10.05 $10.10 $10.15
Benchmark Decision Execution Cancellation

Order placed for 1,000 shares, but only 60% of the order was filled.

Explicit cost = [($20 fee / 1,000 shares) x $10.00] x 100% = 0.2%

Delay/Slippage cost = [($10.05 - $10.00) / $10.00] x 60% = 0.3%

Realized profit/loss = [($10.10 - $10.05) / $10.00] x 60% = 0.3%

Missed opportunity cost = [($10.15 - $10.00) / $10.00] x 40% = 0.6%

0.2% + 0.3% + 0.3% + 0.6% = 1.4%

1.4% x (1,000 shares x $10.00) = $140

Is there anything else that I should know about this?

 Yes.
 Unlike pre-trade costs (see 30i), Implementation Shortfall (and especially Market-Adjusted
Implementation Shortfall) can be negative, which means that these costs can actually end up
being a net benefit to you.

I'm still a bit freaked out about these calculations.

 Think about the big picture - the main point of this Reading is to teach you that implicit trading
costs are typically much greater than explicit trading costs. See the iceberg picture in Exhibit 7.
 Also, always remember that there is a considerable amount of ambiguity about these
calculations because it is not exactly clear which price should be used as the benchmark price,
etc. So they will probably tell you exactly which price to use as the benchmark price.

30h VWAP vs. Implementation shortfall

Contrast volume weighted average price (VWAP) and implementation shortfall as measures of
transaction costs

What is Volume-weighted average price?

 Volume-weighted average price, or VWAP, is a measure that is used when you can't complete a
transaction at a single price.
 For example, you buy 100 shares at $20.00, 250 at $20.01, 500 at $20.02, etc.
 VWAP gives you the "true" price of the transaction by weighting the portions sold at various
prices.

Interesting. What are its advantages?

 It is easy to calculate and easy to understand.

 It's useful for small trades, especially in "trending" markets that have much underlying
movement (no market-adjustment required).

If the primary advantages are "easy to calculate" and "easy to understand", then it must really suck.
  Excellent observation. It does.
 Specifically, it fails to account for market impact (which we discussed in30f).
 Also, it fails to account for all of the costs associated with trading, such as delays or unfilled
portions of orders.
 Finally, traders can game it.

How can VWAP be "gamed" by traders?

 This is covered a bit in Example 5.

 But don't get too caught up in the specifics because you really only need to understand the basic
concept that a trader who has discretion over when to fill an order can wait until the market
price is more attractive.
 However, this involves taking a HUGE risk because the price could move and the client will end
up paying way more to fill their order, which will make the client both very unhappy extremely
unlikely to use that trader again.
 Also, as mentioned in Example 5, it is still possible to game opening and closing prices (actually,
it can be easier), and these

So, how is Implementation Shortfall better than VWAP?

 The primary advantage is that traders can't game it (well, I'm not so sure about this, bu that's
what the Reading says, so assume that it's true).
 Also, it breaks trading cost down into its component parts and allows investors to analyze and
minimize trading costs.
 Finally, it allows investors to see the trade-off between quick execution (realized profit/loss) and
market impact.

But it is not a perfect, right?

 No, it is not perfect.

 Notably, traders don't really use it.

Why don't traders use it?

 Because the calculations are annoying and the definitions are ambiguous.
 Also, they are the very people who stand the most to lose if everyone moves from VWAP to IS.

30i Pre-trade analysis and econometric methods

Explain the use of econometric methods in pretrade analysis to estimate implicit transaction costs

"Econometric methods"? Sounds quantitative and complex.

  It is, so you won't be expected to calculate it on the exam - maybe just "explain" it.
 Using non-linear regression and ex-post data, the costs discussed in 30fand 30g can be predicted
with reasonable accuracy.
 This pre-trade analysis helps investors know what the transaction costs "should" be for an
upcoming trade and help them plan cost minimizing trading strategy.
 It is also useful to look at what costs were predicted and compare them to what they actually
ended up being.

30j Trader profiles

Discuss the major types of traders, based on their:

motivation to trade,
time versus price preferences,
and preferred order types

Trader type Trades based Preferred Highest Note

on... order priority:
type Time or
Price?
Information- Timely information Market Time "Liquidity at any cost" (see 30k)
motivated
Value-motivated Mispriced Limit Price "Dealer's dealer", buy out-of-favour
securities stocks
Liquidity- Reallocation & Market Time (not Less time sensitive than information-
motivated liquidity urgent) motivated traders
Passive Indexer Reallocation & Limit Price May prefer ECNs (30c); Low cost,
liquidity screw liquidity (30k)
Dealers / Day Short term price Market Time Dealers (see 30d)
Traders changes

30k Trading tactics

Describe the suitable uses of major trading tactics,

evaluate their relative costs, advantages, and weaknesses,

and recommend a trading tactic when given a description of:

the investor’s motivation to trade,

the size of the trade, and

key market characteristics

This seems important.

 That's because it IS important.

 Fortunately, I have created a large, but handy table that summarizes...

Stop right there. Pretend that it is only a couple of days until the exam and I don't care about your
massive table. Tell me what I absolutely HAVE to know. Then you can show me your stupid table.

 Fair enough, I will "pretend" that the exam is just a couple days away.
 However, it will require me to provide you with another (smaller) table.

Size of Trade Urgency Recommended

Tactic
HIGH LOW Crossing System
LOW HIGH Implementation
Shortfall

Thanks, but how will I know what is a high or low trade size?

 They will make it ridiculously obvious.

 A large trade will be something like 40% of average daily trading volume.
 Anything under 10% should be considered relatively small.

What combination of size and urgency would make me want to use VWAP as a tactic?

 Using VWAP will (almost certainly) NEVER be the correct answer.

 Here's the table you've been dying for:

Trading Mantra Uses Costs Advantages Disadvantages

Motivation
Liquidity-at- "I have good Immediate Broker Execution is You pay a
any-cost information. execution commissions guaranteed and broker commission,
Must. Trade. will likely be you can remain plus you may have a
Now." incurred. anonymous if huge market impact
you use a and move the price
broker. significantly.
Costs-are- "I want quick Small size Pay the price Prices get sorted The investor loses
not- execution, but trades in without too out by the control and should
important it doesn't have pretty liquid much market, so not possibly consider
to be securities consideration much thiought is lower-cost
 immediately." required alternative trading
tactics.
Need- "I need to Helpful when You pay a By not being so Principal-agent
Trustworthy- make a non- you need to broker, which concerned problem: You give
Agent cookie-cutter execute a large
means about the agent valuable
trade." order in a commission. immediate information, but is it
thinly-traded Also, the execution, you used in your best
security. broker may might get a interests?
leak the info better price.
you're trading
on.
Advertise- "Hey Advertizing It costs a lot to You can get a Other investors may
Draw- everybody! gets enough pull off this market price for attempt to front-run
Liquidity Look at me! I people to take strategy, so it a large size your trade.
want to the opposite better be trade
trade!" side of a worth it.
trade.
Low-cost- "I see the Value- Low actual You pay low You don't know
whatever- market price, motivated and commissions, commissions, whether or when
the-liquidity but I don't like unconcerned but potentially and you have your trade is going
it. How's with timing huge total control to to get done, and you
this?" opportunity wait for your may be trading into
costs. desired price. weakness.

30l Algorithmic trading strategies: Classes

Explain the motivation for algorithmic trading and discuss the basic classes of algorithmic trading
strategies

What is Algorithmic Trading?

 Automated, electronic models that trade according to established quantitative rules within user-
defined constraints.
 Probably somewhere in the range of 30% - 40% of trading is automated (ie. conducted by
algorithms).

Why would you use Algorithmic Trading?

 Ideally, algorithms should be able to identify market trends and seize upon even the smallest
and briefest mispricing.
 The primary advantage is that computers won't commit human error and can minimize trading
costs.
  Also, algorithms can break conceal large block trades by breaking them up into small chunks and
reducing market impact (Meat Grinder Effect).
 This strategy can yield large savings compared to making a single block-trade.

What are the basic classes of Algorithmic Trading Strategies?

Logical Participation Strategies are designed to get an order filled while minimizing trading costs.

Simple Logical Participation Strategies involve participating in the market, but not standing out. There
are three sub-styles:

 VWAP strategy: Match or beat VWAP for the day (Most popular Algorithmic Trading Strategy)
 TWAP strategy: Trade at a constant volume and match or beat TWAP (good for thinly-traded
securities)
 Percent of Volume strategy: Trade a security at a percent of overall volume until your trade is
complete

Implementation Shortfall Strategies also seek to fill an order, but minimize trading costs based on
Implementation Shortfall calculations (as opposed to VWAP or TWAP)

 Complete a trade while lowering trading costs as measured by implementation shortfall

(see 30g)
 To do this, trades are usually "front-loaded in order to take advantage of higher liquidity early in
the trading day (80% of transactions are typically done within the first hour of trading)
 Implementation Shortfall strategies are becoming more popular as its superiority to VWAP is
increasingly acknowledged (see 30h)

Other Algorithmic trading strategies include:

 Opportunistic Strategies are not designed to fill orders, but rather to seize upon opportunities
such as temporarily liquidity or mispricing.
 Passive trading combined with seizing opportunities for high liquidity
 Reserve (Hidden) orders and crossing are used in an attempt to achieve negative trading costs

Specialized Strategies

 Include, but are not limited to, Passive order strategies, Hunter strategies, and a few other
strategies that have approximately 0% chance of being tested on the exam.

30m Algorithmic trading: Strategy selection factors

Discuss the factors that typically determine the selection of a specific algorithmic trading strategy,
including:
order size,

average daily trading volume,

bid–ask spread, and

the urgency of the order

Translating CFA-speak

A big theme in this reading is trying to minimize the effect that your trade has on the market. This effect
is called Market Impact and was first discussed in LOS30b.

Basically, there are quoted bid and ask prices, but the order sizes behind these prices might be very
small compared to your order and you'll have to fill it at successively less attractive prices. In the
reading, this is referred to "an immediate demand for a large amount of liquidity."

The idea behind Algorithmic Trading strategies is to move a chunk of your transaction at the attractive
price (bid or ask depending on whether you're selling or buying) and then waiting until someone else fills
the void that has been created by your counterparty getting out of the market.

Traders must employ the Algorithmic Trading strategy that is best suited to current market conditions.
In order to accomplish this, they will compare potential trades according to factors such as:

 Order size as a % of average daily trading volume

 Bid-Ask spread
 Order urgency

Based on these factors, traders can identify an ideal Algorithmic Trading strategy. For example:

Relative Bid-Ask Order Ideal Strategy Rationale

Volume Spread Urgency
Low Low Low Simple Take the time to break up your trade into
participation (VWAP) smaller pieces and reduce market impact
(not high urgency)
High High High ECN or Broker (ie. NOT This is a very customized trade, which is
an Algorithmic Strategy) best executed by a broker or ECN (see 30k)
Low Low Low Opportunistic Low urgency, highly liquid situation, wait
participation for the price to come to you and take your
shots
Low Low High Implementation If you have a high-urgency situation, use an
Shortfall Implementation Shortfall strategy to get
trades done early
Achieving a trading objective is called an Objective Function and it is a lot like Mean-Variance
Optimization.

30n Best execution: What is it?

Explain the meaning and criteria of best execution

What is "Best Execution"?

 "Best Execution" is like "Prudence" (Standard 3a), in that it is your duty to pursue it, and you
know when it hasn't been done, but it is virtually impossible to define
 Best execution is impossible to define objectively because some trades may have high
transaction costs, but be the right trade in the overall portfolio context
 Best execution can't be known in advance of a trade because each trade takes place under
unique circumstances
 Best execution can be measured after the fact, but trades may take place in extreme market
conditions
 Best execution is an ongoing process that is continually refined, so we have to examine it in a
long-term context

30o Best execution: processes, disclosures, and record keeping

Evaluate a firm’s investment and trading procedures, including processes, disclosures, and record
keeping, with respect to best execution;

Should my firm have policies and processes for trading procedures?

 Yes.

Should my firm disclose these policies to our clients?

 Yes.

Should my firm keep adequate records?

 Yes.

This sounds familiar.

 Clearly, this is a radical departure from every other piece of advice in the curriculum.
30p Fiduciary duties: Trading execution

Discuss the role of ethics in trading

There are ethics in trading?

 In theory.

What are they?

 Be ethical when you trade.

 Respect the client.
 Respect everybody.
 And don't let your relationship with Traders get in the way of your fiduciary duties.

Is this covered anywhere else in the curriculum?

 All of this is covered by Standard 3a.