Hi Everyone,
I would like your opinion on how much of the ADTV should I trade max to avoid too much slippage. I trade small cap so they are pretty illiquid.
My ADTV ceiling to buy stocks is 10% of the average 9 days. Do you think it’s right? Do you think it’s too high? Do you think it would affect the price too much? I use limit on the Open or VWAP to sell.
Thank you
S
Personally, I hesitate to trade 10% of ADTV.
That said, if your system has low turnover and you are very patient with limit orders it can work.
No, It’s pretty high turnover… That’s part of the problem.
Yoram (yorama) provided a link to a paper that may address your question assuming your slippage is similar to this institution’s. There is a HUGE amount of data here.
Wouldn’t it be nice if you could read the number off of the attached graph?
Link to paper: [url=http://faculty.som.yale.edu/Tobiasmoskowitz/documents/TradingCostofAssetPricingAnomalies.pdf]http://faculty.som.yale.edu/Tobiasmoskowitz/documents/TradingCostofAssetPricingAnomalies.pdf[/url]
If this does correspond to the slippage for some of us at P123 then Yoram earns my nomination for the best post in the “ease of use” and “most useful” categories. Even if a person finds they have to add a constant (C ) to the curve for any given Y value he still gets my nomination.
That’s awesome! Thank you
The approximate equation for MI vs ADV is a hyperbola :
MI= (15.8ADV /(0.38+ADV)) + 2.1ADV
Smuff77,
I think it depends on your execution strategy.
If I were a market maker shown a single market order for 10% ADV, I would lift my offer and then skin anyone alive tried to meet the bid before I did. Just saying… all is fair.
10% ADV for an order type which does not remove liquidity from the market is much more reasonable, IMO, but there are added fill risks. Order which add liquidity to the market actually slightly result in a positive expectancy (i.e., negative costs), but result in much greater fill risks.
For some practical pointers, see Jon Shore’s answer here: https://quant.stackexchange.com/questions/1264/how-to-simulate-slippage/1265#1265.
I’ll add that in my experience regularly trading 5-10% of ADV on small cap stocks I expect to achieve execution prices within 10 basis points of the stocks “close” or “daily vwap” benchmarks when using good execution strategies. So it is certainly possible to trade volumes this large and still get reasonably favorable fill prices, but my answer only addresses transaction costs. The article and image linked by Jrinne is a very good source for market impact questions, which are much more difficult to measure or understand.
My generic advice is to only use algorithms like vwap that spread orders out of longer periods of time, and to trade as much as possible on the favorable side of the spread (add liquidity only) for best execution prices. The downside of this strategy is that you’ll frequently deal with partially completed orders, so its more difficult if your trades are extremely time sensitive.
edit: I’d also use a longer look-back period as Chipper suggests. I used 90 days AND a series of additional rules to screen for consistent liquidity.
[quote]
My ADTV ceiling to buy stocks is 10% of the average 9 days.
[/quote]Denny had a post where he wrote that when he used a short look-back period for ADT he got burned when trying to sell stocks, so he extended his look-back period.
I regularly trade more than 10% of ADT using limit orders. I have substantial slippage, get partial fills, sometimes have to buy or sell my position over three to five days, and sometimes see some market impact of my orders (though that’s rare). It’s way worse with the nickel tick size. But that’s the price I’m willing to pay. I set my limit at 50% of ADT. I really don’t see much difference between buying 5% of ADT and 40% of ADT in terms of inconvenience, cost, etc. I figure that with really low ADT stocks, transaction costs are eating up about 15% to 20% of my total profit. But the profit on my transactions has been so crazily high that I take my lumps.
