Trading in volatile times

Times of volatility may call for revised trading strategies. This piece looks at areas where advisers can improve, especially when placing large trades in the marketplace.

The market volatility unleashed by the COVID-19 pandemic has added a new layer of complexity for financial advisers to consider when realigning their clients’ portfolios. While even experienced investors have been caught out by the global business disruption, there are still some key trading principles that should be observed and pitfalls that can be avoided.

Rob Talevski, Director of AUSIEX Trade Execution Services, says there are a few simple approaches advisers can take in the midst of market volatility to lessen trade execution costs and help clawback or protect investment returns.

“I’m not talking about brokerage costs as these are transparent and a known cost to investing. What I am talking about is implicit costs, for example, a large buy or sell order being placed into the lit market (a market where the order book is made public for all who subscribe) without any consideration to market conditions like liquidity and price spreads,” he says.

“This could push a stock price higher or lower as opposed to an approach where managing the total order over a number of small trades would result in less price impact. This reduces transaction costs by paying a lower or receiving a higher average price for the stock.”

Market conditions

A common trap Talevski sees from the trading desk is advisers placing multiple client orders for the same stock with a market to limit price instruction within a short window of time. This can result in client orders competing against each other and therefore increasing the transaction costs.

“For example, in a stock where liquidity is an issue, you will find that each ‘market to limit’ order will essentially leap ahead of the other when there is not enough liquidity at the current bid or offer,” he says. “This often results in each order not being entirely filled and causing the stock price to rise or fall outside of natural market conditions.”

To lessen the impact, Talevski suggests placing orders at a price limit will potentially see more liquidity come onto the market to fill those orders.

“It’s worth knowing that not all investors will show their hand on the lit market and may have more shares to buy or sell as they see demand increase,” he says.

“If there is concern about missing prices then another option could be to aggregate your orders. For example, instead of placing 10 orders to buy 500 shares, you place one total order to buy 5000 shares where your clients can then be allocated 500 shares each at an average price.”

Price discovery

Another trend occurs when a stock has a significant bid/offer spread with no underlying price-sensitive news and orders are placed with aggressive pricing, resulting in price swings that aren’t in tune with what is happening to the underlying company.

“In these cases it’s definitely worthwhile attempting some form of price discovery,” Talevski says. “You’d be surprised how it can help improve or preserve any alpha on your investment.”

A final area of concern is the trend towards placing ‘market to limit’ orders with a send-and-forget mentality.

“Placing such a price instruction doesn’t necessarily mean you will get the entire fill when you submit the order to market,” he says. “So when stock prices are particularly volatile and trading ranges swing wildly, as we have seen during COVID-19, then you need to monitor these orders and amend accordingly.”

Talevski suggests placing a limit order that is several price steps above the current market offer if buying or below the bid if selling to help get the order filled at current levels.

“This is a far better option than placing a market to limit order that will aggressively cross the spread and hit the opposing bid, or offer and then remain at that price as a limit. And, if the stock is moving fast, you may find yourself paying well above or receive well below the initial intended price when you try to play catch-up later in the day,” he says.