Chapter 18 Buy-side traders

1. Chapter 18Buy-side traders

2. Order submission strategy – Market vs. limit orders • The bid-ask spread • Use market orders when the spread is narrow • Use limit orders when the spread is wide • Limit order price depends on the tradeoff between execution price and execution probability • What will happen when limit orders do not execute? Can wait or not? • Must know how execution probability depends on limit order prices – order book, volatility, trader interest

3. Order exposure decision • Full exposure – submit limit orders • No exposure – wait until an opportunity to trade shows up • Trade anonymously using brokers and exchanges • Weighs the benefits of display against the costs of display

4. Benefits of exposure • Easier for other traders to find them • Attract latent traders (reactive traders) • Reactive vs. proactive traders • Traders find it cheaper to be reactive when suitable trading opportunities are rare • The reactive-proactive continuum is similar to the aggressive-passive continuum. The former represents the willingness to bear the costs of searching and the latter represents the eagerness to arrange trades

5. Costs of exposure • Exposure may reveal trader motives • Informed traders do not want to reveal their information (perhaps only initially but not later) • Want to avoid front runners and squeezers • Bluffers do not want to reveal their trading intentions (perhaps only initially but not later) • Exposure may reveal future price impacts • Front runners increase trading costs • Exposure may reveal valuable trading options • Quote matchers

6. Defensive strategies • Evasive strategies – to hide • Use brokers, electronic trading systems, break orders, undisplayed orders, order indications, or simply wait • Deceptive strategies – to confuse • Make a small trade on the opposite side, etc • Offensive strategies – to attack

7. Market design • Markets can reduce front running by adopting a time precedence rule and a large tick size to make front running costly • Allow to submit undisclosed orders • A detailed and accurate audit trail to catch penalize dishonest brokers • Allow to report their trades late