Chapter 18 Buy-side traders
Order submission strategy – Market vs. limit orders n The bid-ask spread Use market orders when the spread is narrow • Use limit orders when the spread is wide • Ø n n 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
Order exposure decision Full exposure – submit limit orders n No exposure – wait until an opportunity to trade shows up n Trade anonymously using brokers and exchanges n Weighs the benefits of display against the costs of display n
Benefits of exposure Easier for other traders to find them n Attract latent traders (reactive traders) n 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 •
Costs of exposure n 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) • n Exposure may reveal future price impacts • n Front runners increase trading costs Exposure may reveal valuable trading options • Quote matchers
Defensive strategies n Evasive strategies – to hide • n Deceptive strategies – to confuse • n Use brokers, electronic trading systems, break orders, undisplayed orders, order indications, or simply wait Make a small trade on the opposite side, etc Offensive strategies – to attack
Market design Markets can reduce front running by adopting a time precedence rule and a large tick size to make front running costly n Allow to submit undisclosed orders n A detailed and accurate audit trail to catch penalize dishonest brokers n Allow to report their trades late n
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