Explain why investors trade and how the reason shapes the trading approach
The idea
The reason for a trade sets its urgency. Profit-seeking trades rest on an alpha signal that decays: fast-decaying alpha calls for quick execution, while slow alpha allows patient trading. Risk-management and hedging trades, such as cutting beta or currency exposure, usually need prompt execution to close the unwanted risk. Cash-flow trades from subscriptions, redemptions or index changes are often tied to a particular time, such as the close. Corporate actions and margin calls create forced trades, and routine rebalancing trades can often be worked patiently. The central trade-off is between market impact, which rises with speed, and execution or opportunity risk, which rises with delay. The trap is handling every order the same way regardless of why it was placed.
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- Explain the factors that feed into choosing a trading strategy
- Contrast the reference prices used to judge trade execution
- Propose a trading strategy suited to given facts and defend the choice
- Explain what usually decides which class of trading algorithm is chosen
- Contrast trade implementation features across spot currency, OTC derivative, futures and options, fixed-income and equity markets
- Explain how the cost of a trade is measured and work out that cost
- Judge how well a trade was executed
- Assess whether a firm's trading processes, disclosures and records meet good governance standards