The Rules, Part XXXI

The Rules, Part XXXI

The offering of liquidity through limit orders is a real service to the market, and on average gets rewarded in lower overall execution costs.  In choppy markets, it can really add value.

I urge all investors to place limit orders as a normal practice.  Better not to get filled on a few orders every now and then, than to get ripped off by market makers when a market order hits a thin market and you end up with a lousy fill.

Patience is a virtue in trading.  Don’t insist that you will get a full position on a stock you you want to own.  Rather, have multiple companies that you might want to own at their respective prices, and own the ones that the market is willing to sell to you.

When you think about “flash crashes” and what drove them, there are many factors involved, but one thing is clear: someone placed a market order at the wrong time, asking to buy or sell, no matter what.

Personally, anytime I place orders that are large relative to the ordinary volume of the market, and/or where the bid/ask spread is wide, I use discretionary reserve orders.  Say the bid is 20.50 for 200 shares, and the ask is 21.31 for 300 shares, and I am looking to buy. I would place a discretionary reserve order showing 100 shares at 20.49, but offer 41 cents of latitude, but with 2000 shares available to be bought.  In doing this, the bid/ask does not change, but if a program trade sweeps through the market seeking to sell at less than 20.90, my trade executes, and some will wonder, “Where did that come from?”

My view is that with high frequency trading, managers must adopt tactics, particularly on less liquid stocks, that we become invisible liquidity providers.  We match stealth with stealth, but look to get good fills on solid companies at very good prices.  We become market makers in a sense, up to the level of our price limits.

If I have done my fundamental homework right, putting out limit orders, even those that are “good till cancelled” offer value to me and my clients, because we get shares at prices that offer good value, and and sell shares at prices that represent full value or more.

via www.alephblog.com




About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.