Given the recent difficulty in placing orders in this tedious, illiquid market, I have been inundated with requests for how to execute orders. So I thought I’d take some time today to expound on the basics of order execution 101.
There are three basic ways to intelligently get an order into the market:
1) The No Brainer Average In. Buy half at the receipt of the Trade Alert and half at the close. It’s that simple. If there is a tight spread and lots of volume, just go to the market. This is what a lot of institutions do, and is why you get the volume spikes in the market at the opening and the close every day.
If you are trying to get into an illiquid position, such as with a far month option, the spreads can be quite wide, possibly as much as 10%. Going to the market can mean giving up a large chunk of your profit up front. So place limit order in the middle of the spread, giving the market makers time to lay off risk in the underlying security, or in the futures. That will enable them to tighten up the spread and fill your order without taking you to the cleaners
2) The Principal Method. If you are a large, high net worth individual or institution, you can call you broker and ask him to make a market in any security. He will give you a bid and an offer wide enough to compensate for the risk he is taking, and you just lift the leg you want. Warning: if your broker consistently losses money trading with you, he will quit returning your phone calls.
3) The Discretionary Method. Find a broker you trust to execute on a best efforts basis at his discretion. He will want to grow your business and will do the best price he can. Expect to pay a higher commission for this service, as you should.
But a good broker worth his salt will usually earn his keep and then some, so it is worthwhile. He has the news feeds right in front of him, has access to in house and third party research, like this newsletter, and is talking to clients and other traders all day long. So he should use this information to your advantage.
Don’t expect his service to be price competitive with discount online execution services. You get what you pay for. Better not to be penny wise, but pound foolish. Caution: many brokers won’t take these orders unless they know you well, as they are afraid of getting sued.
Be very careful of using limit stop losses these days. In the big flash crash, some unfortunate investors got filled down 90%, especially with ETF’s. Better to let your broker use a “pocket” stop loss where he will call you before executing
If you get a Trade Alert from me and the security has already moved 5%, don’t chase it. The 3% rule applies to ETF’s. Sometimes merely going for a refill on your coffee, taking out the trash, or reading the morning papers is enough to miss an opportunity in this market.
I know because I have done it plenty of times myself. Keep your discipline. Wait for the price to come back to you, or wait for the next Trade Alert. There are plenty of fish in the sea, and it is just a matter of time before another juicy one swims by.