Order Execution 101
Given the recent difficulty in placing orders in this violent, 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 on receipt of my Trade Alert and half at the close. It’s that simple. If there is a tight spread and lots of volume, such as you usually get with the (SPY), 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 on the Japanese yen, 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 upfront. So, place limit orders 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 Scale In. Let’s say I issue a trade alert to buy a spread at $4.00. The market is indicating a price of $3.85-$4.15. Break this down into seven orders of $3.85, $3.90, $395, $4.00, $4.05, $4.10, and $4.15. Then, forget about them.
By the end of the day, one will certainly get done, and maybe a few more. They will all get done only if the stock drops. But whatever happens, you will end up with a nice average and the low of the day in a rising market.
The reverse logic is true for put spreads.
2) The Principal Method. If you are a large, high-net-worth individual or institution, you can call your 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 loses money trading with you, he will quit returning your phone calls. That has happened to me a lot.
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 and fees for this service, as you should. A lot of independent financial advisors now operate on this basis.
4) Overnight GTCs. If you live in a foreign time zone when the US stock market is closed, such as Australia, simply enter a spread of Good-Until-Cancelled orders overnight. For example, if I send out a trade alert to buy at $9.00, enter limit orders GTC at $9.00, $9.10, $9.20, $9.30, and $9.40. You should get done on some or all of these. This also applies to Americans who work during the day or don’t want to sit in front of a screen all day.
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 and 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 crashes, some unfortunate investors got filled with market orders down 90%, especially with ETFs.
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.