Trading Around the Open

Transcription

1 AUTHORS Ofir Gefen Managing Director Head of Electronic Brokerage in Asia Pacific Bobby So Vice President ITG Algorithms CONTACT Asia Pacific Canada EMEA United States Trading Around the When balancing the trade off between finding liquidity and avoiding volatility around Asian open auctions, applying careful analysis to the specifics of the order generates more benefits than applying a standard approach or relying on gut feel. INTRODUCTION As the investment process across Asia matures, trading desks at institutional investment houses across the region are looking for ways to add value to the investment process. There is therefore, a growing focus on reducing impact cost, lowering opportunity cost and intelligently sourcing liquidity. The process boils down to two fundamental questions a trader on a buy side desk needs to answer: 1. Should I engage with the market at this point in time? And; 2. To what degree should I engage? There are multiple ways to address these questions, ranging from gut feel or traders market experience to more quantitative methods based on models that optimize the trading schedule to reduce impact cost and timing or opportunity cost (e.g. ITG s ACE). In this short paper we will focus on the question as it pertains to the auctions in Asian markets, offering a methodology that helps traders address the question of engagement around the first few minutes of trading. The goal is to suggest an approach grounded in analysis that helps traders form a view on how to trade during and around the. WHY THE OPEN? THE BALANCE BETWEEN LIQUIDITY AND VOLATILITY The tends to be a liquidity event in most markets. Accrued overnight information is funneled to price formation during the opening auction and the first few minutes of trading. As a result two things happen: the and the trading period right after it tend to represent a significant portion of the day s volume, and given the price formation that takes place, markets tend to display higher volatility. The charts below illustrate these points for Hong Kong and Japan.

2 2 The traded volume around the in Hong Kong is around 1-3% of the daily volume while in Japan, the traded volume around the is around 4. of the daily volume (Figure 1). FIGURE 1 HONG KONG VOLUME PROFILE 10.0% 8.0% JAPAN VOLUME PROFILE 7.0% 6.0% 5.0% 6.0% 4.0% 4.0% 3.0% 2.0% 2.0% 1.0% 0.0% 0.0% Bin Bin 42 Bin 45 Bin 48 Bin 51 Bin 54 Bin Bin 72 Bin 75 Bin 78 Bin Bin 42 Bin 45 Bin 48 Bin 51 Bin 54 Bin Bin 72 Q Q The high volatility is also clearly visible (Figure 2). This has become particularly topical with the increased volatility in emerging markets, in general, and some Asian markets in particular, during Q Note the distinct increase in Q3 volatility in Hong Kong given its China exposure, versus Japan. Not trading at or shortly after the not only excludes the investment manager s input to initial price formation, but also denies access to the liquidity that can be significant at that time. However, participating around this time exposes the investment manager to price volatility and potentially disadvantageous fills if significant reversion follows. FIGURE 2 HONG KONG INTRADAY VOLATILITY JAPAN INTRADAY VOLATILITY Bin 1 Bin 2 Bin 4 Bin 5 Bin 7 Bin 8 Bin 10 Bin 11 Bin 13 Bin 14 Bin 16 Bin 17 Bin 19 Bin 20 Bin 22 Bin 23 Bin 25 Bin 26 Bin 1 Bin 2 Bin 4 Bin 5 Bin 7 Bin 8 Bin 10 Bin 11 Bin 13 Bin 14 Bin 16 Bin 17 Bin 19 Bin 20 Bin 22 Bin 23 Close Q Q3 2015

3 3 TO TRADE OR NOT TO TRADE HOW TO ANSWER THAT QUESTION? Absent any stock specific news, deciding on participation depends on the direction of the trade (buying, selling or shorting) relative to the market trend: momentum, flat or reversion. Using past experience as well as tools that help predict the move on the can help the investment manager make a more informed decision at the start of the day. Our analysis used a sample of about 40 investment management firms, each of which may represent multiple strategies and portfolio managers. We took the order characteristics (stock, side, size and day of trade) and modelled the prevailing execution price for those orders given a set passive participation (*) based on different start times: the, + 1, +5, +10, +15, +20, +25 and +30 minutes. We then compared the weighted average price the order incurred to the benchmark of the price to see if one timing strategy consistently delivered better results. In addition, we analyzed what percent of the trades may not complete given the later start time. ONE SIZE DOES NOT FIT ALL Our review of the results over our sample set suggests that for both Hong Kong and Japan starting an order at the would yield the better overall trading result during Q1 and Q3 of 2015, however during Q2, starting 15 minutes after the yields the best result in HK while a similar result is achieved if starting 30 minutes after the for Japan (Figure 3A and 3B). The later start causes a 2% drop in HK and 6% drop in Japan in order completion rate in our sample. FIGURE 3A Performance vs. The by Quarter (Hong Kong) m +5m +10m +15m +20m +25m +30m /Q1 Sample Universe 2015/Q2 Sample Universe 2015/Q3 Sample Universe

4 4 FIGURE 3B Performance vs. The by Quarter (Japan) m +5m +10m +15m +20m +25m +30m /Q1 Sample Universe 2015/Q2 Sample Universe 2015/Q3 Sample Universe When examining individual orders in more detail over the three quarters of 2015, across the sample, some reversion after the is evident in both the Hong Kong and Japan markets thus it is worth looking at the distribution of best starting time by order (and not only the weighted average). The distribution is similar in the sense that starting at the or 30 minutes after the provides the best result for 62% (by value) of orders in HK and 70% in Japan (Figure 4). FIGURE 4 DISTRIBUTION OF BEST START TIME (HONG KONG) DISTRIBUTION OF BEST START TIME (JAPAN) 40% 3 30% 2 20% 0% 37% 2 8% 0% 0% +5m +10m +1m +15m +20m +25m +30m 4 40% 3 30% 2 20% 0% 42% 28% 8% 4% 4% 4% +5m +10m +15m +20m +25m +1m +30m

5 5 It is clear then that while there is an overall pattern that can be gleaned during less volatile conditions, taking advantage of liquidity and price formation in the generally improves the trading outcome, while during volatile conditions, starting trading later may help the optimal strategy changes from one investment manager to another and sometimes from one quarter to the next. This suggests that there is merit in looking at the specifics of strategy, the manager s trading goals and the trades themselves before coming to a conclusion of the optimal start time. Trading desks should run analyses for their specific profile, potentially by fund type or portfolio manager before converging on a specific strategy. CONCLUSION In this short article we demonstrated a methodology that can help traders at investment managers apply a data driven approach to help design a trading strategy for the. It is clear that the results are not uniform across the data set and differ from one investment manager to the next, as well as from one quarter to the next; it is very plausible results may differ by fund strategy and even portfolio manager. Therefore it is best to run a specific analysis before choosing a strategy for trading at the, and to continuously fine tune it as market conditions, such as volatility, change. ITG s Algorithm Execution Consulting team offers customized analysis to strategize the in Asia. The strategy can be further refined to apply various different attributes and help provide guidance to traders. *We use a participatory strategy as it is relatively passive thus suggests low impact. It is possible to repeat this exercise with higher participation rates, however one would need to account for the increased impact of such strategy Investment Technology Group, Inc. All rights reserved. Not to be reproduced or retransmitted without permission Broker-dealer products and services are offered by: in the U.S., ITG Inc., member FINRA, SIPC; in Canada, ITG Canada Corp., member Canadian Investor Protection Fund ( CIPF ) and Investment Industry Regulatory Organization of Canada ( IIROC ); in Europe, Investment Technology Group Limited, registered in Ireland No ( ITGL ) and/or Investment Technology Group Europe Limited, registered in Ireland No ( ITGEL ) (the registered office of ITGL and ITGEL is Block A, Georges Quay, Dublin 2, Ireland). ITGL and ITGEL are authorised and regulated by the Central Bank of Ireland; in Asia, ITG Hong Kong Limited (SFC License No. AHD810), ITG Singapore Pte Limited (CMS Licence No ), and ITG Australia Limited (AFS License No ). All of the above entities are subsidiaries of Investment Technology Group, Inc. MATCH NowSM is a product offering of TriAct Canada Marketplace LP ( TriAct ), member CIPF and IIROC. TriAct is a wholly owned subsidiary of ITG Canada Corp. These materials are for informational purposes only, and are not intended to be used for trading or investment purposes or as an offer to sell or the solicitation of an offer to buy any security or financial product. The information contained herein has been taken from trade and statistical services and other sources we deem reliable but we do not represent that such information is accurate or complete and it should not be relied upon as such. No guarantee or warranty is made as to the reasonableness of the assumptions or the accuracy of the models or market data used by ITG or the actual results that may be achieved. These materials do not provide any form of advice (investment, tax or legal). ITG Inc. is not a registered investment adviser and does not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy.