Smaller stocks - how to buy & sell - real world experience?

Research
1

Hi,

I have a dilemma. Let me assume that I am rebalancing every day. So, on Day 1 I am told to buy 2,000 XYZ. On Day 2 I am told to sell 2,000 XYZ.

Unfortunately I cannot sell more than 1,000 on Day 2 owing to lack of market liquidity without severely impacting the price. So, what do I do with the other 1,000 which are left in the portfolio?

Which of these in your experience is the best option?

(a) sell the 2,000 regardless of price on Day 2 (may be big loss)
(b) input a manual sell on Day 3, again regardless of price (price may be up or down further)
(c) wait for P123 to issue a sell on the remaining 1,000 (does this work?)

I hope that those who have some real time trading experience here will be able to help me out!

JP

2

I generally put in a limit order to sell a 1/2 percent below my desired price (in other words allow 0.5 % slippage). If it doesn’t sell by mid-day I will assess the company by reading recent announcements, quarterly reports, etc. If I feel that the stock is a really solid investment then I will hold it and put in another limit sell order the next day. If I am uncomfortable with holding the stock a longer time than what P123 indicates then I will loosen up the limit order and try to get rid of it before the end of the day.

You may be able to avoid this situation to some extent (but not always) by setting a mimimum Mktcap in the buy rule.

I hope this helps.

Steve

3

Yes liquidity is always a fun game.

Basically use a professional direct access broker (try IB) with low charges, then your own limit orders actually become the “bid” and “ask” prices.

Don’t put all your order in at once, look at the bid/offer sizes. I have found you can typically buy or sell twice as much as what is currently on offer, but more than that and you run out of buyers/sellers.

If you put in a gicantic order that is many multiples of the NMS then the day traders will have you for breakfast, as if you do that then you are giving away your position, (i.e. you want to buy/sell a lot) and they will definately try to push you. Don’t make your intentions clear by putting in massive orders.

I have found that if you do it quietly you can absorb quite a lot of the days trading volume without anyone noticing, you just have to quickly snap up any large order that come through.

But indicentally the liquidity issue is one of the reasons why I favour a low-turnover strategy, and the “Stitts” challenge really frightened me!

You can add extra liquidity filters, but its usually the small illiquid stocks that are inneficiently priced (because no one else is interested either) and therefore have the most profit potential.

Compare your returns per trade to the slippage.

But I find it annoying that there are no books out there on “how to execute trades”, plenty on technical analysis and what-not.

You just have to sort of fumble through, but I have made some mistakes where I have actually caused the stock price to spike intra-day, and thats me selling out at the lowest price or buying at the highest price - DOH! It definately is a skill.

But don’t give up on illiquid issues, they can be traded, but with just a bit more care and attention than QQQQ!

4

Olikea,

Here’s a book I’ve seen on the shelf before that covers execution practices for institutions.

Coping With Institutional Order Flow (Zicklin School of Business Financial Markets Conference Series Baruch College) (Hardcover)

I haven’t read it, only scanned the TOC (can do at Amazon). May be promising.

BTW, do you have a backup broker to IB for “business recovery” purposes? I have be thinking that I should have one just in case a REFCO or other situation were to hit.

Thanks,
Carl

5

So, in effect there are two different suggestions.

Steve says to allow a larger ‘slippage’ initially and hope to find the volume, and the second by olikea is to allow a multiple trade situation, in effect sneaking the order in little by little, which would multiply the trade commission several fold. Perhaps that is cheaper than the first suggestion - who knows?

All in all it seems that it really is a lot more costly to trade with lower liquidity stocks and perhaps they should just be avoided entirely as they are such a hassle to trade?

Thanks for the input guys!

Denny?

6

Very helpful post. Thank you.

I see how all your tips can work for entries. If the market cooperates I can get all I want if I am patient and use small limit orders. If the market does not cooperate, I can move on to the next pick. But there is no such option when it is time to exit. That is the part about semi-liquid stocks that concerns me.

Any tips about managing exits? Thanks in advance.

7

You can trade fairly small lots without increasing commission costs. I trade with IB which charges 1/2 cent/share with a $1 minimum/trade. So my cost is the same if I make one trade of 1,000 shares or five trades of 200 shares. Now if I had to just trade 100 share lots, my commission cost would double. But it still is no more costly for me to buy 100 share lots and not move the market than to buy a 200 share lot and move the market by 1 cent. But if I were to move the market by 2 or more cents, then that would cost me more than the extra commission fee.

For me, concern about moving the market with illiquid stocks and the bid/ask spread are bigger issues than commissions.

8

All in all it seems that it really is a lot more costly to trade with lower liquidity stocks and perhaps they should just be avoided entirely as they are such a hassle to trade?

Please do look at IB their commisions are laughably low. (www.interactivebrokers.com)

Now as for liquidity, well, there is a trade off, if you go for these illiquid stocks your slippage is going to be higher, but the profit potential is higher too.

I have run a few simulations, and they clearly show that increasing liquidity rules decrease the average profit per trade. Clearly there has to be an optimum somewhere, and my guesstimate is that its in the zone of trading really uncomfortably illiquid shares.

Also if you only rebalance weekly or whatever you could divide your money into 5 portfolios, that way you liquidate a little each day. I know I can do this because my only sell rule is “rank < 95” which by itself is quite arbritrary, it matters neither here nor there if the stock is sold a few days after the rank has passed., but that works because I know my system always leaves “money on the table”, stocks which are sold do continue to appreciate, they are only sold because the rate of appreciation is higher elsewhere.

As an aside, the economic function we are perfoming is sending information to the market. That is the socio-economic benefit of what we are doing. We are rewarded for sending good information and punished for sending bad information. Our information gets incorperated into the aggregate information aka the stock price.

The whole point is we should be prepared to move the stock price a few percent, that is our job - correcting mispriced securities! :slight_smile:

9

John-Paul

Well! Another interesting thread.
Sometimes I think that my trading style is so different from everyone else’s that I don’t know if my inputs help or hurt. However, this is what I do.

Since I have a full time + job I have little time to play with my trades during the day.
First, I try to set my AvgDailyTot so that I have little worry about liquidity, but at the same time I try to trade as low an AvgDailyTot as I can and not have many liquidity problems. So why do I push the edge of having liquidity problems?

If you buy no more than 5% of the AvgDailyTot you will have very little affect on the price. If you trade 10% you will have a little problem every once in a while. So how valuable is trading as low a volume as you can without a problem versus trading a much higher AvgDailyTot so that you won’t have to worry about it?

I ran a test about a year ago testing AvgDailyTot ranges. I tested 3 different Ranking Systems using this set of rules:
10 stock Sims, Buy Rules;
$1 minimum price, 50Mil minimum MktCap, and I ran 6 Sims with the following AvgDailyTot ranges;

AvgDailyTot(20) > 10000 & AvgDailyTot(20) < 500000

AvgDailyTot(20) > 500000 & AvgDailyTot(20) < 1000000

AvgDailyTot(20) > 1000000 & AvgDailyTot(20) < 1500000

AvgDailyTot(20) > 1500000 & AvgDailyTot(20) < 2000000

AvgDailyTot(20) > 2000000 & AvgDailyTot(20) < 2500000

AvgDailyTot(20) > 2500000 & AvgDailyTot(20) < 3000000

I had only 1 sell rule; NoDays > 24

This caused each Sim to buy 530 stocks over a 5 year period selling them after holding them for 1 month.

Using the Flip’s Supper Value Ranking System the results were:

10,000> 500,000; Annual Gain=46, max drawdown = 27.5, avg gain/stock = 3.21%

500,000 > 1,000,000; Annual gain = 48, max drawdown = 34.4, avg gain/stock = 4.34%

1,000,000 > 1,500,000; annual gain = 33, max drawdown = 27.5, avg gain/stock = 2.87%

1,500,000 > 2,000,000; annual gain = 27, max drawdown = 42.3, avg gain/stock = 2.57%

2,000,000 > 2,500,000; annual gain = 11.5, max drawdown = 45.4, avg gain/stock = 1.23%

2,500,000 > 3,000,000; annual gain = 10.0, max drawdown = 55.3, avg gain/stock = 1.15%

So my conclusions are that if you trade less than $1,000,000 AvgDailyTot you can give up 1% extra slippage on every buy and every sell due to liquidity problems and still have a higher gain / stock than if you trade $2,000,000 > $3,000,000 AvgDailyTot.

Therefore, it is worth taking a little risk with less than adequate liquidity.
Oh yes, how do I trade? I check the AvgDailyTot of the last week by looking at the chart. If it looks like I will have a liquidity problem I will break my trade into 2 or 3 trades. I trade 1 in the morning before I go to work, 1 at noon during my lunch break, and 1 about an hour before the market closes during coffee break. All trades are placed with a Market Order, and I take my chances!

Denny :sunglasses:

10

Denny - I’m interested in how your market orders turn out. I used to use market orders at the market opening. I generally got very close to the opening price. But there was one occasion that I got the opening price but happened to be 7% higher than previous close and 7% higher than trades placed immediately after mine. I complained to the broker but to no avail. Since then I have only been using limit orders.

Steve

11

Steve,

You won’t get burned with a market order if you check to see if there is a market first. On the marginally liquid stocks I wait until the Bid and Ask are fairly close together. Then I place the market order. Sometimes the only market out there is a few jerks that place limit orders 5+% away from the last close. You can see these if you check before the market opens. They do this on purpose for low liquidity stocks just to catch a quick profit if someone places a market order overnight. They are the only ones that have an order outstanding. So their limit order is the market and you get burned. So always wait until the Bid and Ask are close.

Denny :sunglasses:

12

Interesting to note that Cybertrader now offers a per share or per trade choice. I don’t trade with them though.

Picture 4.png

13

Denny,

   What would you consider to be a close spread( bid and ask) on an illiquid stock? I too use market orders 90% of the time. Yet there are times that I get cheap and I don't want to pay the offer when buying. It seems as if that is always the time that the stock takes off and I end up chasing it. Also what would you consider illiquid on an average vol per day basis? 
    Thanx for any help    Jbarnh
14

Crakes,
can you elaborate on what you mean by
“BTW, do you have a backup broker to IB for “business recovery” purposes? I have be thinking that I should have one just in case a REFCO or other situation were to hit.”
I’m an IB customer, is there something I should know?

Thanks,
AB

15

AB,

When I signed up with IB, one of the many, many waiver pages to be read and signed stated that I, the customer, had a 2nd broker that I could use to take an offsetting position if the IB computer system had a failure. At the time, it sounded to me (a non-lawyer) that IB was protecting itself from potential lawsuits due to a computer failure.

Have you ever noticed how often IB’s TWS displays the red bar indicating that one or more future exchanges is not available? I do not know if the exchange itself is “down” or is it just that the IB-exchange link is temporarily off line?

Although I have a 2nd broker, I almost never use it due to higher fees. However, if disaster were to hit IB, I do have enough cash in the other broker that I could take out options to simulate exiting the stocks I have in my IB account. I have never had to use it.

Since I do not use margin and do not trade futures, I probably do not need the back up broker. I could financially survive while if I ever had to wait several hours (or even days?) for IB to get up and running again. However, if I were fully margined or had leveraged future contracts, I would want a back up broker in place.

o806