There are a number of ways that a trader may self-sabotage execution:
1. Not having a clear idea of what he is trying to accomplish.
2. Incorrectly identifying the current market conditions and/or selecting an inefficient execution strategy.
3. Lack of urgency when conditions are favorable.
4. Indecision in a fast-moving market.
5. Panicking, and either freezing or thrashing around in the market.
6. Accidentally transacting at an unintended price or incorrect volume by fat-fingering, mis-clicking, or out-trading.
7. Being a passive participant in the market.
Not Having A Clear Idea of What He is Trying to Accomplish
The trader must know the volume he intends to transact and the price that would trigger execution, both of which should have been predetermined in the trading plan. Attempting to sell 1,000 lots at the trader’s $100.00 price target if the market prints at that level is vastly different from wanting to “sell a little, if prices get a bit higher.”
Incorrectly Identifying the Current Market Conditions
Traders who are not active, regular participants in the market are at increased risk of misreading the subtle cues that indicate participant interest, or lack thereof. How is the market trading? Is the intraday trend, if one exists, constructive for the trader’s position and execution plan? How much volume is going through at each price point, how wide are the bid/offer spreads, and how large are the trade-to-trade gaps? If the market is granular enough to observe individual transactions, are bids getting hit or offers getting lifted? How is the market re-framing after each transaction?
If the trader needs to be a buyer and the last 47 trades in the OTC market have been a seller hitting the bid and aggressively trying to get them to double the ticket, there is no need to wade in and start lifting offers like a madman. It would be more productive to sit on the bid and wait for the selling interest to work down to their level.
Conversely, if the trader needs to be a buyer and the last 47 trades in the OTC market have been offers getting lifted and the buyer aggressively asking to double the ticket, sitting on the bid will be unproductive. The trader will have to compete for offers with the aggressive buying interest, or wait on the sidelines until the sentiment changes and motivated sellers emerge.
There is no substitute for market feel, and no shortcut to acquiring it, so in its absence a trader should not attempt to outsmart herself. She should find the best price and the best liquidity and execute as efficiently as possible. Traders that are immersed in the market and in tune with its rhythm will be better able to recognize favorable conditions, allowing them to utilize more of the intraday ebb and flow to wait for better prices and identify pockets of liquidity.
Lack of Urgency When Conditions Are Favorable
Squandering favorable market conditions is the most perplexing, frustrating execution error. Assuming that the trader has a defined plan and is engaged and paying attention to the market, there is no excuse for failing to hit a bid or lift an offer at the desired price and volume. Most commonly, the trader is either assuming that the market will hang around at his preferred level until he deigns to transact, or he is hoping that the price will continue to improve. More often than not, the market will move away from the trader’s target level or another, more aggressive participant will deal on the price.
Indecision in an Unfavorable, Fast-Moving Market
Trying to efficiently execute a runaway market is one of the most frustrating things imaginable, particularly if the trader isn’t 100% clear on the objective. In any proper market explosion or meltdown there will be an inflection point where the price action goes from bad but still orderly to a disorderly melee, with any offer getting lifted or any bid getting hit, regardless of quality. A trader attempting to accumulate a position has the ability to sit on her hands and wait out the madness. A trader trapped in a bad position has no such option, and will have to shift from an idealized “buy/sell at X” to “buy/sell anything better than Y,” and if the market blows past Y, start considering Z, ZZ and ZZZ.
No trader is immune to panic, and sooner or later a combination of a bad position in bad market conditions will test the discipline of even the strongest, most iron-willed risk-taker. Most commonly a trader will either freeze up and become a passive participant in his own demise, or fall prey to the fight-or-flight instinct and hack and slash his way out of the position, irrespective of the P&L damage.
Fat-Fingering, Mis-clicking, and Out-Trading
Things can get hectic on a trading desk, particularly when the market is moving rapidly and/or the trader has an unusually high level of stress. When a fast market meets a distracted trader, the result is often a fat-finger, mis-click, or an out-trade:
• Incorrectly entering a component of a trade when posting an order to an exchange is called fat-fingering, and commonly manifests itself in a misplaced decimal (buy 1,000 shares at $5,900), a trailing zero added or subtracted (buy 100 or 10,000 shares at $59.00), or the transposition of two numbers (buy 1,000 shares at $95.00).
• A mis-click occurs when a trader scrolling around on an exchange screen for some unknown reason randomly presses a mouse button and executes an unintended trade. Bonus points are awarded for mis-click trades caused by spilling a drink on the keyboard or having the mouse hit by a thrown object. A different, less clumsy variety of mis-click occurs in a fast-moving market, where it is possible for the best bid or offer to disappear in the time it takes a trader to physically depress the mouse button. Unless the trader is quick enough to notice that something is different and stop, she will transact on whatever price and volume is next in the stack, no matter how large or small, cheap or expensive.
• An out trade is the verbal over-the-counter equivalent of a mis-click, and occurs when the broker and trader have not communicated properly about the product and/or price under negotiation. There are endless varieties of the out-trade, but the most common are price discrepancies, trading the wrong instrument or maturity, or both parties thinking they are the buyer or seller in the transaction.
Fat-fingers, mis-clicks, and out-trades are purely mechanical errors that can and should be preventable, if the trader has time to verify that what he is actually doing is what he thought he was doing.
Being a Passive Participant in the Market
If there is no bid-offer spread at all, the trader will have to decide if it is worth the risk to act as a market maker to add liquidity and provide some structure to the market. The trader who makes the market should get the first look at any countering bids and offers from interested participants, drawing transactional volume toward the market maker’s prices.
The easiest path to good execution is having a sense of the plan of action and implementing it as efficiently as possible at the first opportunity.
From Chapter 13 - Trading Mechanics, Pages 525-528.
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Excerpt from Trader Construction Kit Copyright © 2016 Joel Rubano. All rights reserved. No part may be reproduced in any form or by any electronic or mechanical means, including information storage and retrieval systems, without permission in writing from the publisher, except by reviewers, who may quote brief passages in a review.