Trading

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Allocation of Brokers

Every investment firm worked with a number of brokers. The management team and in-house traders will decide how many orders to give to each broker. The management can favors one broker more than another broker. The criteria of allocation depend on the transaction cost, execution speed, trading services and investment information supplied by the brokers.

Most investment clients require the fund management company to be transparent on the brokers’ selection and allocation process. The clients would also prefer the fund management company to put in place a "Trading Best Execution Policy".

Trade Blotters

Traders are market and stocks specific. When they received all the orders from the front office system, the information traders required is the aggregated orders of each stocks.

Although funding problem has to be resolved by the front office system, it is imperative that communications between the traders and fund managers are maintained. Traders could provide market information and inform about the market conditions. Traders could advise fund managers in term of the practicality of the price limit orders.

 

Pre-Trade Analysis and Planning

Looking at the trade blotters in the aggregated form, the traders will formulate their trading strategies and plan for the trading day.

Generation of trade blotters is easy. You need to add all ‘Buy’ orders for each stock and add all ‘Sell’ orders for each stock. 

Before the market opens, traders will start calling brokers and distribute orders among the brokers. It is easier for traders to allocate certain stocks such as Stock A to Broker A and Stock B to Broker B. Some investment firm prefers to split up Stock A between Broker A and Broker B. This will complicates allocate later.

The most commonly used platform and messaging system is Bloomberg.

Trading and Management of Brokers

Although traders generally leave the trade orders to the brokers for best execution; traders will still need to monitor the market condition so that they can advise the broker or change the outstanding order when market conditions changes. The traders will use the opportunity to evaluate various brokers’ ability to fill the orders at the best market price.

Allocation

Once the trade is completed, this is the time where traders start considering allocate the shares to each portfolio according to individual orders for each portfolio. Smaller investment firms require their trader to perform such allocation manually. Bigger investment firms rely on trading systems to perform trade allocation. The most common algorithm used in trade allocation is round robin allocation.

Round Robin Allocation

Assuming we have a BUY order for a particular stock with allocation as shown below:

Portfolio A	1,000,000
Portfolio B	200,000
Portfolio C	50,000
Portfolio D	4,000
	1,254,000

  

There is a total of 1,254,000 shares good-till-cancel market order. The lot size is 1000 shares. Only 50% or 627,000 shares are being executed for the day. The round robin algorithm will allocate 1000 shares for each account and portfolio D’s order will be filled in the 4^thround. This can be a disadvantage to the larger portfolio.

To ensure fairer allocation, a lot size round robin will be allocated for each account in the first round, after which, the algorithm will based on percentage of order filled and the system will favors account with the least percentage of orders filled. The system will ensure that all accounts will reach the same percentage before another round robin allocation is applied.

The following table shows part of the allocation process:

		1st Round	% Allocation	2nd Round	% Allocation	3rd Round	% Allocation	4th Round	% Allocation
Portfolio A	1,000,000	1,000	0.10%	4,000	0.50%	1,000	0.60%	4,000	1.00%
Portfolio B	200,000	1,000	0.50%	-	0.50%	1,000	1.00%	-	1.00%
Portfolio C	50,000	1,000	2.00%	-	2.00%	-	2.00%	-	2.00%
Portfolio D	4,000	1,000	25.00%	-	25.00%	-	25.00%	-	25.00%
	1,254,000

The first round robin, all accounts are given 1000 shares. Subsequently, the system will favor the bigger account until it reached 0.5%. Then, the system will allocate equal shares to portfolio A and Portfolio B. After that, the system will favor portfolio A again until its share reaches 1%. And the system will continue similar way of allocation until all available shares are allocated.

Investment firm can set their policy to raise the marker of 1% to 20%. This means that the system will allocate equal lot size for all portfolios below 20%.

For different brokers with different allotment of a single stock, the system can perform trade allocation for Broker A and use the statistics to continue allocation for Broker B.

Pricing of Traded Stocks

During the course of a trading day, a broker may buy the same stock for different prices depending on the time of the day and market condition. The common practice is to average the price for each trench of stock, so that every portfolio have an equal pricing.

For different brokers transacting for the same stock, each broker will be willing to average the price they transacted however you will have different price for different block of shares transacted by different brokers. This creates additional problem in fair allocation. 

VWAP

VWAP is known as Volume Weight Average Pricing. It is a calculated price use primarily by traders and brokers to measure the execution of trade. It is a measurement preferred because VWAP ignore temporary spike in prices which was transacted on very low volume.

The formula for VWAP =

Where P is price of each trade t, Q is the quantity of each trade t

VWAP for a stock involves adding all the transaction value in the exchange. Only the exchange and larger trading platform such as Bloomberg can compute VWAP since it involves computing all the trade transacted for the day.

If the transacted price of a 'Buy' order is higher than VWAP; this means that the broker who executed this trade is unable to execute at market price and vice versa.

We can also compute VWAP internally by computing the VWAP based on the all the transaction for a stock. Then we can measure the local VWAP against market VWAP.

VWAP is used by traders to measure performance of each broker. Clients in turn use VWAP to measure the performance of the trading desk of the investment firm.

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