Most traders and investors ignore this very important rule. They believe that identifying a good stock and managing the risk is good enough. For your information, trading details are not for clerks to worry about. When you buy a little higher and sell a little lower, your total cost of trading is adding up over a longer period of time. And you are missing the icing on the cake!
Why order execution is so critical
A delighted investor told me that his investment had earned an incredible return of 12% in a 3-month period between May 2014 and August 2014. I was hardly surprised, considering that the market was up 30% during this period. In such a raging bull market, a 12% return was nothing to write home about. But it set me thinking on a different trajectory altogether!
How did a smart investor, who had actually bought quality stocks, make just 12% against the market return of 30%? Was it a case of bad execution of trades by the broker or bad instructions given by the gentleman? It turned out that it was a bit of both. The client had never evaluated the cost of bad execution and the broker really missed the point. But look at the cost!
It may be unfair to attribute the entire difference in return to bad execution but therein rested the chunk of the blame. Let me explain. If Tata Steel moves from Rs.400 to Rs.600 in a year, and you trade in and out 5 times during a year and don’t get best buying and selling prices, your returns can be as low as 15%. That is roughly 35% return per annum sacrificed. That sure looks big!
3 COMMON WAYS OF BAD EXECUTION:
Blindly placing market orders
You have a full day to get the best price, then why hurry to execute at the market price. Market prices on screen can be elusive and misleading, especially when automated strategies are at work. Set your price!
The Cardinal Blunder of over trading
Overtrading impacts your returns in two ways. Each time you enter and exit, you miss out on the secular movement of a stock. Secondly, brokerage, STT and other statutory costs have to be paid on each leg. Forget it!
Setting a stop loss too close to your trading price
A stop loss should not be just based on technical levels. It should also depend on the volatility in the market. If you place close stop losses in volatile stocks, you are likely to end up with your stop losses triggered. Isn’t that obvious!
“Play the market only when all the factors are in your favour” – Jesse Livermore
6 REASONS WHY PEOPLE EXECUTE TRADES BADLY
- More often than not, we are in a hurry to get our trades executed. We look at the last traded price and just push in our order at market price. Remember that you can buy at the best sell price, subject to available liquidity in the market. And over a period of time, this really adds up!
- Don’t go by the ticker on the TV screen. Most TV tickers and website tickers come with a pricing delay of 5-10 minutes. In a volatile market, these small delays can make a huge dent. Your sole authentic source of price and volumes should be the trading terminal. You can surely trust that!
- Bulking up your buying and selling orders. If a great stock has corrected 25% in a month, don’t jump in to invest all your funds in one go. Such a sharp fall is normally followed by more sell-offs. Spread your purchase over a period of time, so that you get the best price possible. Makes more sense!
- When you take a secular view on the market, why not take a secular view on the stock too. Keep trailing stop losses for exigencies and hold on. When you overtrade, the brokerage and statutory costs surely add up.
- The ideal strategy in market should be to buy on expectation and sell on announcement. What is the point of buying Larsen & Toubro, when the whole world knows that they have got a big order? That is when the smart money is booking out and buyers are giving them liquidity support.
- The devil lies in the details. Get into these details. Don’t leave the onus of execution on your dealer or trader. Specify the price and quantity clearly; don’t leave it to the discretion of the dealer. Review the minimum flat brokerage clause. You may be paying a bomb on penny stocks and may not realize it. Brokers do charge higher brokerage for small stocks but you must be aware of the same.
WHY EXECUTION IS SO CRITICAL IN PRACTICE:
Unfavourable execution for small investors is nothing new. In his bestseller, “Flash Boys”, Michael Lewis brings how a mix of electronic trading and favourable server location is helping large traders get the execution advantage over small investors. You surely do not have a control over such matters, but you surely have a control over what price you want to buy and what price you want to sell. When you trade aggressively in and out of the market, you become a virtual market maker. You also end up providing liquidity at a cost.
When you trade options, thinking that brokerages are low, think again. You need to read the fine print. Let us say a broker charges you Rs.100 per lot. On an Infosys option with a lot size of 125 that is 0.80 per side or Rs.1.60 on a round trip. Add taxes and it is Rs.2 per share. When you buy an OTM Infy call at, say Rs.10, you incur 20% as execution cost. Now it looks different, right?
TAKEAWAYS FROM THE “LEARN TO EXECUTE” DEBATE…
Michael Lewis rightly says that market trading has changed more in the last 8 years than in its entire 200 year history. For the first time you realize that the screen may be lying. Even Jesse Livermore, who was a great advocate of watching the tape, must be a disappointed man. Caution and smartness are the two weapons that investors need to rely on.
The SEC of the US has outlined 4 rules on its website, which sums up the gist of execution of trades. Trade Execution isn’t instantaneous; your broker has options for executing the trade; you have options of directing the trade; and your broker has the duty of Best Execution! The investor has to take the ownership of trade in his own hands. That is the message!