Topic 2
©R. Schwartz
Equity Markets: Trading and Structure
Slide 1
Purpose
1) Experience what trading involves
– Tactical, fast decision making
– Be a prop trader, buyside equity trader, market maker
2) Participate in a process that translates news into prices
3) Evaluate the effects of trading rules and alternative market
structures on:
– Investor participants (the naturals)
– Market maker intermediaries
– Market quality
4) Compare and understand alternative market structures
5) Compete and have Fun
©R. Schwartz
Equity Markets: Trading and Structure
Slide 2
An Important Distinction
Simulations can be based on either
1. "Canned" data from past events
2. Computer-generated data
TraderEx is based on computer-generated orders and
price changes – not canned repeats of past events
©R. Schwartz
Equity Markets: Trading and Structure
Slide 3
A Trading Simulation Requires
• Prices can be affected by your actions
• You have some basis for anticipating future price
changes
• Prices can move in harmony with news releases
• Prices do not follow random walks
• Simulation runs can be replayed
• Your performance can be assessed
©R. Schwartz
Equity Markets: Trading and Structure
Slide 4
Performance Assessment
1. Performance characteristics
–
–
–
–
Profit and loss (P&L)
Beat Volume Weighted Average Price (VWAP)
Control risk (avoid large inventory positions)
Get the job done (execute your orders, liquidate
your positions)
2. Your Score
– Weighted combination of the above
©R. Schwartz
Equity Markets: Trading and Structure
Slide 5
What Drives Trading?
Machine generated order flow is based on draws from
various statistical distributions. We can view the statistical
events as representing solid economic stories.
Economic stories concerning the motives for trading
1.
2.
3.
4.
New information (news)
Liquidity motives
Technical (noise) trading
Divergent expectations (people disagree with each
other)
©R. Schwartz
Equity Markets: Trading and Structure
Slide 6
Orders Come from 3 Types of Traders
Informed
Liquidity
Order Flow
Technical
Trading
P*
Quotes,
Prices,
Volume
Is p*>offer
or p*<bid?
Is there a
trend/
pattern?
Do the informed
Traders agree with
each other? maybe not!
Trading Mechanism
©R. Schwartz
Equity Markets: Trading and Structure
Slide 7
The Economic Story Behind the
Consensus Price, P*
Ask
Bid
P*
Ask
Bid
Sells
©R. Schwartz
Buys
Equity Markets: Trading and Structure
Slide 8
A Typical Random Walk Pattern Of P*
$28.00
$27.00
$26.00
$25.00
P*
$24.00
$23.00
$22.00
©R. Schwartz
Day 1
Equity Markets: Trading and Structure
Day 2
Slide 9
P* and Best Bid and Offer Quotes
$28.00
$27.00
$26.00
$25.00
$24.00
$23.00
P*
Ask
$22.00
$21.00
Bid
Day 1
©R. Schwartz
Equity Markets: Trading and Structure
Day 2
Slide 10
P* and News
1. In simulations P* need not change
according to random draws from a
distribution
2. When united with news release, new
P* values are set in accordance with
the news
©R. Schwartz
Equity Markets: Trading and Structure
Slide 11
Price (5¢ Tick Size)
Distribution For Generation of
Liquidity Motivated Sell Orders
26.60
26.50
Limit sell orders
26.40
26.30
26.20
Offer
26.10
Bid
26.00
25.90
Executable sell orders
25.80
0%
2%
4%
6%
8%
10%
12%
14%
Probability
©R. Schwartz
Equity Markets: Trading and Structure
Slide 12