Barrow Boys (and Girls!) with Degrees

The Theory and Practice of Equity Trading

Trading and Investing• Important distinction between Investing and Trading.• Investment theory has a good pedigree as an academic

subject.• Trading is about converting an investment decision at the

least cost point.• Trading is also about price discovery. The investment

manager will have an idea of the equilibrium price but this could change in a dynamic and fast moving situation.

• Trading is also about finding price discrepancies and exploiting these for profit

Order Arrival

• Orders to buy and sell will arrive during the market day.• The Trader may be a short-term trader with orders to work

for a client or working for a pension fund or hedge fund.• Traders don’t have the luxury of time. Their decision is to

buy sell or wait.• To assess the market the good trader gauges the balance of

buy and sell orders• At above equilibrium prices the arrival rate of sell orders

are faster than the arrival rate of buy orders.• Similarly at prices below some notional equilibrium, the

arrival rate of buys are greater than sells.

Price Discovery

Bid

Ask

Sells Buys

P*

Students play - Informed Traders

• Informed Traders – agents who trade knowing that the current price level has diverged from the fundamental.

• Buy orders are sent to market if P* (fundamental) > P (actual)• Sell orders are made when P* < P. When P* > P(offer) or P* <

P(bid).• In the theoretical world of costless trading, complete markets,

instantaneous information dissemination, price adjustments are instantaneous.

• In reality prices adjust rapidly with ‘new’ news, but news could be changes in fundamentals, uncertainty, rumour or noise.

• The informed Trader will exploit information and act with a short lag to news about fundamentals.

Students play - Liquidity Traders

• Idiosyncratic reasons for trade. Sometimes called ‘noise traders’.

• Liquidity traders differ in that they issue both market and limit orders but informed traders submit market orders only.

• Liquidity traders will not drive a price back to some previous level or reinforce a trend because informed traders drive the price to equilibrium.

Students play - Technical (Momentum) Traders

• Market technician – using chartist analysis• Algo trader – using a black-box device• Arbitrageur – exploit price inefficiencies to

profit.• Market maker or Day Trader – profiting

from the bid-ask spread or profiting from changing market conditions to buy low and sell high.

What Drives a Market?

Trading MechanismOrder Book, Market Makers, Call Auction

Informed

Is p*>offeror p*<bid?

LiquidityOrder Flow

Quotes,Prices,Volume

Momentum

Is there a trend/pattern?

P*

How is the Trading Room used? Simulation

1) Make trading decisions

2) Understand price discovery

3) Evaluate trading rules for:– market participants

– intermediaries and dealer roles

4) Compare alternative market systems

5) Have Fun

Computer’s Role

Establish “market background”– Generate order flow

– Update display and bid-ask quotes

2) Give participants orders to execute3) Maintain transactions records for

subsequent analysis on– Participants’ order placement decisions

– Market quality (e.g., bid-ask spread)

Order book marketOrder book market

Ask: 213 Ask: 213 offered at offered at

20.6020.60

20.40 Bid 20.40 Bid for 59for 59

Can enter Can enter Chat Chat

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TraderEx Software

• Currently part of year 2 modules in BSc Banking & Finance, BSc Accounting & Finance and BSc Economics & Finance.

• Plan to introduce a dedicated module on market trading and microstructure of financial markets.

• Offer to MSc courses in the Economics Section and Accounting & Finance Section

Assessment

• Year 2 students will get 1 hour assessment on TraderEx

• Not evaluating just the performance as a Trader

• Information will be fed to the market by the Administrator and P* will move.

• Students must interpret information and make trade decisions.

Reuters3000 Xtra

• Data based real time information service for financial professionals.

• Real time data from global financial markets.

• Performs complex analysis with pre-built models and customised calculations.

• Use of historical data for research. Strong charting capabilities.

Facilitate Training

• Reuters-Thompson Certification following a 1-hour online exam.

• Training provided by Reuters-Thompson• One 2 hour lecture + 2 hour Q&A. • Self training of 5 modules. Drop-in sessions• 80+ students from MBA, MSc, year 3

students have applied to do the training and take exam

Financial Markets Forum

• Facilitated by Dr Svetlana Taylor (A&F)

• Run by Anthony Davies former partner J P Morgan and Consultant

• Every Thursday evening 50+ students.

• Share price research done using the Trading Room.

• Lets go down and have a look!