Estimating Realistic Volume Limits & Trading Capacity Estimates

Quote from CPTrader:

A salient issue in system development is the twin issue of realistic volume limits and trading capacity; that is:

1. How much volume can you trade in a particular market and

2. Given the above for each of the markets in your portfolio what is the maximum asset capacity for your trading strategy.

These two issues are of course heavily impacted by market venue (pit or electronic exchange) and market order type.

For the course of this discussion lets consider the following assumptions:

1. Order Type: Limit Orders only

2. Market Venue: Electronic exchanges/Interbank FX

3. Trading Times: all markets trade for 22-24 hours a day/5 days a week

4. Markets: Electronic Indices, major FX pairs, Interest Rate Futures, Crude Oil, Gold,


Ideally we should have:

A. VOLUME LIMIT (VL) = A percentage of average daily volume and

B. TRADING CAPACITY (TC) = derived from VL and your money management algorithm. Let's use a simple money mgmt algo where you limit your margin usage to 20% of account equity (MER).

In this case TC = Sum of VL * Average Daily Volume * Margin for each market divided by MER


My thoughts are VL should be no more than 1% of average daily volume.

What are your thoughts on this issue?

What’s the ideal/most realistic VL estimate?

What other methods exist to estimate market impact and volume limits?

Lets have an intense, focused and insightful debate on this important issue.

Many Thanks.
More...

At some point full time traders do have to consider "volume limits" and "trading capacity" for what they trade.

I trade outside of your four assumptions for the most part so I have had to consider these things differently than you do.

Through these considierations, I have a very different view of how things work compared to what you are inquiring about.

There are some serious considierations in trading when it comes to optimizing market participation. It can be very costly if a person has the wrong trading priorities and objectives.

As I see what you have put on the table, you are inquiring because you are anticipating this and that in the future. When a person actually has to deal with these situations it is from a very different viewpoint in my opinion.
 
Quote from CPTrader:

What are your thoughts on this issue?

What’s the ideal/most realistic VL estimate?

What other methods exist to estimate market impact and volume limits?
More...

What you're asking is very strat dependent. If I had some arb strat that rarely misses, 1% would be way too conservative. If I had some trend strat that always got hyper illiquid right when I needed to bang out, then 1% might be too risky.

So, the ideal is case dependent, and only you can really say, based primarily on your knowledge of the strat's characteristics, then on mkt liquidity and volatility.

Re: methods.... liquidity analysis specific to your strat/mkt (vola as well if you want to get fancy).

This is a tough topic though when you're pushing the limits of size for your given mkt. After doing all the above, you'll really only know until after you gotten stuffed a few times.
 
Kaufman offers an algorithm in his book "New Trading Systems and Methods." This book actually has detailed studies of a lot of questions asked by ETers. Worth getting. I think one is generally concerned about fill time and inherent slippage, not whether the fill will happen.
 
There is something called the Amihud measure that approximates liquidity with a linear regression daily returns on trading volume. You read it as "it takes X volume to move the stock 1%". I don't have time to find a reference right now but I'm sure google would work, Amihud is a finance prof who probably has a website.

Out of the box it is a blunt instrument that gives decent relative liquidity rankings when you compare stocks or instruments but probably won't actually answer your question. You might be able to use the same idea but get a more accurate measurement by using a shorter time frame and using volume imbalance instead of raw volume.
 
"1. How much volume can you trade in a particular market and

2. Given the above for each of the markets in your portfolio what is the maximum asset capacity for your trading strategy."

With the maximum account size you can bring to a market and interact with it, do you (i.e. the banks) make a better return if you can bring an account size big enough to be the liquidity-provider (or one of the majors) of said market??

What are their trading strategies??
 
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