Traders' Roundtable

Hello there,

I have a question and can't find detailed reference on the web. I'd be pretty appreciated if anyone could give me a hand by answering the following questions: In your view, which type of systems are most suited for traders to trade in a illiquid market? Or, which aspect should be emphsized in contrusting a trading system which is aimed at a illiquid market?

Best regards, and thanks in advance.
cnyub.

All markets are illiquid if you're trading large enough size. If your typical order is >25% of the daily trading volume, that market is extremely illiquid for you.

So the first thing to do is look at the distribution of daily trading volume. I'd suggest you look at the 30th percentile of the distribution, i.e. the volume V such that 30 of the past 100 days have a volume less than V, and 70 of the past 100 days have a volume greater than V. Compare that against your expected order size. Will you be pushing the market around? If so then it's illiquid.

I imagine the criteria below would be beneficial when trading an illiquid market

1. Counter-trend method. Buys when prices are falling, sells when prices are rising.
2. Average profit per share per trade is at least 1.0*ATR and, preferably, at least 1.0*MaximumDailyMove.
3. Uses Limit orders to enter and exit
4. Was backtested in Veritrader assuming 100% Slippage and still showed profitability
5. Trades at non-popular times/prices (i.e. not during public frenzies such as at channel breakout points)
6. Fewer trades with larger profit per trade, than in very deep liquid markets.

Illiquid markets often appear attractive because of their seemingly exploitable and large price swings. They may also trend well.

However, tremendous care should be taken as it is often much easier to get into these markets than to get out !!

You might want to (re)read Reminiscences of a Stock Operator. Lots of commentary on getting out of unwieldy positions...

All markets are illiquid if you're trading large enough size. If your typical order is >25% of the daily trading volume, that market is extremely illiquid for you.

25% !

I’m hoping that I eventually have this problem in the S&P and TBond futures.

Liquidity is only an issue when YOU want to trade.

Unless you are in a hurry (never a good way to trade) Limit orders can ensure you get a reasonable fill in illiquid markets.

If want to get out, and choose NOT to join the stampede for the exits, then limit orders, even if executed over a period of time, can still get you the price you want. However, it takes some courage to sit through all the volatility.

Personally, if I found myself dumping positions in a hurry, and getting horrendous fills as a consequence, I would begin to question the validity of a strategy that put me into these positions in the first place.

To paraphrase the pilot's adage;

It is better to be out of the market wishing you were in, than to be in the market wishing you were out.

Tom