Gregoriou, The Handbook of Trading

The Handbook of Trading: Strategies for Navigating and Profiting from Currency, Bond, and Stock Markets edited by Greg N. Gregoriou (McGraw-Hill, 2010) is a collection of twenty-nine papers written primarily by academics. The contributors span the globe and use data from a range of markets. The topics covered include momentum trading, technical trading, ETFs, algo trading, trading volume, and trader psychology.

In today’s post I’ll share a few insights from this book. First, a topic that many books gloss over—the costs and benefits of limit order trading. Here I am drawing from the paper “Order Placement Strategies in Different Market Structures” by Giovanni Petrella.

Assume a continuous order-driven market. Limit order traders face two kinds of risk: the risk of an adverse change in the stock price (winner’s curse) and the risk of the order not executing. The order will execute only if an impatient trader arrives on the other side of the market to buy liquidity or if price movement in the stock temporarily shifts direction. What the limit order trader is looking for, and what is a natural property of order-driven markets, is temporary intraday volatility where negative returns tend to be followed by positive returns and mean reversion rules. As Petrella writes, “Transitory volatility is generated by traders demanding liquidity and the price bouncing back and forth between bid and ask quotes which is also called inefficient volatility since such price movements do not improve the price discovery process.” (p. 86)

Petrella suggests that it is wise to use limit orders on high volatility days or with high volatility stocks. “Traders might even place limit orders on both sides of the market, acting as market makers, to benefit from accentuated intraday volatility.” (p. 89)

The second paper I want to touch on here is “Trading and Overconfidence” by Ryan Garvey and Fei Wu. The authors conclude, based on data collected between 1999 and 2003 from a U.S. broker-dealer whose clients traded mostly NASDAQ-listed stocks, that: “1. Traders learn from their prior successes and become overconfident. 2. Overconfident traders experience lower performance. . . . 3. Experience matters. Traders become less overconfident over time.” (p. 418)

The last paper I’ll highlight here is “The Impact of Hard versus Soft Information on Trading Volume: Evidence from Management Earnings Forecasts” by Paul Brockman and Jim Cicon. Hard information is quantitative; soft information, qualitative. The authors used the software package Diction to analyze company-issued guidance press releases between 1994 and 2007. They measured the level of two soft information variables, optimism and certainty, in each forecast. Optimistic language endorses a person, group, concept or event. Certainty focuses on resoluteness, inflexibility, and completeness. The authors found that “qualitative information associated with greater optimism increases investors’ propensity to trade, while qualitative information associated with greater certainty decreases their propensity to trade.” They also found “no significant relation between abnormal trading and quantitative information.” (p. 352)

The book’s official website, by the way, has over 300 PowerPoint slides related to the articles available for download.