Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

V. Trading Performance Measurement

who exhibit little deviation in performance measures are consistent, while those who often have extreme scores are gambling or taking risks. (b) Weighted RPM When intermediaries have discretion over how they execute orders within a specific horizon, the RPM based on all market activity traded in that horizon reflects their ability to work orders and seize the best available trading opportunities. However, when the trader is given a predefined execution strategy, using the RPM over the entire trading horizon may provide noisy performance measures when the instructions or constraints set by the investor are not neutral. This is the case when they force traders to execute the majority of shares at times of the least or most favourable prices. For example, an aggressive strategy in a falling (rising) market will refer to a low (high) RPM for buys, suggesting poor (good) performance. 29 To avoid noise and really distinguish between trading performance and investor constraints, the RPM must be adjusted upon the specified strategy as follows:

the trader did a good job since 80% of market activity traded at less favourable prices than he did. If the order had been a buy, all market activity higher than € 31 would deliver a RPM of 20%, indicating poor performance.

Figure 12: Relative performance measure

29 - We have a similar phenomenon on the sell

The RPM is superior to any other benchmark-based performance measure because it provides a meaningful metric that is consistent across days and across stocks. Suppose, for example, that a trader’s performance measure built on a benchmark is 15bp in stock A and 40bp in stock B. As we mentioned earlier, this information cannot help determine if this was good or bad performance or make any comparisons across stocks. By contrast, if the trader has an RPM of 20% in stock A and 75% in stock B, we can easily determine that the trader did badly in stock A but very well in stock B. This means that the trading performance was better in stock B than in stock A, even though the trader has a better benchmark score in stock A. These conclusions are meaningful and easy to reach with the RPM since it is consistent over time and across stocks. Furthermore, using a sufficient number of observations and analysing the distribution of RPM facilitates a reading of the consistency of intermediaries. Those

side. An aggressive strategy in a falling (rising) market will deliver a high (low) RPM for sells, suggesting good (poor) performance. A passive strategy will result in the opposite.

x

j ∑

j X RPM j

RPM * =

,

where RPM j

is the RPM computed over

the trading period j , x j is the quantity to execute in period j and X the total order size. This weighted RPM attempts to provide insight into the quality of prices obtained by the trader during the times he is requested to trade.

(c) Measure of value-added When intermediaries deviate from

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