Trade Execution Across Asset Classes

Different asset classes exhibit unique market structures, liquidity conditions, and trading mechanisms. Understanding these distinctions helps select the most effective execution strategies.

1. Equities

• Market Structure:
  • Primarily traded on stock exchanges (lit markets) and dark pools.
  • Equity markets are technologically advanced, with most trading conducted electronically.
• Execution Characteristics:
  • Algorithmic Trading: Common due to liquidity and high technological adoption.
  • Dark pools reduce information leakage for large trades.
• Execution Methods:
  • Scheduled Algorithms: Appropriate for passive, low-urgency trades.
  • Liquidity-Seeking Algorithms: Used for larger or more urgent trades in fragmented liquidity environments.

2. Fixed Income

• Market Structure:
  • Vast number of heterogeneous securities (e.g., multiple issues per issuer).
  • Typically low liquidity with large order sizes.
  • Predominantly dealer-based, quote-driven markets.
• Execution Characteristics:
  • Electronic RFQ (Request-for-Quote): Growing but limited to liquid instruments like on-the-run U.S. Treasuries and futures contracts.
  • High-Touch Execution: Dominates for most fixed-income securities.
• Execution Methods:
  • High-Touch Principal Trade: Used for urgent, large trades requiring immediate execution.
  • High-Touch Agency Trade: Suitable for less urgent orders to minimize costs.

3. Exchange-Traded Derivatives

• Market Structure:
  • Transparent and electronically traded, with centralized exchanges.
• Execution Characteristics:
  • Futures: More suitable for algorithmic trading due to their liquidity.
  • Options: Less suited to algorithmic trading because of their complexity.
• Execution Methods:
  • Direct Market Access (DMA): Common for buy-side traders.
  • Algorithmic Trading: Limited compared to equities but increasingly used for futures.

4. OTC Derivatives

• Market Structure:
  • Dealer-based, quote-driven markets dominate.
  • Regulatory shifts since 2008 (e.g., Dodd-Frank Act) have encouraged greater transparency and central clearing for simpler products like interest rate swaps.
• Execution Characteristics:
  • High-Touch Execution: Required due to the complexity and customization of OTC derivatives.
• Execution Methods:
  • Principal Broker Risk Trades: For large, urgent trades.
  • High-Touch Agency Trades: For less urgent, cost-conscious execution.

5. Spot Foreign Exchange (FX)

• Market Structure:
  • OTC market with three tiers:
    1. Interdealer (largest trade sizes, smallest spreads).
    2. Interbank.
    3. Bank-to-Client (smallest trade sizes, largest spreads).
• Execution Characteristics:
  • Combination of electronic trading and high-touch broker approaches.
  • Spread and liquidity vary by trade size and market participant tier.
• Execution Methods:
  • Large Urgent Trades: RFQ with brokers to secure liquidity.
  • Large Non-Urgent Trades: Scheduled algorithms or high-touch agency approaches to minimize impact.
  • Small Trades: DMA for direct, cost-effective execution.

Key Takeaways by Asset Class

Trade execution varies significantly across asset classes due to differences in liquidity, market structure, and trade urgency. Selecting the right method ensures efficient execution, cost minimization, and alignment with portfolio objectives.