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i am developing a simulation trading in US stocks. i have 1 transaction a day per stock, assumed for simplicity to be executed at the daily closing price. in order to determine a reasonable maximal size for the transaction, i need some assumption concerning the liquidity of the stock. if the stock's daily turnover is X USD, i would like to know what would be a reasonable assumption for the transaction size relative to X, so that the transaction is considered small enough to be executed at the historical daily price. e.g. is 0.1X good enough?

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I have no real source for this, but my rule of thumb is 5% of ADV for trades executed from open to close. Be sure all information you use for this was available as of the previous day's close to avoid look-ahead bias. –  Tal Fishman Aug 14 '12 at 20:07
    
We've done a survey once on what window you'd have to use to estimate a price at which to trade a certain (fixed) amount of securities, minimising the distance to the final settlement price. We found that the VWAP within the last 17 minutes is within a .1% distance 99% of the time. But this approach needs constant monitoring obviously. So far we changed our initial finding of 14 minutes to 17 minutes. NASDAQ100 stocks btw. –  hroptatyr Aug 15 '12 at 7:00

1 Answer 1

The common practices are:

  • if you trade less than 8% of the Average Daily Volume, you can use a VWAP or Implementation Shortfall algo.
  • you need to "add" a slippage of 1/3 of the bid ask spread of the stock.

Your only issue is that you want to use the close price instead of the VWAP one. Best option is to use the daily VWAP as a proxy. Otherwise measure the std between the close and the VWAP and add a multiple of it to your "liquidity premium".

You can find more details in "Navigating Liquidity 6: A global menu for optimal trading" pages 42 and more.

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thanks. how did you come to these numbers? –  eyaler Aug 16 '12 at 15:42

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