# Determining maximum strategy capacity and optimal order size for low frequency equity strategy

I have developed a low frequency equity trading strategy that seems to work well with stocks in the S&P 500. Someone asked me about the maximum capacity of the strategy (how much AUM I could handle), and that led me to think about how best to determine how much of each stock I could trade, with the considerations of slippage, market impact, and creating a footprint in the market with a large order in mind.

My initial thought was to assume that I could safely trade (that is avoid undue cost and visibility) a small percentage of each stock's ADV, so the maximum capacity of the strategy would be the dollar value of the sum of x % of ADV of all of the stocks. If each order was then roughly say <1% of the stock's ADV, I would probably enter these orders as limit orders with a minimum display size and the rest in reserve, with the expectation that the market will work its way through my limit. While this would minimize slippage, I am concerned that predatory systems could pick up on the reserve quantity, and that that will provide information. I could layer the order in at different price levels, but that could be expensive. Any thoughts on this are appreciated.

I am also thinking about adding money management considerations to each order size (Kelly Consideration or Fixed Ratio), which may only further complicate the question of max capacity. Is there a general rule of thumb for determining capacity at a high level? Cheers

• What is the underlining quantitative financial model of the strategy? Are they any simulations using current market data? Aug 23, 2016 at 4:11

First it would help to know some more details about what you mean by maximum capacity.

However here are a few things to consider.

1. Do you have a simulator you use to simulate your strategy with market data?
2. If answer to above is yes then you can clearly see the linear impact due to market liquidity constraints for your increased size.
3. Now 2 is easy only if you take liquidity. If you actually provide liquidity it is more difficult.
4. That said 2 will atleast give you an estimate of the lower bound ( by lower I mean minimum friction).
5. you then also have to consider the market impact, adverse selection and all these are far more complicated.

So to summarize you need to know the edge you have and how much of the edge gets eaten up by each of the successive steps above. Hope this was helpful.

• For maximum capacity I mean the maximum dollars I can realistically trade with the strategy, given the trading frequency, slippage, temporary and permanent market impact, and visibility concerns. Put differently, say you were starting a hedge fund and you wanted to determine how much AUM you could handle with a particular strategy. Jan 19, 2016 at 3:31