Trading Strategies For Publicly Informed And Privately Informed Participants

You are required to complete a report after the labs sessions in Weeks 5, 6 and 8. You should select two trading sessions played in those three weeks. You should select the two sessions where you can make the most insight comments. 

Effect of trading by informed traders and liquidity traders

In this session I was trading as an informed trader, hence, I had information about the prediction of the true value of the stock. The objective of this session was to examine the effect of trading by privately informed investors and liquidity traders on the price discovery process. My objectives were to make a profit from the private information, make accurate transactions and limit the impact of my trades on the price of the stock by making many small orders to avoid disrupting the market balance. In this session, I expected the informed traders to take advantage of any market mispricing compared to the predicted value of the stock, as they are privately informed. The informed trader would be expected to sell share if the predicted value true value is less than market value and buy the stock when the predicted true value exceeds the market price of the share so as to maximize their profits. These informed participants will trade in a small batch to avoid disclosing their information to other traders through the flow of buy/sell orders. For example, if the informed player places large buy order the other players will study the information implied by this large buy order hence wait for the price to increase rather than sell at that moment. However, when the information the informed traders has is close to being made public they will trade aggressively so as to profit before other traders become informed. The liquidity traders would trade depending on the limited public information provided and how they expect the information to affect the value of the share. However due to actions of the informed traders and uninformed traders who can closely predict the true value of the stock using the public information the market price will move toward the true value. The actions of these traders will either increase the demand of shares if they think the stock is undervalued or supply of the shares if they think the share is overpriced causing the equilibrium price to shift toward the expected true value. When most participants believe that the stock is overvalued, the supply of share will outstrip the demand leading to a decrease in the stock price. On the other hand, when the feeling amongst most traders is that the current stock price is below the true value the demand of the share will exceed the supply leading to an upward pressure on the price of the stock. The objective was to maximize the profit and since all traders can place unlimited orders I would expect informed traders to buy or sell all their shares as they insider information.  

Importance of following rules and analyzing public information

In this session, there were no informed traders and all the participant were trading as just publicly informed traders or liquidity traders. The objective of this session was to follow the rules, analyze the flow of buy/sell order to predict the direction of stock price and use financial analysis skills to try to predict the true value of the stock using the public provided new with aim of maximizing the profit. The objective of following the rule specifically meant that if one draws a liquidity shock then they would first fulfill liquidity target to avoid penalties. I would, therefore, expect traders will first fulfill their liquidity shock draws before trading based on their understanding of the publicly released news. I would expect different participants to react differently to the information they receive about the company depending on how they interpret the news. However, I believe most traders have financial knowledge and would predict the direction the stock price will move depending on their valuation of the true value of the stock using the public released news and the last closing value of the company. The participants would also be expected to study the flow of buy or sell orders to evaluate how most traders are reacting to the news released. So after the traders have met their target they would then embark on the objective of maximizing their wealth for example if the liquidity target was to sell 5000 shares but the trader believes the stock is underpriced according to their analysis of information received. The traders would then start buying the shares of the stock as many as they can to profit on the expected increase in the price of the stock. In contrast, if the traders received a buy liquidity shock, and actually believe that the stock is undervalued, they would continue buying the shares even after achieving the liquidity target. This would continue up to point where their valuation of the stock is matched or exceeded by the market price of the shares. As the traders pursue profit maximization objective, the market forces of supply and demand would push the market price toward the true value. Therefore, the trade price series would follow the trend that most traders believe the stock price head to a given time. 

For this session, I traded with private information and I could therefore accurately know how the price of the stock would move. My strategy was to trade on this information stealthily to reduce the chances of other uninformed trader noticing unusual trades in certain direction hence figuring out the implied underlying value by the buy/sell orders flow. In this session, I made a net loss of ($647,000- $500,000) + (42,000-50,000)*26.68 =$(65,840.00) after selling most the share at a price below the true value of the stock. My strategy was to place small sell orders with a goal of making profits before price adjustments take place. Evidently, this strategy failed, as I was not able to make a profit. After analyzing my strategy I discovered that I failed to place many or large sell orders when I had the knowledge that the market prices were higher than the true value of the stock. This delay caused the market share to adjust and fall below the true value may be because other informed participants made huge or many sell orders causing an excess supply of stock and consequently the price fall.

Maximizing profits while avoiding disrupting the market balance

I would improve and change some of the strategies that failed including lack of flexibility, volume, or size of orders, number of transaction and speed of transacting. My order size was small and I did not place many sell orders when the market price was higher than expected true value and most of my order volume was lower than 1000. In this regard, I would change my strategy by increasing my average orders. Lack of flexibility contributed significantly to the failure of my strategy, for example, I continued trading when the mispricing had already been reversed and ended selling my share at a price the true value. Therefore, I would suggest more flexibility in strategy that is varying the strategy with the market developments. Another improvement require is the accuracy of the transaction, for instance, there is a sell order I place with an asking price of 20 which is very far from the fundamental value of the stock. Another improvement that I would recommend is transaction speed. If I placed my orders immediately after getting the information, I would have increased my chances of profiting before the market adjusts the stock price.  

In this session, only the public available news was provided and hence the ability to profit depended on how well one interpreted the effect of the information the value of the stock. My strategy in this session was to follow the rules and analyze all the publicly provided information to predict the value of the stock. I was able to meet the liquidity target of selling 5000 shares however I was unable to analyze the news provider in time and make a decision on whether to buy or sell shares. I made a net loss for this session, which was;

($578,500- $500,000) + (45,000-50,000)*34.1 =$(92,000.00)

Clearly, my strategy did not work, or I was unable to execute my strategy in time before the market closed. If given a chance to play the game again I would only make a few adjustments to the execution of my strategy, as the failure of the strategy was because of its execution and not the strategy itself. I would improve the speed of analyzing news so a to make a decision on whether to buy or sell as quickly as possible. I would also seek to meet the liquidity target at the earliest possible time by making a large order instead of many few orders. I would also study the sell or buy orders flow in the market to predict direction, which the price is likely to follow.