Getting to Grips With VWAP

TRADING STRATEGY

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Trading Strategy

Getting to Grips with VWAP

Market Commentary 2 October 2013 “

Getting to Grips with the VWAP Benchmark Love it or Loathe it, It’s Not About to Disappear from TCA The VWAP benchmark – which measures the difference between the average

execution price and the market wide volume weighted average price – is well

established as an industry standard approach to measuring trader performance.

While there are various arguments against the use of VWAP as a measure of

execution quality (see Why Be Average? for further details), it is not likely to

disappear from transaction cost analysis (TCA) reports – including Credit

Suisse’s ExPRT – any time soon.

To help traders better understand their performance versus VWAP, this report

looks at the relative cost of trading different European countries based on data

from our ExPRT client execution database (see side box for further details). We

also investigate how performance versus VWAP varies with respect to intra-day

volume profile stability, spread costs, participation rate and exposure to dark

pools. Finally, we consider whether the closing print has much impact on full

day VWAP, and whether the absence of an industry-standard consolidated tape

matters in the context of measuring performance versus VWAP.

One Region, Mixture of Microstructures Market Microstructure is Key Driver of VWAP Performance Some countries in Europe have very similar microstructures, while others vary

significantly with respect to turnover, bid-ask spreads, top-of-book liquidity,

trade frequency, volume profile stability and fragmentation (see Exhibit 1 and

Algorithmic Trading in Europe Spreads its Wings for further details).

Unsurprisingly, our analysis suggests that each country’s market microstructure

is a key driver of execution performance versus VWAP. We find that those

markets with the most stable intra-day volume profiles and lowest spread costs

tend to have the least slippage and the lowest variation in performance. We also

find that more aggressive trades tend to cost more versus VWAP and that

exposure to dark pools improves execution performance. Is there much

difference between the VWAP with and without the closing auction, or using

primary market only versus consolidated data? Our analysis suggests that there

is.

Mark Buchanan + 44 207 888 0908

[email protected]

Liesbeth Baudewyn + 44 207 888 7988

[email protected]

Xiang Lin + 44 207 888 0974

[email protected]

Key Points

The VWAP benchmark is an industry

standard approach to measuring trader

performance.

Performance versus VWAP is highly

dependent on a country’s market

microstructure.

Those markets with the most stable

profiles and the lowest spread costs tend

to have least slippage.

More aggressive trades tend to cost more

relative to VWAP.

Dark pools exposure improves execution

performance versus VWAP.

VWAP is highly sensitive to the closing

print, as well as the venues and trade

types included in its calculation.

How We Crunch the Numbers The transaction cost data used in this report is

extracted from ExPRT, Credit Suisse’s

proprietary TCA tool (see ExPRT for Dummies

for further details). It represents trading by a

broad range of institutional investors via the

single stock, portfolio trading and AES desks

over the period from Jan 1st – Aug 30th 2013.

Our analysis is based on VWAP strategy tickets

only, as these tactics explicitly target the VWAP

benchmark. Limit orders, orders which are not

fully executed, amended orders and trades

impacted by extreme price moves have been

excluded.

Exhibit 1: Bid-Ask Spreads vs. Top of Book Liquidity

Source: Credit Suisse Trading Strategy, January 1st – August 30th, 2013

https://edge.credit-suisse.com/edge/Public/Bulletin/Servefile.aspx?FileID=18221&m=1358197681



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VWAP Slippage Varies by Country Top Countries Have Similar Costs, Others More Variable Those markets with the lowest slippage versus VWAP are separated by

fractions of basis points in terms of their performance (see Exhibit 2). The

standard deviation of performance versus VWAP for these markets is also

remarkably similar.

However, as you move beyond the top markets to consider the smaller and less

developed markets in Europe, both the average slippage and standard deviation

of performance versus VWAP increase substantially. For example, average

slippage in South Africa is 3.3x that of the UK, while Turkey is even more

expensive and variable.

Profile Stability Matters Countries with Stable Volume Profiles Track VWAP Best VWAP tactics slice orders according to a stock’s historical intra-day volume

profile. The more stable the historical profile, the more likely that the VWAP

tactic will slice orders in line with the stock’s actual volume profile on the day of

the trade. It is therefore not surprising to find that those countries with the most

stable profiles also tend to have the lowest slippage versus VWAP (see Exhibit

3).

Exhibit 2: VWAP Slippage & Variation in Performance vs. VWAP by Country

Exhibit 3: VWAP Slippage vs. Volume Profile Instability by Country



Worse performance

Worse performance Higher standard

deviation

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How Important Are Spread Costs? Countries with Low Spread Costs Track VWAP Best Spread cost is another key determinant of performance versus VWAP (see side

box). In order to maintain scheduling versus the stock’s historical intra-day

volume profile, the trader is generally required to pay the spread on some

portion of the order. The wider the bid-ask spread, the more costly this could be

relative to VWAP. This pattern is borne out by the data (see Exhibit 4), with

higher spread costs corresponding with higher deviation versus VWAP by

country.

Why does Turkey have such high spread costs? This is partly because the tick

size structure in Turkey forces bid-ask spreads to be wide (see Exhibit 1 and

Global Equity Markets Handbook - Feb 2013 for further details). The resulting

high depth of book in Turkey means that a significant amount of volume can be

taken from the near-touch without ever reaching the trader’s VWAP order. The

trader is therefore often forced to pay the spread more often than he/she would

like to relative to other markets.

Poland is another interesting case. Although its spread costs are comparable to

those of the lowest cost markets, the fact that it has one of the least stable

intra-day volume profiles makes it challenging to match VWAP (see Exhibit 3).

Spread Costs Can Drive Extreme Performance

We also find that spread costs are an important driver of variability in

performance versus VWAP. Where spread costs are low (i.e. less than 10bps),

the distribution of performance versus VWAP is fairly tightly distributed around

the average (see Exhibit 5). In contrast, trades with high spread costs are more

negatively skewed versus VWAP and exhibit much higher variability of

performance.

Matching VWAP is Tougher during Periods of High Volatility Since bid-ask spreads and volatility are highly correlated (see Europe Chartbook

(Aug-13) for further details) it is not surprising to find that matching the VWAP

benchmark is tougher during periods of high volatility (see Exhibit 6).

Anecdotally, it may also be the case that traders need to pay the spread more

often in high volatility environments and that volume profiles are less stable (see

Executing in Earnings is Extra Expensive for further details).

How We Calculate Spread Cost For each individual child level fill, we compare the

execution price with the prevailing near touch quote

on the primary market. Spread cost is the weighted

average of the difference between these two

numbers expressed in basis points.

Exhibit 4: VWAP Slippage vs. Spread Cost by Country

Exhibit 5: Distribution of VWAP Slippage vs.

Spread Cost

Exhibit 6: VWAP Slippage vs. Volatility



Source: Credit Suisse Trading Strategy, January 2007 – August 2013

Worse performance

0bps

J.P. Morgan

acquires Bear Stearns

Global Financial Crisis

Greece Debt Crisis

Euro Crisis


https://edge.credit-suisse.com/edge/Public/Bulletin/Servefile.aspx?FileID=24799&m=-256161668



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More Aggressive Trading Costs More High Aggression Rates Have Higher Deviations vs. VWAP More aggressive trading typically incurs higher spread costs (see A New EDGE in

Impact Cost for further details). It is therefore not surprising to find that, on

average, trades with higher participation rates have higher slippage versus VWAP

(see Exhibit 7). To ensure an apples-to-apples comparison between the

participation rate buckets, we have normalised our data set with respect to trade

size and bid-ask spreads.

Exposure to Dark Pools Makes a Difference Trades with Higher Exposure to Dark Pools Outperform There are three main reasons why exposure to dark pools is likely to reduce

slippage versus VWAP. First, dark pools help traders reduce signalling costs. In

Measuring Dark Pools' Impact and The Cost of Primary Market Only Execution

we found that posting even small orders on lit markets can cause prices to move

against the trader (see Exhibit 8). Second, by facilitating execution within the bid-

ask spread dark pools help traders reduce their spread costs. Thirdly, dark pool

prints allow VWAP algos to slice orders into even smaller waves and therefore

better match a stock’s actual volume profile.

Approach to Analysis

To test this theory, we analysed the performance of Credit Suisse VWAP

tactics during 2013 and split the sample into those exposed to the dark (i.e.

Credit Suisse Crossfinder and MTF dark pools) and those not. We paired the

samples so they are similar with respect to trade difficulty, as measured by

%ADV, bid-ask spread and participation rate. We have considered only market

orders that were fully filled and trades impacted by extreme price moves have

been excluded.

Results

On average trades exposed to the dark outperformed on a relative basis versus

VWAP across every trade size bucket (see Exhibit 9). Overall, the relative

outperformance was 0.94bps and the difference in performance was

statistically significant at the 5% level. We also found that orders exposed to

the dark had slightly lower variability of performance versus VWAP. As the other

meaningful factors were controlled for in the construction of the two samples,

there is evidence to suggest a link between exposure to the dark and execution

performance

Source: Credit Suisse AES Analysis, January 1st – August 30th, 2013

Source: Credit Suisse Trading Strategy, November 22nd – December 17th, 2012

Bid Imbalance

Ask Imbalance

*Note: Our approach is to track the movement of the mid-point of the bid-ask spread from the point where the bid-size is greater than 5x the ask size (and vice versa) for 2 consecutive ticks, but the

bid/ask size is no more than the average primary market trade size

for the stock.

Exhibit 8: Signalling Costs in FTSE 100 and Euro

STOXX 50 Names*

Exhibit 9: VWAP Slippage by Dark Pool Exposure

Exhibit 7: VWAP Slippage vs. Participation Rate


-15.2% -18.7%

-19.5% -57.0%

-30.8%

Worse performance





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To Include the Closing Print, or Not VWAP Benchmark is Highly Sensitive to the Closing Print In a previous analysis, we found that stocks in Europe tend to have the most

stable closing volume profiles (see Exhibit 10 and EDGE Update:**NEW MOC

Pre-Trade in EDGE** for further details). As a result, VWAP tickets in Europe

typically include the closing print, whereas they are often limited to continuous

trading in the Americas and Asia.

Since the closing print accounts for around 15% of average daily volume in

Europe, it could reasonably be expected to have a significant influence on the

market wide VWAP. Our analysis, which compares the VWAP price during

continuous trading with the full day VWAP, suggests that is indeed the case

(see Exhibit 11).

VWAP Analysis without a Consolidated Tape VWAP Benchmark Highly Dependent on Venue Selection The lack of an industry standard consolidated tape is frequently cited as one of

the most important issues facing traders in Europe. As evidenced by the MiFID

II discussions, all parties agree on the need for affordable, consolidated post-

trade data. However, their views differ on how that might best be achieved (see

MiFID II: Hail CESR! for further details).

In the absence of an agreed-upon standard, data vendors and TCA providers

have devised their own proprietary consolidated tapes. Due to on-going

concerns about the underlying content of over-the-counter (OTC) prints, most

TCA products tend to focus on primary market and multilateral trading facility

(MTF) prints only. However, different providers’ VWAP prices may still vary due

to venue selection or the exclusion of certain trade types.

In a TCA context, does it make a big difference what trades or venues get used

to compute the VWAP benchmark? Our analysis suggests that it may. By

comparing the VWAP price computed using primary market prints only to the

price derived when MTF and primary trades are taken together (sourced from

the ExPRT database), we find that there is a high degree of variation between

the two (see Exhibit 12). With MTFs accounting for over 40% of FTSE 100

turnover and over 35% of Euro STOXX 50 turnover this is perhaps not a

surprising result. However, it does demonstrate the importance of using the

most appropriate measure when evaluating VWAP performance.

Exhibit 10: Closing Volume Profile Instability by Country

Source: Credit Suisse Trading Strategy, August 21st, 2013

Exhibit 12: Distribution of Primary Market VWAP

Slippage vs. Consolidated VWAP Slippage

17.4% of notional has

slippage >2bps better

19.5% of notional has

slippage >2bps worse


Exhibit 11: Distribution of Full Day VWAP vs. VWAP

ex. Closing Auction

Source: Credit Suisse Trading Strategy, August 1st – September 27th, 2013

17.4% of prices are higher

by >0.5bps

15.4% of prices are

lower by >0.5bps




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USA

Phil Mackintosh +1 212 325 5263 [email protected]

Victor Lin +1 212 325 5281 [email protected]

Ana Avramovic +1 212 325 2438 [email protected]

Stephen Casciano +1 212 325 0776 [email protected]

Europe

Mark Buchanan +44 20 7888 0908 [email protected]

Colin Goldin +44 20 7888 9637 [email protected]

Liesbeth Baudewyn +44 20 7888 7988 [email protected]

Asia

Karan Karia +852 2101 6322 [email protected]

Credit Suisse

Trading Strategy

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Getting to Grips With VWAP

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