Do you like having snacks regularly and forego regular meals? Or do you prefer to have 3 meals a day? It’s simply that the snacks you have, are going to be smaller portions compared to a full meal (at least I suppose that is the idea). I’m not a doctor, so I have no idea which is healthier or which is optimal for calorie burn, but let’s just ignore that point for a moment. The objective, of not being hungry, is going to be satisfied either way. They are simply different approaches to attaining the same goal, where we are eating at different frequencies.
When it comes to markets, investors have varying trading frequencies. What influences the trading frequency of an investor? One is how much capital they have to invest. If it is in the order of hundreds of billions of dollars, it can become very difficult to be trading in and out the market regularly. As one of my friends explained, in a way it is like trying to get a supertanker to turn when an investor has very large positions and is thinking of changing course. Trying to turn a supertanker quickly is going to cause a lot of turbulence. Using our analogy, this is the case where we have large meals infrequently. Of course, a very large AUM could be allocated to many different portfolio managers, who can diversify their strategies across different time horizons, strategies and assets. Precisely what type of strategies they run and their asset universe, will depend on their mandate. It might seem attractive to focus on higher frequency strategies, given that they might well have higher risk adjusted returns. The cost is that they tend to be more sensitive to trading costs and have less capacity. To use our analogy this could be like snacking! Hence, the only way to allocate large amounts to higher frequency strategies is to spend more research time developing more (hopefully, uncorrelated) strategies. For very high frequency trading strategies, the technology cost of execution will also be an additional significant sunk cost, which needs to be overcome first, before you begin to make any money from your strategies.
The factors which you use to trade at different time frequencies will also vary. At high frequencies, it could be an understanding of market microstructure which is the key. At longer frequencies, we might have more of an interest in long term capital flows, and longer term trends in economic fundamentals. Such factors are clearly not as relevant with very short holding periods.
Whatever the trading frequency of turnover of an investor’s portfolio, we also need to think about trade execution. Typically a portfolio manager will give their order to a trade execution desk. They will typically work the trade into the market at shorter time horizons. How much leeway an execution trader has to work that trade depends on their mandate. Furthermore, it is important to understand market liquidity, to ensure that market impact is not huge. It is not always the optimal strategy to execute as soon as possible, even if it might be possible to get a risk price from a bank for a certain size. If there is poor communication between execution and portfolio managers, it can result in portfolio managers running strategies which are basically not suitable for the market’s liquidity.
There is no correct time frequency to trade and it depends on the circumstances of an investor. Indeed, this has been my observations over the years, working in banks and also now independently working with funds and asset managers. Not every type of frequency trading strategy will appeal to every investor. We can sum it up with a few of the following questions. What type of technology does an investor have (and what type of skill set is in their firm)? How much notional are they investing? What is the mandate they have been given by clients.? Indeed, sometimes there might be no trading opportunity and it could be better to sit tight, rather than run the risk of over trading a book.