Participation

This strategy attempts to maintain a constant fractional trading rate.

Its own trading rate as a fraction of the market's total trading rate should be constant throughout the execution period.

If the fractional trading rate is maintained exactly, participation strategies cannot guarantee a target fill quantity.

Parameters of a participation strategy:

- Start time

- End time

- Fraction of market volume the strategy should represent

- Max # of shares to execute

Along with VWAP and TWAP, participation is a form of nonoptimized strategies, though some improvements are possible with optimization.

Typically, the VWAP or arrival price benchmarks are used to gauge the quality of a participation strategy execution.

The VWAP benchmark is particularly appropriate because the volume pattern of a perfectly executed participation strategy is the market's volume pattern during the period of execution.

An ideal user of participation strategies has all the same characteristics as an ideal user of VWAP strategies, except:

He is willing to forego certain execution to maintain the lowest possible fractional participation rate.

Participation strategies do not use a trade schedule.

The strategy's objective is to participate in volume as it arises.

Without a trade schedule, it cannot guarantee a target fill quantity.

The most basic form waits for trading volume to show up on the tape, and follows this volume with market orders.

Example:

Assumptions:

- Target fractional participation rate = 10%.

- An execution of 10.000 shares is shown to have been transacted by other market participants.

--> A participation strategy would execute 1000 shares in response.

Participation strategies can closely track the actual volume pattern.

VWAP strategies may experience large deviations from an execution period's actual (as opposed to expected) volume pattern.

However, close tracking has a cost.

In the previous example, placing a market order of 1000 shares has a larger expected market impact than slowly following the market's trading volume with smaller orders.

An optimized form of the participation strategy amortizes the trading shortfall over some period of time.

The result is a lower expected shortfall, but a higher dispersion of shortfalls.