TY - JOUR T1 - The Practice of Optimal Execution JF - Trading SP - 52 LP - 60 VL - 2006 IS - 1 AU - Merrell Hora Y1 - 2006/03/20 UR - http://guides.pm-research.com/content/2006/1/52.abstract N2 - Optimal execution is a term that is widely used, and even though the concept is intuitively clear, in practice it is not uniformly achieved. In fact, the gap between this intuition and the perceived reality of algorithm behavior probably accounts for much of the remaining skepticism regarding algorithmic trading. This article examines why the gap exists and how it can be reduced. The typical approach is based upon a formulation that abstracts away from critical elements of the problem facing a trader who is executing in actual markets. It is not surprising that this approach fails to address a number of material risks facing the trader and portfolio manager. One particular risk is known as signaling risk, the risk of conveying information about trading intentions to market participants. It is demonstrated that when signaling risk is ignored, the typical solution is not the strategy that an intelligent, risk-averse rational trader would employ in real-time. By examining how information is utilized by the market, it is possible to derive practical conclusions that can help manage signaling risk from within a trading algorithm. Building on this, it is shown how the execution optimization problem should be revised to provide a better representation of actual trading environments. Solutions to the revised problem correspond to optimal trading strategies that can be employed in practice with greater confidence that signaling risk is being managed. ER -