Transaction Cost Analysis

Exploring its role in optimising your trade execution

Discover how Transaction Cost Analysis (TCA) helps sharpen execution strategies through data driven insights.

In this latest episode of Banking & Markets Explains, Victoria Bryan, Manager Trade Performance and Analytics at Northern Trust, breaks down the fundamentals of TCA - a vital tool for evaluating the effectiveness of portfolio transactions.

Victoria explores how TCA empowers investment managers to measure trade performance, boost execution quality and receive actionable insights to refine their trading strategies.

TCA stands for Transaction Cost Analysis and is the study of trades or transactions to determine whether the prices they were executed at were favourable – buying at lower prices and selling at high prices. TCA can be used by investment managers to determine the effectiveness of their portfolio transactions.

There are four main reasons why investment firms (i.e. asset managers and hedge funds) should be using TCA:

The first is to measure trade performance:

Each executed trade is analysed based on a series of performance benchmarks.
Effective trade execution saves a client money and can enhance the performance of the overall portfolio.

The second is to prove best execution:

This means that by measuring and comparing performance to benchmarks, the firm can better understand its execution strength in relation to market movements. It can also be used to show compliance with best execution regulations.

The third is to improve trade execution quality:

TCA brings science to the art of trading, and this has tangible consequences for the trading outcomes and performance. TCA provides an understanding of how certain decisions lead to specific outcomes.
As such, TCA plays an important role in execution strategy in all trading environments for all asset classes.

The fourth is to get actionable insights:

TCA goes beyond providing awareness and transparency on specific trading outcomes. TCA offers insights that help firms learn from their past trading results, both before during and after the execution, to improve future trade execution outcomes.

To show how TCA is calculated we are going to take Stock X and arrival price as an example. If a decision is made to buy 100 shares of Stock X at 10am and currently the share price is $1.00, my expected total price based on the $1 arrival price times the total number of 100 shares is $100.

By the time that execution is completed the actual average price over the trading interval ends up being $0.99 as the market is moving in favour, meaning the price went down while trading. This means the actual price paid for all 100 shares is $99.

This results in a difference between what was actually achieved verses the expected outcome of $1.

In order to calculate the Implementation Shortfall otherwise known as IS, we take the cost and divide it by the original arrival price. In this case that is $1 divided by $100 giving an IS of 0.01 or 1%.

A basis point represents one hundredth of one percentage point and is used in trading as the market movements can be very small. In order to calculate this metric in basis points the percentage would be multiplied by 100. In this case 1% times 100 equals 100 bps.

This is just the calculation of one benchmark, and there are hundreds that can be used in the analysis of trading. Looking at the analysis across a variety of benchmarks can be used to create the actionable insights.

To understand more about TCA, or how Northern Trust can help discover actionable insights in your trading, please contact us.

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Victoria Bryan

Victoria is a manager of trade performance and analytics at Northern Trust Banking & Markets.

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