Chopping up large trades into many smaller ones is common practice among institutional investors seeking to minimize market impact, but the cost can be high.
And recognition of those costs might be driving investors back to block trading.
"There are times when these parceling techniques have a large effect on the (overall) trade, and you could have been better off trading in a block," said John Wightkin, co-founder of Quantitative Services Group LLC, Naperville, Ill., which provides transaction cost analysis services to institutional investors.
"By going to a parceling technique, you're introducing a lot more risk from a timing standpoint, and that can be six to eight times as large as the liquidity charges," he said. "So if you can go in and improve your parceling strategy to take advantage of more liquidity or find a block, you will perhaps have a larger (market) impact, but you could realize substantial savings on the timing of the trade."
James Bryson, president of New York-based trade analysis firm Elkins/McSherry LLC, added that by parceling trades — known as slicing and dicing — institutions could be paying a high opportunity cost as well.
"If you begin buying a stock at 90 and you're working the order over a day, two days or a week, and you finish at 105, your average cost might be 102," he explained. "By slicing up orders you lose opportunity" of completing the order at a better price — buying at a lower price or selling at a higher price.
The prime reason for the increase in smaller orders is decimalization (when stock prices went from being quoted in eighths of a dollar to pennies), according to traders. George Bodine, director of trading at General Motors Asset Management, New York, said the quicker pace of trading and the increase in electronic trading have also driven order size down.
"The ability for the broker to see the order flow and try to build a picture — there's a lot of people buying drug stocks or selling paper stocks — is not there," Mr. Bodine said. "That lack of information lessens your willingness to commit on larger blocks."
While smaller orders will have little market impact, those orders — and that impact — build up as the entire position is traded, driving a stock lower if the position is being sold or higher if it is being purchased.
But that's not necessarily the case with large-capitalization stocks like Microsoft Corp. or General Electric Co., according to Wayne Wagner, chairman of Plexus Group, Los Angeles. He said on those very liquid names, traders can do 10 or more 500-share orders a minute.
"The advantage of that, most buyside traders would tell you, is that they don't have to give up any information" about what they're trying to do, Mr. Wagner said. Giving up information, known as leakage, has become a bigger problem for portfolio managers and their traders since decimalization began in 2001. That's another reason trade size has declined.
"Leakage is a real issue when you have intermediaries — full-service broker/dealers with proprietary trading desks and specialists on the floor of the New York Stock Exchange," said Ted Oberhaus, director of equity trading at Lord, Abbett & Co. LLC, Jersey City, N.J.