A common question among Advisors upgrading from manual trading or single-order entry tools to a trading and rebalancing tool like Autopilot is, “Should I still be using limit order types when submitting trades?” In this article we cover what you need to know about using limit orders with Autopilot.
The Autopilot Trade File
To understand how limit orders interact with Autopilot trades, it helps to remember the mechanics of the Autopilot trade file. With the exception of LPL trade files, Autopilot dynamically generates block market orders when a block trade can be made. The format of these files is such that both block orders and allocation instructions can be submitted simultaneously and requires no additional work from the Advisor. Block orders also help prevent accidental price discrimination. For a full review of these concepts, refer to the What is Block Trading article.
Limit Orders and Blocks
Many advisors operate under the best practice of using limit orders any time they place a large purchase order. So you might be wondering, why not make these blocks into limit orders instead of market orders? The answer lies in supply and demand.
Let's say you've submitted a block market order for 9,000 shares of $VT, to be evenly allocated across three accounts, 3,00 shares per account. The price of $VT moves from $75.15 to $75.21 between the time the order is submitted and filled. The custodian averages out the execution price at $75.18 and each client receives 3,000 shares of $VT at an average execution price of $75.18.
Imagine however, a limit order is used instead of a market order and only 5,000 shares of $VT fill before the limit is reached. This partial fill means the allocation instructions generated by Autopilot can no longer be used, and the Advisor is left to:
- Make the decision as to which clients get what percentage of the 5,000 shares executed.
- Manually format this information on an allocation file
- Calculate how many shares of $VT need to be purchased in order to get the remaining client accounts to target.
- Manually format a second block trade and allocation file.
A partial fill in this example leaves the advisor with a labor intensive process, and unlike this simplified example a real world trading scenario would likely include several partial fills - exponentially complicating the reconciliation process.
All hope is not lost! By following a few best practices you can ensure that you enjoy the efficiency of Autopilot PLUS the protection offered by limits.
Best Practices for Limit Orders
Limit orders can be particularly helpful when purchasing large quantities of ETFs, which advisors can now easily do thanks to tools like Autopilot. What are the best practices advisors should follow?
Switching an order from 'Market' to 'Limit'
Take a moment to review your trades after uploading the Autopilot Trade File into your custodian's trade blotter, but before sending the orders. You will see a column for "Order Type" or similar. You may need to scroll right or left to expose this field. The Autopilot file defaults to type=Market, but you may manually change that field to "Limit" when appropriate. Enter the limit price and send your orders, sells first then buys.
Setting the Limit Price
If you're already familiar with using limit orders, you probably have a formula for deciding the limit price. Whatever your method, make sure to use a marketable limit order to give trades the best chance of filling completely. If a block purchase doesn't fill completely, you'll have to manually allocate the partial block and submit a new order for the remaining balance.
In the case that you're not sure how to set the price, your custodian's trade desk should be prepared to help you. Depending on the ETFs you use, you may also have access to help from the ETF provider. First Trust for example has a team dedicated to helping advisors place orders for their funds, and can help advisors determine pricing. Riskalyze cannot recommend prices on limit orders.
When to use Limit Orders
Limit orders are effective when placing large orders, or orders for thinly traded securities. Remember for thinly traded securities, in particular, to call your custodian's trade desk or the fund provider before placing your orders. Ultimately, it is up to each advisor to determine when taking the time to build a limit order makes the most sense, versus sending market orders immediately after the Autopilot trade file is downloaded.