The analysis of some trading strategy on the stock market with the liquidity shortage

Abstract

Purpose: The aim of this article is to determine and analyze the optimal trading strategy of purchasing a given number of the stock shares with the constraint of the constant trade velocity when the trading is executed and with the possibility of the liquidity shortage of the market. Design/Methodology/Approach: The market stock price is modelled as a stochastic process with the trend which is characterized with use of functions desribed by two parameters and this seems to induce the flexibility availaible with respect to fitting the model parameters to the stock price evolution forecasts. The considered optimization problem is posed with the use of the theory of probability. The mathematical analysis is applied to obtain the optimal trading strategy. The exemplary results of the numerical computations, with the use of the formulas shown in the article, are included. Findings: The optimal strategy of purchasing the stock shares in the considered set of trading strategies is determined and the significance of the trend in the stock market stock price is shown. Practical Implications: The shortage of the liquidity in the stock market implies the transaction costs which are induced by the market impact. The profitability of the transaction may be also affected by the trend in the stock price. The optimization of trading on the stock market may imply the increase of the profitability of investing on the stock market. Originality/Value: The results shown in the article are original and can be applied by the stock market participants who implement the trading strategies with the constant speed of the trade execution, to increase the expected profit of the investment in the stock shares.