23/05/2023
In the
world of finance, liquidity structures and execution strategies help to inform best possible
price and can also be a crucial element for managing market risk; particularly for larger
market orders. In this blog post, we will delve into the concepts of sweepable and tiered
liquidity, helping you grasp the differences between these two approaches and determine
which one might be better suited for your trading style.
Sweepable Liquidity
Sweepable
liquidity refers to a market execution strategy where each level of liquidity is “swept”
across liquidity pools or exchanges to execute the order amount at a volume-weighted average
price (VWAP). This approach aims to fill the entire order at a single price that reflects
the overall liquidity available in the market. When using sweepable liquidity, traders are
not limited to the best available price at the top of the order book. Instead, the execution
algorithm works its way through the different levels of liquidity, aggregating the available
prices until the entire order is filled. Consequently, this approach can help minimize the
market impact and reduce the likelihood of adverse price movements caused by large order
executions.
However, there are also potential drawbacks to using
sweepable liquidity. For one, this method may result in higher transaction costs, as the
order is executed across multiple price levels. Additionally, the time taken to fill the
entire order might be longer, as the algorithm needs to access liquidity from various
sources.
Tiered Liquidity
Alternatively, tiered liquidity
is an execution strategy that focuses on targeting the best price with an amount that can be
filled in full. In other words, the order is executed at the top of the order book, where
the highest bid or the lowest ask is located. This approach prioritizes the best available
price for the trader, rather than the speed of execution or minimizing market impact. Tiered
liquidity can be particularly beneficial for traders who prioritize price over the speed of
execution. By targeting the best available price at the top of the order book, traders can
potentially save on transaction costs, as they avoid paying more than necessary to fill
their orders. Moreover, tiered liquidity can be more straightforward and easier to
understand for novice traders, as it focuses on a single price level.
Nevertheless, tiered liquidity also comes with its own
challenges and limitations. For larger orders, traders may struggle to find sufficient
liquidity at the top of the order book. As a result, the trader may need to divide the order
into smaller parts or wait for more liquidity to become available at the desired price,
potentially leading to missed trading opportunities.
Choosing the Right Approach
Ultimately,
the choice between sweepable and tiered liquidity depends on your trading objectives and
preferences. If you prioritize price over speed and are comfortable with the possibility of
partial order execution or waiting for more liquidity, tiered liquidity might be the better
choice for you. Conversely, if you are more concerned with minimizing market impact and
completing your order quickly, sweepable liquidity could be the more appropriate option.
In practice, many traders may use a combination of both
approaches, depending on the specific circumstances and market conditions. By understanding
the advantages and limitations of each execution strategy, you can make more informed
decisions and enhance your overall trading performance.
Both sweepable and tiered liquidity offer advantages and
disadvantages. Sweepable liquidity can help reduce market impact and achieve a more balanced
execution, while tiered liquidity prioritizes the best available price. Traders should
always exercise caution when trading as this is a high-risk activity. Traders choosing to
risk their capital should always make sure they are as informed as they can be about both
the asset in question and the execution method being utilised.