Definition of transaction cost analysis

A method of determining the effectiveness of a company’s portfolio transactions. Transaction cost analysis (TCA) is essentially a rating of the spread between two possible prices – and the difference between those prices is often called “slippage.”

The first number is the price of a particular transaction if it were executed at the prevailing price at the time the portfolio manager decided to buy or sell. The second is the actual price of the transaction, including commissions, taxes and other costs. [1]

Transaction cost analysis (TCA) is the study of trade prices to determine whether the trades were arranged at favourable prices - low prices for purchases and high prices for sales.  Investment managers, brokers, and exchanges all analyse transactions to determine whether their trading procedures are producing the best possible results.  Investment sponsors also use TCA to determine whether their managers are trading effectively.  Results from these analyses are often used to fine tune trading processes to make them more effective.

The main challenge of TCA is to determine whether a trade price is high or low given market conditions at the time the order was processed.  For this purpose, trade prices are commonly compared to benchmark prices such as the volume-weighted average trade price of the day (VWAP analyses) or the midpoint of the bid/ ask spread at the time the order was first created (implementation shortfall analyses).  Purchases with prices that are high relative to these benchmarks are considered expensive trades as are sales at prices below benchmark prices.  

Transaction cost analyses sometimes also consider the opportunity costs associated with trades that are not completed.  The failure to trade can be very detrimental to portfolio performance if the trade turned out to be very profitable had it been completed. [2]

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