Order shredding is the practice of taking a position in the market by breaking the order up into pieces and entering the market one piece at a time, rather than taking the entire position all at once. There are 3 main advantages to shredding orders rather than going into a position all at once, which I demonstrate below with data output from simulations.

1. Order shredding reduces the entry price.

Below I display the output from a simulation using SPY data from the past year. I show the range of expected entry prices you would have achieved depending on how many pieces into which you broke up a $10,000 order over the past year. The simulation assumes the days upon which trades are placed are selected at random, and it puts equal dollar amounts into the market in each trade. Since these are only the mean execution prices, the effect in reality would be even more pronounced, on account of the fact that more volume would accumulate at the lower prices than at the higher prices.

Shredding the order not only reduces the overall entry price, but it also reduces the variability in the entry price.

2. Order shredding reduces the size of drawdowns.

I ran a second simulation which utilized historical SPY return data to simulate performance over a 1-year holding period. I recorded the maximum drawdown experienced as a percentage of total portfolio value in each run and did full simulations for different amounts of order shredding. In the case of the unshredded position entry (Orders = 1), the full position is taken at the start of the year. I had the order pieces placed at equally spaced intervals throughout the year, ensuring that by the end of the year the full $10,000 starting value had been put into the market. Results are displayed below.

The more you shred the order, the lower the expected maximum drawdown and the lower the drawdown size in the high end of the distribution (75th percentile).

3. Order shredding can increase confidence when you identify a position you want to take.

Imagine you identify a position you want to take, but you’re concerned that if you put the position on soon, you might be paying too much, or you feel the risk of a sell-off in the near term is considerable. Order shredding can help you ensure that you’re paying a price that’s representative of prevailing prices in the market. If prices rise after you begin to enter the market, then you got a deal on the earlier trades. If prices fall, then you have an opportunity to get a discount and purchase more size at lower prices. The size of the drawdown relative to your total portfolio will be attenuated. Of course, all of this depends on prices rising in the long term, but if you didn’t think that prices would rise long term, you wouldn’t want the position in the first place!

Order shredding can help alleviate concerns over short term price volatility when putting on a position you plan to hold for a long time. I shred my orders when implementing a position, and lots of market professionals do too. Feeling nervous about putting on a position you like? Order shredding could be the solution for you.