Basket trading is an active strategy primarily used by institutional traders, hedge funds, and algorithmic or quantitative traders and fund managers, but is it suitable for retail traders? Basket trading allows traders to focus on sectors or target asset classes. Bask trading Forex strategies are equally popular, and traders with smaller portfolios can use a bask trading strategy to gain maximum exposure while lowering the overall risk profile.
Exchange-traded funds (ETFs) deploy basket trading and continue to gain popularity as they displace mutual funds from portfolios. Should you consider a basket of securities over individual asset selections?
How is a Basket defined?
A basket refers to a collection of multiple assets, for example, equities, currencies, and commodities. They can share a theme or cater to an identical goal. There is no limit on how many assets or sectors are in a basket. The weighting of each position related to the basket is up to the trader or portfolio manager. Basket investing allows for portfolio diversification. It is an efficient strategy to achieve cross-asset exposure and decrease risk while keeping profit potential attractive. Bask trading can also lower volatility. Equity baskets remain the most traded, followed by a Forex basket trading strategy, while basket options trading remains a niche strategy.
The different types of Trading Baskets
Basket trading has expanded to all sectors and accounts for a growing share of daily trading volumes. ETFs and algorithmic traders execute basket trades throughout the day, and retail traders can easily use a basket trading strategy by using ETFs.
Here are the most traded types of Baskets:
Equity baskets can consist of dozens of shares covering the same sector, for example, small-cap technology companies, or have an identical characteristic like a 5% dividend yield
Currency baskets can focus on a currency, for example, the Swiss Franc, and deploy long and short strategies within the basket
Commodity baskets may track the sector in general, focus on a sub-sector, for example, oil, broaden exposure to include a theme, like soft commodities
Fixed income baskets are ideal for portfolios to add diversify into a low-volatility sector to lower overall portfolio price fluctuations and offer exposure to various timeframes for steady income generation
Cryptocurrency baskets are the latest addition and an excellent approach to lower the high volatility in this sector
Cross-asset baskets mix trading instruments from multiple asset classes that share a theme, for example, gold mining stocks, commodity currencies, and gold
Basket Trading Explained
Basket trading is an essential strategy for fund managers who must keep allocations at set levels as capital moves in or out of the fund. Index tracking funds also engage in basket investing as they must hold all securities in the tracked index. Without the ability of basket trading, many funds would offer sub-standard products. Basket trading presents an efficient method to rebalance a portfolio based on predetermined criteria. It also assists retail traders in creating well-diversified portfolios or executing complex trading strategies that require transacting several assets simultaneously.
How do traders execute Basket Trades?
Traders must decide on the basket of securities they wish to buy or sell and their respective portfolio allocations. Not all brokers support basket orders, and they often come with minimum requirements, for example, a set amount of assets or capital. Once all assets are in the basket, the purchase takes place in one block order. All securities are listed individually in the portfolio, allowing traders or portfolio managers to retain control and flexibility.
Two order types supportive of basket trading include market-buy/market-sell on open and market-buy/market-sell on close, ideal for index-tracking strategies. An efficient basket trading strategy relies on algorithmic trading solutions with human oversight.
Basket Trading Examples
Below is a basket trading example for an equity basket, a currency basket, and a multi-asset basket.
1. Equity basket trading example
A trader wishes to purchase an airline stock but does not know which will offer the best risk/rewards ratio. Rather than picking one airline, the trader applies an equal weighting to all airlines stocks, gaining exposure to the entire sector. A trader may narrow the basket on criteria like regional versus international airlines, dividend-paying companies, financial metrics like cash burn, or fundamental aspects like insider trading.
2. Currency basket trading example
A trader seeks exposure to commodity currencies, favoring hard commodities over soft commodities. The basket allocation could result in 35% Australian Dollar, 35% Canadian Dollar, 20% New Zealand Dollar, and 10% Swiss Franc. Diversifying with multiple currency pairs associated with the four currencies can balance the portfolio. It also results in weight dilution. For example, buying the AUD/SGD, the EUR/CAD, the NZD/JPY, and the USD/CHF adds exposure to four more quote currencies.
3. Multi-asset basket trading example
A trader targets the oil sector with a multi-asset basket trading strategy. The basket consists of shares in dividend-paying oil producers weighted at 50%, crude oil and associated futures contracts weighted at 30%, and the USD/CAD and GBP/CHF weighted at 20%. The basket of securities offers cross-asset exposure to oil to a varying degree.
Basket Trading Benefits for Investors
Basket investing offers notable benefits, explaining the rise of basket trading over the past decade, with exceptional growth potential ahead.
Basket trading benefits for investors include:
Basket trading creates personalized investment portfolios, granting exposure to fine-tuned investment themes, criteria, sectors, industry groups, etc.
Basket trading provides portfolio managers swift allocation, allowing proper weighting based on cash, units, or percentages, as capital flows in and out of funds
Basket trading grants control to portfolio managers who want to fine-tune baskets by adding or removing individual positions or changing their weighting
Basket trading allows traders to achieve diversified portfolios with a decreased risk while maintaining attractive profit potential
Basket trading lowers volatility and price risk, as each basket usually consists of more than a dozen assets
The Significance of Basket Algorithmic/Program Trading
Algorithmic trading accounts for an ever-increasing share of daily trading volume, but the definition varies. For institutional traders, program trading refers to executing a minimum of 15 assets valued at $1M+, per NYSE definition. Professional traders deploy sophisticated algorithmic trading solutions with basket trading functionality, especially when using a Forex basket trading strategy. The speed, size, and complexity of basket trading make algorithmic trading an ideal choice, but development costs for custom-tailored solutions price most retail traders out of it.
Basket trading is ideal for investors and traders seeking asset diversification or focus on desired themes, sectors, or goals. It lowers risk, reduces volatility and price risk, and provides an efficient method for weighted portfolios or index-tracking funds. While algorithmic solutions increase the efficiency and effectiveness of basket trading, manual traders can execute a basket trading strategy. ETFs rank among the most notable institutional basket traders, followed by hedge funds and professional traders.
Is basket trading good?
Basket trading is ideal as it offers numerous advantages without notable disadvantages. Not all brokers support basket trading, but algorithmic solutions can bridge the gap. Basket trading allows traders to personalize portfolios, decrease risk and volatility, and is ideal for smaller portfolios to diversify.
What is a basket fund?
A basket fund consists of more than a dozen securities sharing a common theme, for example, a sector, an industry, a financial or fundamental metric, etc.
What is the basket approach?
The basket approach refers to a basket trading strategy or simultaneously executing trades in numerous assets with a common theme.
What are basket derivatives?
Basket derivatives are contracts related to a basket fund, mostly an ETF or ETN. It tracks the performance and grants traders exposure to price action, and dependent on the derivative, it does not necessarily result in ownership of the underlying asset.
How do you price a basket option?
Companies underwriting basket options have mathematical models for pricing purposes.