Optimal Trading Strategy and Supply/Demand Dynamics

　　The supply/demand of a security in the market is an intertemporal, not a static, object
and its dynamics is crucial in determining market participants' trading behavior. Previous
studies on the optimal trading strategy to execute a given order focuses mostly on the
static properties of the supply/demand. In this paper, we show that the dynamics of the
supply/demand is of critical importance to the optimal execution strategy, especially when
trading times are endogenously chosen. Using the limit-order-book market, we develop a
simple framework to model the dynamics of supply/demand and its impact on execution
cost. We show that the optimal execution strategy involves both discrete and continuous
trades, not only continuous trades as previous work suggested. The cost savings from the
optimal strategy over the simple continuous strategy can be substantial. We also show that
the predictions about the optimal trading behavior can have interesting implications on the
observed behavior of intraday volume, volatility and prices.