Closing in on liquidity
Gary Stone, chief strategy officer, Bloomberg Tradebook, explains how to trade at the most liquid time of the day.
Even during periods of
volatility, the European equity closing auctions are an important source of
liquidity. Prior to the last period of volatility in the summer of 2011, the
closing auction for the members of the FTSE 350 represented anywhere from around
15% to 22% of the average daily volume (ADV), depending upon the market cap of
the stock. Closing auction participation declined during the volatility but
still represented a robust 11% to 16% of ADV (Figure 1).
Navigating the close
The value of the closing
auctions is finding liquidity and at a price that represents the official
closing price. Despite their importance, the closing auctions are incredibly
difficult to navigate. Many of the exchanges do not offer closing auction order
types that enable queuing or that make the transition from continuous trade to
auction smooth and seamless. The exchanges also do not support auction market
or auction pegged-limit orders.
Thus, traders are forced to
set and reset limits manually. This is typically very complex because auction
buildups tend to be volatile and unpredictable.
With price and volumes changing throughout an auction there is a risk
of not being filled.
Bloomberg Tradebook provides
transparency and closing auction participation options to intelligently
interact and leverage one of the most significant period of liquidity during
the trading day. Tradebook’s execution consultants can help clients understand
the impact of the options on the stocks that they trade and optimise their
interaction during these liquidity events.
Let’s start with transparency.
Tradebook’s Strategy Analyzer (STAZ<Go>) analytic provides traders with
statistics on the importance of both the opening and closing auctions.
Openingauctions typically only represent on average around 1% of the ADV. The
STAZ analytic provides disclosure of the importance of the closing auction as
well as pre-trade information about the stock and suggested execution
strategies (Figure 2). Tradebook’s market depth monitor (BMQ<Go>)
displays the auction buildup information in realtime. The top of file price in
the monitor and the ‘Exchange Status’ indicator in the monitor will turn
magenta when the exchange is in the auction period.
With Bloomberg Tradebook,
traders can choose their degree of participation in closing auctions. For
example, traders can specify an allocation of a benchmark strategy into the
closing auction, work a passive order over the day with the residual flowing
into the auction or queue an order to be worked in the auction. Traders that
benchmark to the VWAP may experience deviation from their benchmark because
they do not participate in the closing auction.
There are two ways to
participate in the closing auction (Figure 3).
Allocate shares: in this
option, the trader can specifically instruct the algorithm to allocate shares
and place them in the closing auction.
Residual shares: If the trader
places a constraint (limit or % participation) on an algorithm, this option
instructs the algorithm to place the residual unexecuted (residual) shares into
the auction using the same constraints.
The closing auction strategy
(Figure 4) will queue orders for the closing auction. The algorithm uses price
and volume prediction routines based on the buildup to adapt to the dynamics of
the auction. It uses proprietary techniques to establish priority queue
position early in the auction, and it will split orders to adapt to changing
auction dynamics and to hide footprints. Traders can elect to constrain their
participation with a limit or % participation constraint. It doesn’t matter
what market cap of the stock is: the closing auction is a liquidity opportunity
that is significant in normal trading conditions as well as times of stress.
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