Continuous trading offers investors better outcomes than auctions, finds Citadel Securities

The market maker has used the example of the Taiwan Stock Exchange’s 2020 transition away from auctions as evidence that continuous markets can foster better liquidity and pricing.

Continuous markets generate better outcomes for end investors than auctions, research from Citadel Securities has found.

In a study of the Taiwan Stock Exchange (TWSE), which transitioned from a frequent batch auction with a duration of 5 to 5.2 seconds to a continuous matching one in March 2020, the market maker claims to have found that continuous markets offer better liquidity and price discovery, lowers bid-ask spreads, more stable prices, and higher trading volumes.

These combined benefits also reportedly lowered the cost of capital for companies involved in capital raising and subsequently bolstered the markets more generally.

“The Taiwan Stock Exchange’s shift from frequent batch auctions to continuous trading in March 2020 presented a unique opportunity to settle a longstanding industry debate over which process is most beneficial to investors and the real economy,” Matthew Steinert, head of Americas business development at Citadel Securities, told The TRADE.

“Our analysis clearly shows that the shift resulted in more liquidity, lower volatility, greater trading volumes and reduced trading costs for retail and institutional investors – contributing to more efficient, accessible and cost-effective capital markets.”

According to Citadel Securities’ research, TWSE saw its volumes double to roughly $8 billion per day after its shift to continuous trading; while liquidity was significantly improved, finding that the average number of shares on offer in the top five levels away from the midpoint went from 600,000 before continuous trading to around 1.3 million shares at an average price of $53 Taiwan Dollars (TWD), after.

For the top 30 stocks that trade on TWSE and account for 80% of total shares traded, available liquidity was four to five times higher after the shift away from auctions. The less liquid stocks saw less of an improvement and the market maker acknowledged that continuous markets often favour more liquid stocks while those with lower demand “may benefit from liquidity programs” to incentivise their liquidity provision.

The report also found that, taking into account conditions caused by the pandemic, volatility had decreased by 18% from before continuous trading was implemented, to after.

Using these figures, Citadel Securities claimed that TWSE had saved investors $550 million in a single year due to the effects of lowered volatility, better liquidity and smaller spreads. This lowered the cost of capital and improved the real economy.