Buy-side traders need to employ more covert strategies to cope with the lack of liquidity on order books in today’s difficult trading environment, according to Jonathan Tse, analyst, AES trading and product development at investment bank Credit Suisse.
“In a thin order book, it’s a lot easier to spot someone’s intentions, and in the current market, where there is much less liquidity, minimising signalling risk has become ever more important,” Tse told theTRADEnews.com. “We have been actively encouraging our clients to use stealthier strategies that reduce signalling whilst taking advantage of all available liquidity.”
A new report from Credit Suisse’s Advanced Execution Services (AES) division found that order book density in the Euro Stoxx 50 index of leading European equities fell by around 16% over the period from 18 August to 13 October. Order book density is a proprietary calculation used by Credit Suisse to determine the available liquidity in a stock at a given point in time. The more dense the order book – in other words, the more volume available at a particular price point – the less the price will move following a trade of a certain size.
This reduction in liquidity is in turn creating more intraday volatility. “To secure any given amount of volume, you have to move through more price points,” explained Laurent Boldrini, an associate in Credit Suisse’s portfolio strategy group and co-author of the report. “We are seeing this create more impact and intra-day volatility in the markets.”
According to the study, daily volatility has “exploded” since the bankruptcy of Lehman Brothers on 15 September. Credit Suisse currently sees sustained levels of 70% realised and implied volatility across the Stoxx large-, mid- and small-cap European indices it monitored for the study. Intraday volatility has more than doubled to 0.49% in the period after 15-19 September, from 0.22% in the period before 15-19 September.
A potential driver for the shallower liquidity, according to Credit Suisse, is the lack of arbitrage activity caused by the dearth of cheap credit. “To be able to trade arbitrageurs need to finance their long position in stocks and for that they need to have low cost of funding,” said Boldrini. “As the cost of funding is increasing, opportunities are going away, and so when there is a shift in the market, there is no-one to provide matching liquidity to those large moves.”
In addition to a lack of liquidity and increasing daily and intra-day volatility, the trading environment from August to October has also been blighted by widening bid-ask spreads. In the period between 18 August and 17 October, bid/ask spreads increased by 32% across all market capitalisations in Europe.