Capturing the spread is an important part of controlling overall trading costs. Whenever the spread is crossed the cost of the executing the order increases. However, waiting passively to capture the spread increases the possibility that the market moves against you and the price of the stock rises without even the benefit of acquiring the shares. It is part of the trader’s skill to decide how to optimise both minimising price impact along with minimising potential opportunity cost of adverse price movements.
Not capturing the spread reflects a price concession necessary to complete transactions quickly. This can be an important indicator of market quality and in determining trading performance. In general, execution costs can be understood as the cost of paying for liquidity. The important point for our concerns is that all the individual decisions on whether to capture or not capture the spread in aggregate constitute the market’s price momentum.
We look here at trends in spread capture using data from the LiquidMetrix research database. We compare trends in spread capture since the beginning of 2020 across regions and for stocks with varying degrees of liquidity.
- Overall in 2020 for both the US and EMEA, less liquid stocks have slightly lower percentages of spread capture than more liquid names.
- In EMEA the percentage of spread capture is lower for both more and less liquid stocks compared to the US.
- If we look at the rate of change in spread capture since the start of the year, we see that the amount of spread capture has increased in the US while it has declined in EMEA.
To define what is a “more” liquid and “less” liquid security, we employ the MiFID II categorisation of financial instruments into Tickbands used in RTS-28 reporting. We will not examine illiquid names with an average of less than 80 executions per day, but focus on the “High” liquid securities (Tick Bands 5 and 6 with more than 2,000 executions per day) and “Medium” Liquidity names (TickBands 3 and 4 with 80 to 1,999 trades per day). We are using a research dataset with over 256 million trades for High Liquidity stocks and over 44 million trades for Medium Liquidity stocks since the start of 2020.
Figure 1 shows the 25th percentile, median and 75th percentile average spread capture since the beginning of 2020 for US stocks across both the High and Medium Liquidity groups. The median spread capture by day for High Liquidity stocks is 59% which is 5% greater than the median of the less liquid names. For High Liquidity stocks, 25 percent of days had an average spread capture of 62% or higher while for less liquid stocks the 25th percentile was an average spread capture of 57%.
In Figure 2, EMEA shows less difference in average spread capture between the more and less liquid stocks. Where there is a 5% difference in the median spread capture in the US among the more and less liquid groups of stocks, there is only a 2% difference in EMEA. Looking across regions, we see that for both the more and less liquid stocks, the percentage of spread capture is higher in the US than in EMEA. The top 25% of days in the US for High Liquidity stocks had an average spread capture of 62% or greater compared to only 55% in EMEA. Similarly, the bottom 25 percent of days in the US had a spread capture percentage of 57% for High Liquidity names compared to 50% for EMEA.
Let’s turn now to see if there are any trends in changing spread capture percentages since the start of 2020. Our approach is to index the daily average spread capture since January 2nd.
Figure 3 shows the change in high and less liquid US stocks since the beginning of the year. Interestingly, Medium Liquidity stocks are showing more of an increase in higher spread capture. 25 percent of trading days show an increase in spread capture of 10% or greater, while 50% of days have a rise in spread capture of at least 4%. In contrast, the Highly Liquid stocks experienced only a 6% increase in spread capture for 25% of trading days. However, for both High and Medium Liquidity stocks, the trend is moving towards higher average spread capture.
When we turn to EMEA, we see an entirely different story. Figure 4 shows the analogous chart. In EMEA the trend has been to lower spread capture. For Highly Liquid stocks, the median day has an average spread capture 3% lower than the Jan 2nd baseline and a quarter of trading days had a spread capture that was at least 7% less than the baseline. For the less liquid group of stocks, there was a wider dispersion but the same overall trend towards a lower spread capture percentage. The bottom quartile of days had an average spread capture that is 10% less than that of January 2nd.
What does this mean? The lower percentage of spread capture in EMEA means traders were more inclined to cross the spread. This may indicate a greater urgency to trade. However, it is premature to jump to this conclusion. It might instead be a function of different market structures. For example, the decline in spread capture in the EMEA may be the result of greater use of Auction and Block venues that use mid-point orders at the expense of executions that formerly would have been executed passively. Further research will be required to come to a firm conclusion as to the driver of shifts in spread capture.