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Uneven Liquidity & Unused Tools in the US Equity Market Landscape

Kevin Tyrrell
Head of Research, NYSE

April 14, 2022

While geopolitical unrest, persistent inflation, and recession concerns pushed volumes and volatility broadly higher in Q1, not all financial markets were equally impacted. S&P 500 stocks, for instance, saw only modest volume bumps, and their spreads widened more than 60% versus pre-pandemic levels.

The finding – and others like it from this deep dive into the contours of market volumes and liquidity – highlight the importance of a nuanced understanding of shifting market conditions and the tools available to cope with them and drive efficient trading.

Just one quarter in, 2022 has already been beset by various challenges in financial markets. The terrible human tragedy in Ukraine has sparked global turmoil and concerns about energy sources, fanning the existing flames of inflation. Central banks have meanwhile begun unwinding highly accommodative stances taken during the pandemic. Trading in commodities and fixed-income instruments has received a lot of attention in light of these developments, but at the same time Q1 2022 equities volumes were 71% higher than in Q1 2019 (and notional value traded increased even more, up 110%). However, as we have seen for nearly two years now, impressive top-line volume numbers do not necessarily equate to liquid trading conditions across the market.

What are people trading?

While both share and dollar volume are up across the board, these gains vary greatly based on the type of security and the metric being examined. For example, stocks trading below $5 per share have increased their share volume traded by 163% since Q1 2019; at the other end of the spectrum, S&P 500 stocks have increased a healthy but far less exciting 17%. While S&P 500 notional volume traded is up 95%, this is mostly due to the rise in average asset values between these periods.

% Change Q1 2022 vs Q1 2019

Share VolumeDollar Volume
S&P 50017.2%95.1%
Corporate Stocks < $5163.3%148.5%
All Other Securities73.1%95.5%

Share volume growth in S&P 500 stocks has been robust yet modest in comparison to that in other securities.

Another way to think about this is in terms of the number of shares changing hands each day reflecting widely-held, large cap stocks compared to ETFs and other securities. Three years ago, 31% of all market volume was in the S&P 500; in 2022 that figure has declined by roughly a third to 21%. Notably, despite the dramatic increase in low-priced and smaller-cap companies, ETFs have slightly grown their share of market volume from 20% to 22%. (For more details on recent ETF activity see our ETF market review).

These volume shifts have resulted in greater variety among the most actively traded securities. In Q1 2022, 29 different securities were the most active stock in the market for at least one day, compared with just 19 different securities in Q1 2019.

Adding to the volume environment’s complexity, more of the volume growth has occurred off exchange than on exchange. This is more pronounced in shares traded than dollar value traded, showing the influence of lower-priced stocks trading off exchange on overall market volume.

US Equity Market Volume Growth

Q1 2019=100

US Equity Market Dollar Value Traded Growth

Q1 2019=100

The gap between off-exchange trading growth by volume and dollar value traded shows that much of that volume growth has been in lower-priced stocks.

What does this mean for market conditions?

With 2022’s higher volatility, most market quality indicators such as quoted spread, displayed liquidity, and price volatility are currently more challenging than they were in the relatively low-volatility environment of 2019. For example, the median quoted spread for the S&P 500 was 6.9 bps in Q1 2022 vs. 4.2 bps in Q1 2019.

We’ve covered the growth in retail trading from multiple angles. Combined with higher volatility, this has led to increased levels of off-exchange trading and a shift within off exchange to OTC trading from ATS trading. We’ve seen this trend mostly hold even through 2022’s volatility: OTC share of market volume was 29-31% for most weeks in January and February, with ATS share between 10% and 11%. The corresponding share values in 2019 were 25-26% for OTC and 11-12% for ATSs.

How are traders reacting on exchange?

In today’s environment of higher volatility and uncertain liquidity conditions, traders need to leverage all available tools to maximize their venue interactions. We can measure this on NYSE Group exchanges by looking at order type usage, where we have seen some rather modest changes. While we publish order type usage for all of our equities exchanges, we focus here on NYSE and NYSE Arca as those are the largest individual venues and capture primary trading for both corporate securities and ETFs.

For example, on NYSE in Q1 2019, 47.1% of displayed limit-order executed volume used Add Liquidity Only (ALO) and/or Intermarket Sweep (ISO) order instructions. These order types allow a more predictable limit-order experience and often represent more sophisticated limit-order posting strategies such as those a market maker may use. In Q4 2020 these order types had risen slightly to 48.6% of displayed limit-order volume, but then in the more volatile Q1 2021 they rose to 50.8%, reaching a high of 51.2% in February. Similarly, NYSE Arca had 41.8% of displayed limit-order volume using these order types in Q1 2019, with that share rising to 45.3% in Q1 2022.

We also saw a small shift in non-displayed trading inside the spread. As volatility increased, the share of non-displayed liquidity using a straight non-displayed limit order increased relative to the share of volume using the Midpoint Passive Liquidity (MPL) order type, which pegs to the midpoint and therefore moves more often in volatile markets. As stock prices have risen over time, we have seen increased use of non-displayed limit orders, and recent volatility has accelerated the trend. NYSE MPL share of all non-displayed volume was 61.3% in Q1 2019, falling to 51.5% by Q4 2021 and then further to 49.4% in Q1 2022. NYSE Arca has seen the same long-term trend with increasing non-display limit usage but saw MPL gain relative to non-display limits during recent volatility, a shift we are studying further.

Conclusion: look past headline numbers and adopt additional tools

As the numbers show, today’s higher market volumes are very unevenly distributed, and liquidity can be challenged when volatility jumps in a sector or across the market. We observe some small shifts in order type usage in today’s market environment, but no dramatic changes in exchange interaction during periods of volatility.

Given the geopolitical and macroeconomic outlook, we are likely to see more volatility in the near future. This is the time to explore opportunities to leverage unique liquidity events like the NYSE Closing Auction for larger orders and look to new tools like the NYSE Arca DPO order type for flexible execution logic seeking to maximize spread capture.

This column originally appeared in Curatia News on April 13, 2022.

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