Not long ago, the market used to trade 6 billion shares a day on a pretty regular basis. Today, 10 billion shares are “normal,” and we’ve even been seeing 9 billion shares a day in the middle of summer. This raises the question, is the stock market really that much more liquid?
It's hard to compare notional trading because with the market at all-time highs, market capitalization has increased too. But looking at headline shares traded doesn't really show what is driving the real increase in shares being traded, as we see in today's charts.
Chart 1: Trading has spiked after Covid (average daily volumes, per week)
As usual, classifying what is retail is hard. In the chart above, we classify all non-ATS-TRF as “wholesalers,” although a fraction of that data includes other bilateral trades, like block trades that will be institutional. However, a study showed the proportion of wholesalers has been rising and was recently over 81%.
Also, what we call “institutional” above represents all multilateral trading venues. Consequently, a fraction of that volume would reflect retail limit orders on exchanges. But it’s not possible to separate them using public data.
Volatility first drove volumes up
The first thing we see is that trading significantly spiked as Covid spread. Normally that would be completely explained by the price discovery and repositioning that needed to happen as news about Covid and its impact on companies and the economy evolved. As we noted in a prior study, volatility spikes almost always come with additional volumes (and wider spreads).
But the Volatility Index fell back below 20 back in March 2021 and has mostly stayed below that level since then. Realized volatility has fallen even lower. So why are volumes still 50% (or more) above prior levels?
Retail is growing and driving volumes up
We know from multiple sources that retail participation in the market is growing. Some suggest that retail now accounts for close to 25% of all trading. Other data suggests retail has become consistent net buyers of stocks ever since the first lockdowns and stimulus checks.
However, that’s not the whole story. Data also shows that retail typically trades more of the lower-priced stocks. Consider the average retail trade is $8,000, which represents 4,000 shares in a $2 stock but less than three shares in AMZN. That makes them look like outsized players in the market.
Chart 2: Retail (non-ATS-TRF) market share is consistently higher for lower-priced stocks (most dots on the left are green) while in higher priced stocks retail activity also tends to increase reported trading volumes (green dots are high).
A lot of the gains in ADV are from non-ATS-TRF
As we recently discussed, retail often trades off-exchange with wholesalers. That seems consistent with the contribution to total average daily volume (ADV) coming from the growth in non-ATS-TRF (green in chart 1). That also potentially overstates the liquidity available to mutual fund investors.
If we separate the data from Chart 1 out and exclude Q2-2020, which was most affected by Covid, we can see that non-ATS-TRF (“retail” trading) has more than doubled between the pre- and post-Covid period, to 3.8 billion shares per day.
Interestingly, this data also suggests the growth in retail trading caused by the introduction of free commissions (in late 2019) isn’t that obvious.
Importantly, we noted recently that the volume trading in non-ATS-TRF far exceeds estimates of retail trading, so it’s likely that this is affected by institutional trading too.
Chart 3: Volumes pre and post covid by venue
In fact, even the “other” volumes we show in blue, representing exchanges and dark pools which are typically considered “institutional,” have seen volumes increased by a similar number of shares (although a much smaller percentage, 40%).
Large-cap stock trading has increased little
Another problem with looking at “top-line ADV data” is it includes ETFs too, which tend to be used more by retail and hedge funds – and less by mutual funds.
Another way to look at single stock liquidity trends is to focus on stocks in the S&P500.
Doing that shows a trading and liquidity spike during the onset of Covid (Q2-2020) that subsided pretty quickly. In fact, S&P volumes are mostly back to levels they were trading at before Covid, at around 2 billion shares per day.
Chart 4: Average daily volume in S&P500 components over time
Other data suggests lit market depth is declining
A recent study by Wellington looked at stock liquidity in a different way – by looking for the average depth quoted on the NBBO for S&P500 stocks over time. Their results seem to show that on exchange liquidity in large-cap stocks is actually falling, with the average notional value falling from around $200,000 to below $100,000 over the past 10 years. That’s despite the market rallying.
Chart 5: Decline in average value on NBBO for S&P500 stocks since 2010
Source: Wellington Management
It is actually harder for mutual funds to trade
What does this all mean?
Liquidity is important for mutual funds, which usually make very large trades on behalf of aggregated retail investors, to assess how large their trades can be without causing excessive market impact. On-exchange liquidity is important to execute trades and keep signaling costs low when they post orders in the market.
Although current headlines show volumes growing 50% in two years, a deeper dive into the data shows the story for a stock picker is a little different.
The growth of retail trading has added more to off-exchange volumes and is skewed toward smaller-cap stocks. Large-cap volumes are like they were five years ago, but intraday quoting in large-cap stocks has actually been falling. This data seems to show that it has become harder, not easier, for mutual funds to execute their trades. That’s probably not what most portfolio managers expect.