Exchanges May Be Losing Grip On ETFs

August 09, 2013

Although there is some volatility, it’s surprising to see that in the past year, investors have consistently kept between 30-35 percent of their ETF trading off traditional exchanges. However, when we see significant volume spikes in the market as we did in June, volume increases are more on the exchanges than off-exchange.

And it makes sense to some degree—speculators aren’t necessarily utilizing liquidity providers, agency brokers or dark pools to execute their trades, they’re relying on on-screen liquidity.

However, I do question why investors would use those off-exchange platforms during periods of low liquidity and low volatility, but abandon those venues for traditional exchanges during periods of high volume but high volatility. As we saw during the volume/volatility spike in June, investors exiting fixed-income ETFs tended to pay up for such liquidity by selling at significant discounts.

I understand the need to access liquidity immediately, but there’s something to be said for accessing liquidity at the correct price.

It’s hard to deny the benefits of trading off-exchange, especially for ETFs like HYMB that experience poor quoting during times of low volume.

HYMB Quote Screen

Going back to Dave’s example, if I were an investor sitting on 30,000 shares of HYMB bought at a price of $51.20, it’s unlikely I would realize my gains in the current market by dealing with on-screen exchange liquidity and selling at the current bids.

It’s precisely at times like these that investors should utilize agency brokers and dark pools. Although the above quotes seem to indicate that liquidity is thin in HYMB, chances are there’s ample liquidity available off the screen.

The dynamic between volume, volatility and off-exchange activity isn’t necessarily new for the broad universe of exchange-listed securities, but it’s something that ETF investors should keep on their radars.

Good trading isn’t just a matter of limit orders versus market orders, but proper routing of orders for best execution.

At the time this article was written, the author held no positions in the securities mentioned. Contact Ugo Egbunike at [email protected].



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