Two years after the Flash Crash – Spreads are Narrower and Liquidity Deeper than Ever Before? Guess Again.
I bought 500 shares of IBM on the opening print today. You would think 500 shares would be pretty easy to liquidate within a penny or two considering how our market scholars claim that the market has deeper liquidity and tighter spreads than ever before. Anyways, a minute after the open, this is the quote that I was trying to liquidate that 500 shares into:
*charts courtesy of Neovest
Yes that’s right you are reading the quote correctly. The spread was 37 cents. 100 shares x 100 shares. Looks pretty thick and deep to me. And why does the quote change so many times in the one second increment that I have shown? HFT liquidity providers change their quotes continuously in that 1 second increment, usually trying to aggressively penny each other, but then cancelling their orders simultaneously.
So if I wanted to sell my 500 shares at the market, I could be filled on one hundred shares at 203.10, and pay that 37 cent spread. And on the last 400 shares, who knows where I would be filled.
But this is just an isolated quote isn’t it? Guess again. Here is the quote two minutes later. It’s actually a penny wider, 38 cents.
But it does gets better, and the spread does tighten up. 11 minutes into the trading day the spread is now a tight 27 cents.
Well IBM is a $200 stock so of course the spread is going to be wider. This isn’t the case with other DOW components is it? No they are indeed tighter.
Proctor & Gamble (PG) had a nice tight spread of 21 cents, 19 seconds after the open.
Coke (KO) had an 11 cent spread, in the first 30 seconds of trade.
Then tightened to a 10 cent spread, 100 shares x 100 shares 2 minutes after the open.
MMM had a cool 25 cents spread after the open.
These are supposed to be some of the most liquid stocks on our exchanges. Where is all this liquidity that our academic scholars claim the market has?
Well if you analyze spreads in the middle of the day, you will get an entirely different picture.
If you bring up the IBM quote in the middle of the day, you will typically find the spread to be only a few cents. Coke and P&G will usually have a 1 cent spread Why is this? HFT liquidity providers do not like risk, and when there is so much uncertainty of where the price is going (like when the stocks open, or right before market moving events), they simply do not quote aggressively. Many HFT programs don’t quote at all.
Nanex showed images of the E-mini liquidity around a 10:00 economic number release on April 19th. http://www.nanex.net/aqck/3233.html They call it a liquidity vacuum, as HFT participants cancel their orders ahead of the number.
Was this lack of liquidity an isolated event today? Hardly. This is a daily occurrence. I would challenge all our academic scholars who analyze spreads to take a good look at liquidity a few minutes after the open, or around any type of market impact event such as a 10:00 economic news release. You’ll find liquidity to be very thin and very dispersed. Indeed, we have plenty of liquidity in the market, just not during periods of market uncertainty.
Update: We’d like to thank Nanex for taking the time to post liquidity charts of the stocks mentioned in this article: