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TrADe ToPiCS: oN voLUMe

Recently there have been several articles focused on the decline of equity trading volume in the United States. Since reaching a peak of approximately 12.3 billion shares per day in March 2009 we have witnessed volume return to between 6 and 7 billion shares per day more recently. All of these articles focus on that same three year period. With this note we have decided to pull the focus back a bit and analyze a longer time period (just over 13 years). We will also discuss some of the events in the market and changes to the market that have impacted volumes both positively and negatively over this period.

is volume growing?
Our data begins in September, 1998. This is the earliest data we were able to locate in which we have a reasonable degree of confidence (see note on data sources). While it would not seem that the simple act of counting volume would require confidence, if one digs deeply enough into the available data sets one will find a number of inconsistencies that are difficult or impossible to reconcile. Data sets that purport to represent the same thing can differ by as much as 35%. There are also historical anomalies such as when first NASDAQ and then some dark pools systematically double counted their volumes by counting both buys and sells. More recently that problem has been solved by reporting matched volume. We can have no disagreement that volume has declined from its peak level in 2009. However, in thinking about growth or shrinkage the choice of starting points is significant. Graph 1 shows average daily volume by month going back to 1998 aggregated across all US exchanges (grey bars). The light blue line represents the approximate growth rate of volume from September 1998 through December 2006 extrapolated to the present. Based on this extrapolation, current volumes are only modestly below trend.

Average daily composite volume

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Which is the correct growth rate to focus on when discussing volume? The 1998 to present growth rate (light blue line) Or the 2007 to 2009 growth rate (dark blue line)

The dark blue line extrapolates the approximate growth rate from December 2006 through May 2009 to the present. Based on this extrapolation, current volumes are barely one third of the trend.

It seems then that the right question to ask is which growth rate is reasonable? If the 1998 through 2006 growth rate is the choice, how can we explain the meteoric growth from 2006 to mid-2009 and the subsequent decline?

Average daily composite volume vs vix

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Graph 2 overlays the VIX Index on the volume graph. From September 1998 through December 2006 VIX and volume are negatively correlated. As volatility is in a general decline volume is generally increasing. From January 2007 through April 2012 the opposite appears to be the case. Volume tends to rise and fall as volatility rises and falls.

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0 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Sep-98 May-99 Sep-99 May-00 Sep-00 May-01 Sep-01 May-02 Sep-02 May-03 Sep-03 May-04 Sep-04 Jan-05 May-05 Sep-05 May-06 Sep-06 May-07 Sep-07 May-08 Sep-08 May-09 Sep-09 May-10 Sep-10 May-11 Sep-11 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

ratio of volume to volatility vs SPx index

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0 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Sep-98 May-99 Sep-99 May-00 Sep-00 May-01 Sep-01 May-02 Sep-02 May-03 Sep-03 May-04 Sep-04 Jan-05 May-05 Sep-05 May-06 Sep-06 May-07 Sep-07 May-08 Sep-08 May-09 Sep-09 May-10 Sep-10 May-11 Sep-11 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

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Graph 3 adds a third factor to the analysis. Here we present a ratio of volume to volatility to get a measure of units of volume that trade per unit of volatility. Against that we graphed the SPX Index. Now we see a different pattern. From September 1998 through September 2002 the amount of stock market participants were willing to trade per unit of volatility fluctuated in a relatively tight range as the market first rallied and then fell. After September 2002 attitudes toward volatility appear to have changed and appear to be dependent on what the overall market is doing. In rising markets market participants are more willing to increase the amount of trading they do per unit of volatility. And the opposite also looks to be true. When the market moves lower market participants decrease the amount of trading they do per unit of volatility. This implies that volatility is not the only driver of the willingness to trade. It is almost as if traders view volatility when the market rises differently (better) than an equal amount of volatility when the market falls (worse). We do not think that will be a surprising statement necessarily in spite of the fact that in theory all volatility is the same.

SPX INDEX

Market structure factors

Market volatility and price movement do a good job of summing up broad macro causes of volume increases and decreases. Some of these factors include the quant crisis and de-levering in 2007, the mortgage crisis in 2008 and 2009, the sovereign debt crisis of 2010 through 2012. However, there are a number of factors related to market structure that have also contributed to the increases in volume we saw up until 2008. It is a truism that when a good or service gets less expensive people will use more of it. Equity trading is no exception. And from 1997 through approximately 2009 there has been a persistent trend of decreasing costs to trade. Regulatory changes combined with the markets reaction to them have been behind most of this price improvement. The first attempts to lower the cost of trading came in the form of decreasing minimum bid/offer spreads. Prior to June, 1997 the minimum tick size for stocks trading on the NYSE and NASDAQ was 12.5 cents. The minimum was then moved to 6.25 cents for a pilot group of stocks before being rolled out to the entire market. Between August, 2000 and January, 2001 the minimum tick size was lowered again to 1 cent making it possible to trade at 100 increments per dollar rather than the original 8 increments. The greater number of increments also meant that the available

liquidity did not bunch up as much at each price point. So while the inside market was tighter, the shares at the inside were often smaller. However, the overall cost of trading was still lower. In between the two minimum tick decreases another important event occurred. Regulation ATS went into effect in 1999. Prior to Reg ATS the SEC issued individual no-action letters to ECNs that allowed them to operate within certain bounds. With Reg ATS the SEC formalized the idea that there should be competition amongst exchanges based on innovative ideas for trading. As a result many competing models for lowering the cost of execution have risen and the near monopoly the NYSE once enjoyed trading the shares of stocks that list on its exchange has been eroded with the NYSE now trading 31.3% of its own listings. The pace of change began to increase at this point with innovation typically coming from new entrants and responses to new business models coming from the main exchanges. In 2004 dual listing of stocks began allowing any exchange to trade any stock. In 2006 BATS began operations and in its first year became a major player by offering to pay participants to provide liquidity on its trading platform. A number of mergers and consolidations took place in attempts to be better positioned for the new regulatory environment (Instinets ECN changed hands three times between 2001 and 2005). And from 2006 to 2008 NYSE

began to experiment with a variety of rebate models before being joined by NASDAQ in this effort in 2008. Throughout the period the common theme was greater competition drove greater innovation and decreasing costs for investors and traders. With decreasing cost volumes grew. But, it also created some confusion as the competing business models have often been difficult to reconcile. With the passage of Reg NMS in 2007 enforcing a trade through rule (among other rules) a type of market structure arbitrage became possible and high frequency trading grew substantially from 2007 to 2009. Since then there has been little that is new in market structure. Changes have focused on new pricing schemes rather than new business models. This has resulted in a shuffling of where volume occurs rather than a general increase in volume. So while the growth rate of volume between late 2006 and mid 2009 jumped to a level not seen before, with the lack of innovation since then and the macro factors mentioned earlier we appear to have fallen back to the implied levels of volume from 1998 to 2006, extrapolated to the present. Please share comments and thoughts at info.globaltrading@sungard.com. While we may not be able to provide analysis on every idea, we will respond to every request.

For more information: email: paul.daley@sungard.com contact: 630 482 5188

Note on data sources

For the period January, 2004 through April, 2012 the NYSE provides, through its website, consolidated volume figures for Tape A, B and C securities. For the period September, 1998 through December, 2003 a combination of Bloomberg data sets for each individual exchange (Cincinnati, Midwest, NASDAQ, NYSE, Pacific, Philadelphia and SIAC) was used to create a consolidated volume estimate. A comparison of both data sets was made over the overlapping period of January, 2004 through December, 2004. During that time period the assembled Bloomberg consolidated volume was an average of 3.8% greater than the NYSE provided consolidated volume figure. Neither data provider includes a rigorous definition of their volume statistics or an explanation of collection methods. Given this lack of detail, all figures should be viewed as estimates rather than precise measurements.
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