Equity trading focus | Market quality | Michael Krogmann Of figures and fairness
Michael Krogmann* provides a holistic insight into defining market quality.
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t feels like ages ago when the comparison of explicit trading cost combined with the liquidity in a specific instrument seemed enough for market participants to make an educated choice on which market to trade. This was before the credit crunch in 2008. Investors lost a lot of faith then, and in the face of an increasingly fragmented European equities trading landscape it should surprise no-one that this faith has not been fully restored yet. Consequently, market participants have been looking for better means to identify the very trading venue which supports their individual strategy best. Over the last few years, their focus has been shifted from cross-venue comparisons regarding market share and liquidity to a much bigger picture: the overall quality, accessibility and the level of pre- trade transparency a market has to offer.
Quantifiable indicators There is an industry-wide consent that market quality can be determined – and compared – by measuring spreads at touch, best prices at touch, and the quoted
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order book depth of a market, per instrument or index. A very popular example for this is the “battlemap of the exchanges”, a comparison of these indicators plus the respective market share regarding Europe’s major trading venues, and including eleven European indices. This decision-making tool, provided by LiquidMetrix, a neutral and independent research provider, has proven so useful for market participants that Deutsche Börse decided to provide the relevant data on
xetra.com for comparing market quality for trading of the German benchmark index DAX. However, these indicators work best with big trading venues attracting all kinds of investors, providing a heterogeneous and pan-European order flow. The more specialised a trading venue is, the less weight these figures have, and the less they qualify for comparison.
The need for diversity The kind of liquidity a market participant needs to pursue his investment objectives depends on his trading strategy. And just like trading strategies, liquidity
pools can vary widely – making it considerably more difficult to compare trading venues. A marketplace attracting mainly high frequency traders might provide high liquidity which could be of lesser benefit for other kinds of investors. Thus, a liquidity pool reflecting a multitude of traders’ interests will cater to the needs of a broad variety of investors. Another important factor
regarding the diversity in counterparties is their direct influence on a market’s ability to recover from the impact of an order. The more diverse the liquidity in a specific instrument is, the more resiliency a market participant can expect.
Fairness: a fundamental factor Part of the academic literature differentiates between market quality and market integrity, maybe because integrity cannot be quantified as neatly as transaction cost or liquidity. In fact, integrity is a vital part of the overall market quality – and, of course, part of transaction cost, if not an obvious part. Michael J. Aitken,
Best Execution | Summer 2013
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