After years of decline, the average cost of trading Australian equities suddenly increased in 2007/08, thanks to a blowout in spreads caused by higher market volatility as the All Ordinaries headed southward.
According to the ‘Q2 2008 Market Microstructure’ report by Investment Technology Group (ITG), median spreads on ASX 200 trades fell from 51.71 bps in 2004 to 26.41 bps in 2007. ITG gives credit for this fall in spreads to the rise of direct market access (DMA) venues and algorithmic trading, which itself is exemplified by a big increase in trading during the traditionally ‘dead’ lunch time period between 12 noon and 2pm. This two hour window, which accounted for 14.4 per cent of volumes in 2005, had by 2008 spiked to 17 per cent.
The fall in trading costs up until 2007 was a global phenomenon, according to ITG’s Clare Rowsell, as algorithmic trading combined with a host of alternative venues including block crossing networks (like ITG’s own Posit, or Liquidnet), other dark pools like broker-internalised trading systems, or smart order routing to link up different liquidity pools.
But for the peculiar ASX rules dictating that all trades must be executed through it, the local bourse would probably be heading for a similar situation to that faced by the New York Stock Exchange, which in 2007 saw the proportion of daily trading volume in NYSE-listed stocks which it executed fall below 50 per cent.
However the market volatility which began to increase from August 2007 has reversed the narrowing of average spreads, from 26.41 bps in 2007 up to 31.97 bps for 2008 so far. The standard deviation of trading costs – be it the visible cost of broker commission, or the intangible costs of delay between decision and execution, and market impact – has increased even more dramatically from 2007 to 2008, from 14 bps to 32 bps, according to ITG.
“This highlights the importance of adopting ongoing trade cost measurement and ‘best execution’ processes to limit any unnecessary or disproportionate trading costs in volatile markets,” Rowsell said.