04.18.2012
By Terry Flanagan

Finding Liquidity

While lower market volatility is suppressing trading volumes, traders are finding alternative methods to access liquidity.

“While large caps are generally more liquid than small caps, there’s still quite a bit of liquidity in small caps,” said Dan Neiman, portfolio manager of the Neiman Large Cap Value Fund. “What a retail investor in small caps has to realize is if they try to take a position in a stock at a certain price, and an institutional buyer tries to take a large position in that same stock at the same time, the price paid by the retail investor could be significantly higher than they expected to pay.”

However, despite that, there is still sufficient liquidity in the markets.

“That said, I don’t think there’s been a break down in liquidity in our stock markets,” added Neiman. “With electronic execution and the merging of exchanges, the markets are far more liquid than they used to be.”

Broker-dealers are also helping to source liquidity as well. Both Goldman Sachs and UBS have each recently introduced algorithmic trading strategies specifically designed for the trading of illiquid, small-cap stocks.

“The availability of equity liquidity is never a given, but for some securities it is even more elusive,” said Owain Self, global head of algorithmic trading at UBS.

Both algorithms use similar strategies, in that they take a wait-and-see approach, sit by idly, and only execute when the opportunity is right and when market impact will be minimal.

“Traditional algorithms were built to trade on a schedule, which means they are not suited to appropriately capture unanticipated bursts of liquidity,” said Self. “Our clients tell us that at times, for certain securities, they need a strategy to operate on an ‘I would if I could’ basis. So we designed Swoop to wait, watch and intelligently act upon those unpredictable moments.”

Despite the decline in market volatility, market liquidity is still on a long-term growth path and is better than other bear markets.

“I think our markets are more liquid today for all stocks than they were ten years ago during the dot-com bubble, and even more liquid than when stocks used to trade at eights of a dollar,” noted Neiman.

Either way, market volatility usually doesn’t stay suppressed for long, and it’s only a matter of time before it returns in some form.

“Volatility is driven by investor uncertainty,” said Neiman. “The global economic crisis, upcoming presidential election, unemployment rates remaining high, interest rates remaining low, yet rising corporate profits, all contribute to volatility and I don’t see the VIX or any other measure going lower at any time this year. On the liquidity side, when there are too many buyers or even too many sellers, markets become less liquid. If the market happens to continue its upward trend, this will create less liquid markets, but mainly for large institutional buyers trying to take large positions.”

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