Euronext researches trading costs

Pan-European exchange operator Euronext has published a study which compares the cost of trading in the continuous session of its markets versus the closing auctions and the findings are somewhat surprising.

Counter-intuitively the research found that it’s far costlier to trade large orders in the continuous session than it is to trade those orders in the markets closing period.

Euronext found that in a trade that represented 3% of the daily volume the cost of trading in the continuous session amounted to 13.90 basis points whilst the cost associated with trading in the close was just 3.70 basis points.

The Euronext study looked at trades in 160 stocks across cash equity markets in Belgium, France and the Netherlands from early November 2019 until the end of January 2020. A period that did not include any COVID-19 related market volatility.

Euronext found that the closing auction was the most liquid point in the trading day and that trading costs are commensurately lower when liquidity is at its peak. The trading costs that Euronext was trying to measure are unrelated to commissions rather the study assessed the degree of market impact that larger orders have on the execution price.

The lower an orders market impact then typically the lower those trading costs will be. Traders talk about the difference between the arrival price, that is the prevailing price when the order was instructed, and the final execution price when it’s completed.

In the absence of new information or news flow, the deviation from the arrival price should largely just reflect the supply and demand scenario in that particular security or market.

Given the findings of the Euronext study, the question that must be asked is there still a role for the continuous trading session?

The Euronext report believes there is saying that: “Nevertheless, intraday trading remains essential in order to benefit from intraday price opportunities, or when the fund manager’s short-term alpha offsets the greater market impact of continuous trading”

Essentially that means that the continuous session is best for orders that are potentially time-sensitive. That is they need to be filled sooner rather than later. However, orders which can be implemented over longer time horizons are probably best executed in the closing auction.

The process of measuring these price deviations and trying to minimise them through specific execution strategies is known as TCA or trading cost analysis.

This type of analysis is very familiar to equity markets is becoming more commonplace in derivatives as well.

We recently wrote about Citi’s launch of an implementation shortfall algorithm for use in futures trading which is specifically designed to try and reduce the differential between the arrival and execution prices.

However, trade cost analysis is not that common in the world of FX trading. However, after a year of volatile markets, buy-side institutions are beginning to ask for this kind of analysis and the tools with which to conduct it.

Non-bank market maker Virtu Financial has recently introduced open source applications, to allow its data science team to provide customers with just this type of analysis.

Refinitiv’s FXall platform launched a TCA analytics package in February last year and Bloomberg added the service to its FXGO functions in late November 2020. We would expect to see more execution venues and FX brokers introduce this kind of tools and analysis to their offerings in the year ahead.