Fluctuating retail volumes pose a challenge for brokers

Key Takeaways

• Retail volumes surged during the pandemic and dropped after
• Non-volatile markets make it difficult for brokers to trade large blocks
• Algo technology helps brokers trade while reducing market impact

Retail trading has been on a steady upward trajectory for several years, a trend fuelled by a confluence of factors. The advent of widespread internet connectivity, including mobile access, has democratized access to investment advice, information, and trading platforms.

The growth of retail-focused brokers offering zero commission also drove this trend. Such brokers have worked hard to attract non-traditional investors by offering user-friendly trading apps, often including ‘gamification’ features designed to encourage regular engagement (for example, regular milestones and achievements).

The COVID-19 pandemic marked a significant inflection point in this journey. Potential traders found themselves with more free time and disposable income thanks to savings on commuting and social activities. Many governments also provided direct financial support to individuals, and much of this capital found its way into the markets.

The resulting surge in retail trading was further bolstered by historically low interest rates, which made investment a more attractive proposition than cash savings.

However, the end of the pandemic brought with it a shift in the landscape. As the unique conditions of global lockdowns receded and interest rates rose, cash savings once again became an appealing prospect. Consequently, growth in retail volumes began to reduce.

Post-pandemic challenge

This decline in retail volumes posed a challenge for brokers, particularly when it came to trading large block orders. For big players, such as pension funds, this is a perennial concern. During the peak of retail activity, large volumes could be released into the market with minimal impact, thanks to the ample liquidity available to match them. However, with the drop-off in retail volumes, market participants, especially big players, now need to consider market impact more closely.

While venues are striving to attract as much retail business as possible, brokers must grapple with the current impacts of the decline in retail volumes.

One potential solution is to structure market activity to target the most active or liquid periods, such as the close. The closing auction period is often highly liquid for various reasons, including traders closing their positions at the end of the day and passive investors seeking to achieve the closing index price.

Automation and dark trading

Automation can play a crucial role here, enabling brokers to efficiently maximize their participation in the closing period. Algorithmic orders can be set to meet key price benchmarks and switch strategy at selected times, allowing traders to efficiently manage more orders, even in the busiest periods of the trading day.

Another traditional remedy for trading large volumes while minimizing market impact is dark trading. By keeping market depth confidential and anonymous, dark venues facilitate the dealing of large blocks with minimal impact. With new dark venues being launched continually and a dark book becoming a key offering for major venues, this approach is gaining traction.

However, it also brings its own challenges, as the growing number of venues inevitably leads to fragmented liquidity. Here, too, automation can provide solutions, allowing brokers to manage orders across multiple venues and achieve an optimal balance of volumes between lit and dark markets, according to changing conditions.

Algo wheels present yet another potential solution for managing liquidity while reducing market impact. By automating the process of switching liquidity between multiple algos to ensure the best algos are used for the order’s instrument, these tools can enable both the buy-side and sell-side to trade large volumes better. However, it’s worth noting that reducing market impact is not the primary goal of most algo wheels, and specific configuration may be needed if this is the main objective.

Creative approach needed

Stakeholders across the capital markets are making a concerted effort to attract retail investors and to realize the potential growth hinted at by the pandemic-era boom in volumes. However, retail volumes are likely to be inherently volatile, fluctuating up and down due to a range of economic and political factors. Even if retail trading bounces back, brokers cannot depend upon this extra liquidity being consistently available.

For firms that need to manage large block trades and achieve execution with minimal market impact, more creative approaches are needed. Technology has a key role to play. From monitoring when liquidity is poor, to working across multiple markets, automated solutions can provide key advantages when liquidity is scarce or hard to access.