By Irene Aldridge
The last two weeks witnessed a somewhat forgotten phenomenon — a market headed south at a rapid pace for several consecutive days. Unlike flash crashes, brief spikes of downward volatility that can be predictable (see Aldridge, I., “High-Frequency Runs and Flash Crash Predictability”, Journal of Portfolio Management, 2014, and AbleMarkets Streaming Flash Crash Index), the sell-off of the past two weeks was methodical, slow and painful.
AbleMarkets, a Big Data platform for finance, tracks institutional activity by pinpointing electronic algorithms used to break up large orders throughout the day. AbleMarkets uses the most granular tick-level data from exchanges to identify market microstructure footprints of institutions in real time and, as a result, separate institutional trading activity from that of retail activity and intraday arbitrage, often known as high-frequency trading (HFT). Such separation delivers meaningful predictive results: institutional investors typically do thorough research and invest large amounts and subsequently move the markets, and their behavior results in substantial long-term predictability of the markets’ impending movement. On the other hand, aggressive HFTs prey on intraday variations and volatility, and, while their behavior is highly predictive of volatility for several days, aggressive HFTs tend to be market direction-invariant. Still, retail investors often trade without significant preparation and may generate noise instead of meaningful directional market movement.
On the heaviest sell-off days, October 10-11, 2018, for example, institutional investors sold the S&P 500 in favor of Euro, Japanese Yen and Swiss Franc, according to AbleMarkets estimates of institutional activity. In fact, the institutional trend began on October 9, 2018, when institutions comprised 77% of the S&P 500 buyers and 79% sellers, while initiating 64% of all trades buying EUR/USD, and only 45% of all trades selling EUR/USD. The October 9, 2018, institutional figures for the Japanese Yen buyers and sellers were 36% and 19%, respectively, and in Swiss Franc, 45% vs. 39%. However, other, less liquid, currencies experienced a sell-off: in Australian Dollar, institutions comprised 32% of all buyers, while reaching 40% of all sellers; in Pound Sterling, institutional buyers vs. sellers squared off 27% vs. 38%.
On October 10, 2018, institutions initiated 71% of all S&P 500 buy trades and 88% of all S&P 500 sell trades. The outflows from the US markets into the most liquid currencies mostly continued with institutional behavior reversing in Pound Sterling: institutions preferred buying to selling 55% to 43% in Euro, 49% to 38% in Japanese Yen and 47% to 43% in Swiss Franc, and 52% buyers to 36% sellers in Pound Sterling. Institutions continued selling Aussie 25% to 32%.
On October 11, 2018, many institutions continued selling the S&P 500, with 64% of the buyer-initiated trades and 85% of all seller-initiated trades. At the same time, institutional currency traders began reversing their accumulation of liquid currencies. On October 11, 2018, institutional sellers outnumbered institutional buyers in Euro, Swiss Frank, GBP/USD, and AUD/USD (63% to 74% for Euro, 17% to 39% for Swiss Franc, 37% to 62% for Pound Sterling and a whopping 9% to 56% for Australian Dollar). Interestingly, the money continued moving into the Japanese Yen, with institutional buyers outnumbering sellers 63% to 24%.
Finally on October 12, 2018, when the selloff of the S&P 500 stabilized with institutional buyers comprising 65% of buyer-initiated trades, and institutional sellers generating 70% of seller-initiated trades, the institutional currency flows calmed down as well. On the same day, Pound Sterling, Euro, Swiss Franc and Japanese Yen were net sold by institutions: institutions comprised 29% vs. 31% of buyers vs. sellers in the Pound Sterling, 47% vs. 51% in Euro, 21% to 25% in Swiss Frank, and 38% to 43% in Japanese Yen. Institutional activity in Aussie also reversed direction: institutions were 36% of all buyers of AUD/USD and 29% of all sellers in the currency.
The institutional flow from the U.S. markets into liquid currencies may seem surprising, particularly since the shocks affecting the U.S. markets have been shown to affect foreign markets. In the case of the sell off of October 10-11, 2018, however, the institutional move into the currencies may have been a safety hedge — most liquid currencies are able to absorb extensive volume very quickly, something that very few U.S. instruments can afford.
What happens after the institutions invest in currencies? As AbleMarkets recent research shows, institutional buying activity raises prices in short and medium term, buoying currency levels.
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Irene Aldridge is Managing Director and Head of Research at AbleMarkets, a Big Data and Deep Learning Platform for Finance. She is a co-author of Real-Time Risk: What Investors Should Know About Fintech, High-Frequency Trading and Flash Crashes (with S. Krawciw, published by Wiley, 2017) and the author of High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems (2nd edition, Wiley, 2013). She is also a Visiting Professor of Financial Mathematics at Cornell Tech in Manhattan.