Analyzing the Meaning Behind the Level of Off-Exchange Trading

A Report in the US Equity Market Structure Analysis Series

As discussed in our Market Structure & Liquidity Matter note, Reg NMS had several unintended consequences, including the rise in off-exchange trading. While this aspect of market structure may have changed, it is not necessarily a bad thing. It is a function of market structure and will shift based on current characteristics. In this report, we analyze:

Traditional View: Analysts traditionally calculate the level of off-exchange volumes as a percent of total volumes: 41.5% in 2020, 44.2% YTD (+4.7 pps, +7.4 pps versus historical)
Off & On Exchange Volumes: Both off- and on-exchange volumes have experienced significant increases since 2019: off-exchange YTD ADV 5.4B shares, +104.2%; on exchange 6.8B shares, +49.8%
Alternative Views: While both notional value traded & trade count have also seen strong growth, the level of off-exchange trading is lower under both views: notional YTD 37.7%, -6.5 pps to volume; count 30.1%, -14.1 pps
Another Look by Tape: Tape C (Nasdaq-listed stocks) showed the highest increases for volume (+106.8%), notional (+87.8%) and trade count (+108.3%), driving the overall market increases
Market Quality: What does this mean? Variances by metric, off-exchange trading not 100% retail trades, the level is a function of market structure…in short, the increasing level is not a sign of declining market quality.

Executive Summary

There have been many discussions lately, including among regulators and legislators, about the increase in the level of off-exchange trading as a percent of total equity volumes in the U.S.1 The level reached 41.5% in 2020 and is at 44.2% YTD 2021 (through July 30), representing increases of 4.7 pps and 7.4 pps respectively versus the historical average (36.8%).

As discussed in our Market Structure Matters note, Regulation National Market System (NMS) had several unintended consequences. One of which is this rise in off-exchange trading. While this aspect of market structure may have changed, it is not necessarily a bad thing. The level of off-exchange trading is a function of market structure and will shift based on current market structure characteristics.

This report analyzes the data behind the numbers stated above, as well as presents alternative views to measure the level of off-exchange trading. Additionally, we look at these figures as related to retail trading and market quality.

A traditional view of volumes: Exchange and market structure analysts traditionally look at consolidated equity trading volumes in shares and then calculate the level of off-exchange volumes as a percent of total volumes. This is also the method used by regulators when discussing off-exchange trading. As such, we first assess the level of off-exchange trading under this view. Using the share method, unquestionably the level of off-exchange trading increased last year and remains elevated as compared to historical trends. On average for 2018 and 2019 the level of off-exchange trading as a percent of total volumes was 36.8%. The 2020 average of 41.5% was +4.7 pps greater than (or 1.13x) the historical average, while 2021 YTD (through July 30) was 44.2% (+7.4 pps, 1.20x historical average).

Trends in off- and on-exchange volumes: Before we move on to look at new views of measuring and analyzing off-exchange trading, we compare recent trends in off-exchange and on-exchange volumes in shares. Since 2020, volumes have gone up in aggregate: total equity ADV moved to 10.9 billion shares in 2020 and 12.2 billion shares in YTD 2021 (as of July 30), from 7.0 billion shares in 2019, +52.5% and +69.8% to the historical average respectively. While both off- and on-exchange volumes have experienced significant increases since 2019, the increase in off-exchange trading has been greater than that of on-exchange trading. From 2018 to YTD 2021, off-exchange trading volumes have more than doubled.

Off-Exchange – 2020 ADV 4.5 billion shares and 2021 YTD ADV 5.4 billion shares, from 2.6 billion shares in 2019 (+72.0% and +104.2%)
On-Exchange – 2020 ADV 6.4 billion shares and 2021 YTD ADV 6.8 billion shares, from 4.4 billion shares in 2019 (+41.2% and +49.8%)

Alternative views of volumes: Statistics can also be viewed by total notional (or dollar) value traded daily and total number of trades occurring daily. Like volumes, notional value traded has seen strong growth. On average for 2018 and 2019 the level of off-exchange trading as a percent of notional value was 34.5%. The 2020 average of 38.2% was +3.7 pps greater than (or 1.11x) the historical average, while 2021 YTD (through July 30) was 37.7% (+3.2 pps, 1.09x historical average). What is more interesting than the growth trend is that the level of off-exchange trading as a percent of total notional is less than the level as a percent of volumes: 2.3 pps less historically (-6.1%), 3.3 pps less in 2020 (-7.9%), and 6.5 pps less in YTD 2021 (-14.7%).

Average volumes increased 58.5% versus 50.9% for average notional value – as notional value equals price times volume, if notional is increasing less than volumes, price must be declining – the average price of stocks traded has declined

Similarly, trade count traded has seen robust growth. On average for 2018 and 2019 the level of off-exchange trading as a percent of trade count was 22.17%. The 2020 average of 26.5% was +4.4 pps greater than (or 1.20x) the historical average, while 2021 YTD (through July 30) was 30.1% (+7.9 pps, 1.36x historical average). As with notional value, the level of off-exchange trading as a percent of total trade count is less than the level as a percent of volumes: 14.6 pps less historically (-39.7%), 14.9 pps less in 2020 (-36.1%), and 14.1 pps less in YTD 2021 (-32.0%).

Trade Count increased 72.6% versus 58.5% for volumes – the increase in trade, or transactions, count outpaced the increase in shares traded – there are less shares traded per transaction

Another look at volumes by tape: The historical market volume data also includes statistics for volumes broken down by tape: Tape A is NYSE-listed stocks; Tape B is everything else, used to be referred to as the regionals (now mostly ETFs); and Tape C is Nasdaq-listed stocks. We highlight the following trends for volumes by tape:

Tape A – volumes +34.9%, notional +32.0%, trade count +52.6% – while it posted the lowest increases in volume and trade count versus the other tapes, it still saw significant increases across all measures
Tape B – volumes +43.1%, notional +32.0%, trade count +60.0% – the smallest tape (0.4x volumes of both Tape C and Tape A) also saw significant increases in all measures
Tape C – volumes +106.8%, notional +87.8%, trade count +108.3% – showed the highest increases for volume, notional and trade count, driving the overall market increases; for example, Tape C volumes increased 106.8% while the market increased 58.5%

Off-exchange trading and market quality: As analyzed in this report, the level of off-exchange trading as a percent of total equity volumes (and notional value and trade count) has increased. While this is an accurate trend analysis of the data, what does it mean or not mean?

Variances by metric – There are different growth rates when looking at off-exchange as a percent of volumes versus notional value or trade count. Which is the “correct” metric? Most other countries look at the market in terms of notional value instead of volumes, and this metric shows a lower level of off-exchange trading.
Off-exchange not all retail – Much of the growth in off-exchange trading starting in 2020 has been attributed to retail investors. Based on our market structure survey, market participants estimate retail investors now represent 20%-30% of total equity volumes, up from 10% historically. However, all off-exchange trading is not 100% retail trades – off-exchange trading as a percent of volumes in July was 43.1%, greater than the estimate for retail trading from market participants. Off-exchange volumes also include block (trade size 10,000+ shares) and other institutional trades (plus bank capital commitment as part of institutional trades).
Function of market structure – Further, as one market participant eloquently said, “So what if the level of off-exchange trading has risen”? Market participants note that the level of the percent off-exchange trading is not a measure of market quality, more directly, the increase in off-exchange trading is not a sign of declining market quality. The increase in off-exchange volumes is an indicator of volume growth, in particular retail trading growth and trading in low dollar stocks, not a sign that flows are shifting. The percent of off-exchange trading is a function of market structure, and the optimal level of off-exchange trading is the actual amount in that given time period. Any increase may impede price discovery, and any decrease may hinder trading. In other words, the percent of off-exchange trading is self-correcting, ebbing and flowing based on current market structure characteristics.

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