2017 was a remarkably calm year in equities, with key indicators showing the lowest volatility since before the 2008 financial crisis. Throughout this period, E-mini S&P 500 futures (ES) maintained elevated levels of market depth, a sign that market participants were comfortable with leaving more and larger orders open for longer periods. This level of market depth was not necessary to support market transactions, as transaction size is typically much smaller. High levels of market depth are not unusual during extended periods of low volatility.
Likewise, when volatility rose suddenly in late January 2018, markets responded as they normally would, by reducing the number and size of orders left open for a significant period of time. The resulting change in market depth initially may have looked like a fall in liquidity. However, volume from that period indicates that the liquidity available was more than sufficient for market participants to execute trades and hedge their risk.
There are, of course, other potential influences driving market depth, leading to the decrease in ES market depth in February. It’s possible that other measures of market health impacted the market depth during this period. These possibilities, including volatility, are examined more thoroughly below, but ultimately, the data supports the belief that volatility is responsible for this change in market depth.
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