Liquidity Matters Weekly Series
Read the full blog series below:
Introducing Liquidity Matters
Financial markets operate through the medium of liquidity, enabling the efficient transfer of assets between buyers and sellers. The normal state of liquidity is asymmetric, ebbing and flowing continuously around an asset’s fair value until a supply and demand equilibrium appears.
Price is the conduit for this equilibrium, and the process is known as price formation; it is fuelled by competition, and benefits from market concentration and price transparency. High demand dictates a higher price, low demand a lower price. Thus liquidity and volatility are inextricably linked and in turn so are trading costs, risk and asset returns.
This is relevant to investors and issuers alike. A company may have great financial results, but if the shares are illiquid, investors require a higher risk premium and therefore a lower price.
Like fund managers, issuers care about liquidity too and work hard to maintain it in the market through corporate actions and other interventions. They also care about inclusion in indexes as they form the basis of investment vehicles (or products) that allow for passive investment of which many ETFs are created from. These investment vehicles increase liquidity and demand for their stocks, as we see during re-constitution events. Investors expect management to be aware of the liquidity in their shares.
Our Liquidity Matters series helps both generalists and specialists across all industry stakeholders to understand the market structure and its application to practical matters such as asset selection and trading, and highlights recent trends and notable events. Complexity in the market micro-structure, often referred to as the fragmentation of liquidity pools, presents challenges for managing trading costs and therefore asset returns, for accurate risk management and reporting. Our aim is to help clarify and summarise this complexity, using illustrations from our sophisticated data analytics and recent market observations.
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Episode 1: Why Addressable Liquidity Matters
Headline trading volume figures routinely overstate the magnitude of liquidity available to investors, and by as much as €28bn euros per day in Europe based on 2025 data. This is 32% higher than the amount investors can reasonably rely upon for estimating trading costs and for investment decisions. The industry refers to the more precise notion of Addressable Liquidity. In this episode, we describe this concept and why it matters.
The discrepancy of 32% is illustrated in the chart below, which introduces the difference between ‘On Order Book’ trades (in blue) and ‘Off Order Book’ trades (in green). In this episode, we will expand upon this high-level definition of On and Off Order Book trading, which forms the foundational structure of the European equity microstructure as enforced by regulation.
The left chart shows headline volumes of €115bn Average Daily Value Traded ‘ADVT’; with just 45% traded on the order book. The right chart shows the adjusted number for Addressable ADVT of €87bn, with 60% traded on the order book.
This substantial difference is found in the Off Order Book segment, where the market’s trade reports must be sifted and categorised to eliminate trades that do not interact with the market, and therefore neither contribute nor take liquidity, nor contribute to price formation. On Order Book trades do not require this treatment as they are produced directly by electronic matching engines using strict regulatory definitions. A further complication is that Off Order Book trades are published with up to a minute’s delay whereas On Order Book trades are published instantly.
How is Addressability defined?
Addressability refers to whether a given market participant can access a pool of liquidity systematically through automation, phone calls, chat or other mechanisms, with a reasonable probability of trading at a price which is at least as good as any other currently available in the market for a given size. Addressable liquidity is different for every participant because it depends on their technical setup (for example their access to electronic trading venues), network of brokers and market makers who can help them to find counterparties bilaterally or offer risk.
Why does the difference matter?
The difference between headline and addressable liquidity matters because a precise understanding of the size and reliability of liquidity is essential to avoid unexpected performance decay induced by implicit trading costs, especially during major events such as transitions, rebalances and substantial cash inflows and outflows. This is because estimates of trading impact, normally based on liquidity and its close relationship to volatility, are only as good as the predicted size of the liquidity available, measured through spreads and market depth. If trading costs are not accurately modelled, you may trade too fast, too slow, or with the wrong hedge. Consequently this affects returns performance and risk management. This also affects the quality of regulatory reporting as required under PRIIPS.
Therefore, liquidity should be ‘reliable’ in the sense that its size and distribution among different trading mechanisms and venues should be reasonably predictable with reference to recent history (normally 20 days). Non addressable liquidity should be eliminated from pre trade estimates, order routing strategies and post trade performance reporting.
How do we identify and measure addressability?
The blue-ish colours in the charts represent liquidity pools consistently available to everyone: in this case European Exchanges and MTFs, where multilateral, electronic trading takes place on a first-come, first-served basis, either continuously or in auctions. This is reliable, 100% addressable liquidity, that provides predictive value over ongoing liquidity availability provided that investors, through their brokers, have appropriate memberships and technical access to these venues. This landscape is constantly changing as venues innovate their services with new market mechanisms to try to capture liquidity from their competitors. Stakeholders in the industry must remain vigilant in following these trends to monitor whether their capabilities are up to date and can access these pools effectively.
The green-ish colours represent bilateral trades away from the Order Books of Exchanges and MTFs; between brokers on behalf of clients, market makers, or proprietary trading firms. These trades occur between two counterparties only, away from the competitive multilateral electronic venues. We have categorised these trades as ‘Internalisation’ (normally risk trades executed by investment banks) ‘Agency Off Book’ (cross trades between brokers on behalf of investors) and ‘OTC’ for everything else. Liquidity is more fragmented in these categories because trading is ‘bilateral’ and less visible. Every broker and market maker represents a potential pool of liquidity, which compels an investor to build and maintain a network of brokers and to invest in electronic RFQ and IOI mechanisms. Therefore, this type of liquidity is less reliable and not 100% addressable.
A firm must assess whether their execution is broadly distributed in line with the market share of all these liquidity pools in granular detail to gain an understanding of whether they are proportionately accessible to them for their needs, and if not be able to justify whether over-performance justifies a bias towards some pools more than others. In future episodes of Liquidity Matters we will dive into the details of the different types of Off Order book liquidity pools and explain their structure and measurement.
Why does a gap exist between Addressable and Non Addressable Liquidity?
All trades transferring beneficial ownership must be publicly reported. However, many are duplications or technical in nature and therefore do not contribute to price formation or provide a liquidity pool. These are highly varied in nature and can be very large. A common example is a ‘back to back’ trade where risk positions are consolidated into a single entity of an investment bank from its local dealing entities in other countries. These trades are classified in the Off Order Book category but in effect double count ‘real’ trading that has probably taken place earlier in the day in the local market. We must filter out this kind of trade to determine Addressability and sub-categorise Off Order Book trading to provide more visibility. This reclassification exercise produces the €28bn difference between headline figures and the more reliable Addressable Liquidity estimate.
Not all shares follow the same liquidity pattern.
Crucially, the picture varies significantly between shares; for example mid and small caps trade a larger proportion away from order books than in the case of large caps. This variation has material implications for portfolio construction and execution planning where inclusion criteria include liquidity thresholds. In the next episode of Liquidity Matters we will be looking at the measurement of trading cost by type of trading venue to investigate the relative cost of using different liquidity pools.
Taking Action
Precise measurement of Addressable Liquidity is a must have for investment and trading decisions and risk management. For precise measurement, xyt provides Addressable Liquidity Datasets for daily consumption. This provides high levels of granularity (symbol, sector, index, country etc) and is delivered through flexible access methods (via files, APIs or via our App) to help you explore or integrate Addressable Liquidity estimates into your internal workflows.
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Episode 2: The Cost of Liquidity
Understanding where and how trades execute relative to the best available price is fundamental to managing execution costs. While our first episode explored the concept of liquidity pool addressability, we take the analysis deeper by examining the price premia associated with different types of trading venue. By measuring what proportion of trades execute at, inside, or outside the consolidated European Best Bid/Offer (EBBO), we can quantify trading cost differences between liquidity pools and make more informed decisions about where to route orders.
Using the EBBO, and a benchmark of the bid for a seller and the offer for a buyer, we can measure whether a liquidity pool offers a premium (or discount) for immediate liquidity versus current prevailing price. Deviation from the benchmark suggests increased (or decreased) liquidity cost and the analysis can be used to assess whether any execution bias towards one type of pool or another is justified.
As shown in the first chart, the ‘default’ position is the electronic intraday liquidity pool, consisting of the displayed and non displayed books and periodic auctions. This is the ‘most addressable’ intraday liquidity pool. As trade size is a determining factor for the liquidity premium, among others such as availability of liquidity and volatility, we use it to build a granular view of the premium across different types of liquidity pool.
Figure 1: Distribution of trades by size buckets for European markets, March 2025 to January 2026. The upper panel shows average daily value traded in EUR at each price point. The lower panel shows the ratio of trades per price bucket at the given price point to all trades in all price buckets.
Figure 1 illustrates that over 96.5% of all trades fall into a size range below €25k, representing 61% of intraday order book liquidity. Of these, the proportion of trades executed at the EBBO is 77% with a further 19% falling inside the touch, with the latter being in periodic auctions and dark pools. This is a good demonstration of the value of these mechanisms in drawing order flow into the multilateral marketplace. On a value weighted basis across all buckets, 96% of trades pay no premium to EBBO, and of these 28% receive a discount. This underlines the importance of the electronic order books as not only the most substantial liquidity pool but also the most reliable, even at larger sizes.
But why not 100% for all order sizes? Owing to the fragmentation of the order books, latency in order routing means it is possible for an aggressive order to be ‘in flight’ on its way to one trading venue when a better price simultaneously appears on another venue. Secondly an order that ‘drills the book’ by taking more than one price level without reference to prices on other venues may fall outside EBBO. Maybe it is more surprising that this figure (less than 4% of all trades) is not higher. It is a sign that the market is efficient in respect of order routing and dealing with latency. It is not shown in the chart but curiously, the phenomenon affects buy orders more than sell orders (let us know if you want the details).
Next we move to the Off Order Book liquidity pools, depicted in the second chart. As discussed in Episode 1, these liquidity pools are less addressable as they depend on an investment firm’s access to a network of brokers or market makers and their IOI/RFQ setup.
Figure 2: Distribution of trades by execution price point and by size buckets for European markets, March 2025 to January 2026. The label in both panels depicts the average daily value traded in EUR per price point and ratio of all trades executed in a given size bucket to the overall number of trades.
First, a caveat; Off Order Book trades must be reported by a market participant (as opposed to an electronic trading venue) via a trade reporting facility. The time limit set by the regulators to submit a report following a trade is one minute. This means analysis of these trades suffers a time lag to the EBBO, although much of the reporting is automated and instantaneous, particularly in the case of internalisation. This is noticeable in that 29% of trades are executed outside of the EBBO benchmark in the Agency Crossing category and 12% in the Internalisation category, compared with only 4% for the Order Books. Using a time window of one minute as a tolerance for EBBO will significantly reduce this effect - such a tool is available in our Best Execution analytics service.
Nevertheless, Agency Crossing and Internalisation liquidity pools demonstrate very high levels of EBBO price improvement with 50% of trades executed inside the touch - a significant liquidity discount and more than the Order Books at 19%. Of course, these two Off Order Book liquidity pools account for only 16% of smaller trade sizes executed on the Order Books, an indication of the proportion of trades that could be potentially drawn back into the Order Book if spreads were tighter.
When we scale up the trade size bucket to look at trades above €500k, we find that trading in these two liquidity pools is 5.4x more than that of the Order Books by value, as would be expected. The proportion executed outside of EBBO is 77.5% which indicates that these are trades where prices may be manually negotiated and where the reporting latency is a significant factor.
Figure 3: Consolidation of all trade categories, On Order Book and Off Order Book, March 2025 to January 2026.
Figure 3 brings together the first two charts to give a consolidated view of the whole market showing that the bigger the trade, the higher the liquidity premium, as expected. The data reveals a clear hierarchy in execution quality across liquidity pools. Intraday order book trading delivers the most consistent EBBO execution for small and medium sized trades, while Off Order book liquidity pools offer greater price improvement through mid-point matching, but for a smaller pool of liquidity.
For larger trades, the picture shifts considerably, with negotiated executions and dark pools playing a dominant role despite higher apparent deviation from EBBO benchmarks. These findings underscore the importance of precise monitoring and demonstrate that execution strategies should be calibrated not just to trade size, but to the specific cost characteristics of each type of liquidity pool and each trading venue. Investors can compare their own trading results to this overall summary of the market to identify the strengths and weaknesses of their routing strategies.
In our next episode of Liquidity Matters we will extend this analysis to examine whether the quality of a liquidity pool is durable, i.e. whether the premium paid for immediate liquidity erodes over time as price evolves, or increases.
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