On a standard trading day, the normal trading time for the US stock market is 390 minutes. However, judging from the current situation, the last 10 minutes require special attention from investors.

According to data compiled by trading algorithm developer BestEx Research, currently about one-third of all stock trades in the S&P 500 index are executed in the last 10 minutes of the trading day. That's up from 27% in 2021.

The European stock market is in a similar situation to the US stock market. New evidence has emerged in Europe that this trend may be hurting liquidity and distorting prices.

For critics of the global passive investment boom, this is the new “ammunition” they are using to criticize, as index funds drive this phenomenon. These products usually trade stocks at the close, and their goal is to copy the last price of the day to set a benchmark.

Data compiled by foreign media shows that in the past 10 years, in the US alone, the assets of passive stock funds have soared to more than 11.5 trillion US dollars, and there are more and more transactions carried out before the end of transactions. Active investors seeking to take advantage of this liquidity have joined in, creating a self-reinforcing cycle.

According to data from Bloomberg Intelligence (Bloomberg Intelligence) and analysis company Big XYT, closing auctions held in Europe after regular transactions have ended currently account for 28% of public place transactions, up from 23% four years ago.

Benjamin Clapham of Goethe University of Frankfurt said: “As we all know, the closing auction is a very, very good mechanism. This may be true, but if we shift our trading volume to the last trading opportunity of the day, we may see price inefficiency.”

Clapham, co-authored with colleague Micha Bender and Bundesbank researcher Benedikt Schwemmlein, the paper “Transferring Trading Volume to Closing: Price Discovery and the Consequences of Market Quality”, focuses on large-cap stocks on the London, Paris, and Frankfurt Exchanges over the four years up to mid-2023. The three analysts found that the stock price usually fluctuates between the price at the end of continuous trading and the final price set in the closing auction, but 14% of the fluctuation was reversed overnight, indicating that the fluctuation was driven by unidirectional liquidity rather than fundamentals.

The new study echoes earlier research, including a 2023 US paper which also argues that fluctuations during the closing auction will resume overnight due to liquidity dynamics.

This is one of many allegations against passive investing. Other allegations include that passive investment may blindly inflate company valuations and cause serious damage when major indices are rebalanced, triggering multi-billion dollar one-way transactions. A series of concerns have sparked high-profile criticism from critics such as Elon Musk (Elon Musk), and David Einhorn (David Einhorn) of Greenlight Capital (Greenlight Capital) recently joined the ranks of the detractors.

However, the extent to which price distortions at the close should attract attention is uncertain, and like many things in the modern market, the debate is unclear.

For Hitesh Mittal, founder of BestEx Research, an overnight price reversal is part of normal market function. Passive funds may be bought at a slightly higher price at the close, but he believes this cost is “much lower” compared to the fees that liquidity providers charged on their transactions earlier in the day when liquidity was weak.

In the US, the mechanism for determining the closing price is carried out in the last few minutes of continuous trading. According to data compiled by Rosenblatt Securities (Rosenblatt Securities), nearly 10% of US stocks were traded in the closing auction last month, close to the 2019 high. Chuck Mack, head of strategy at NASDAQ North America trading services, said market participants liked transparent price discovery and the “depth of liquidity” in closing auctions. He said that intraday liquidity in the US is more affected by the growing fragmentation of stocks traded on different platforms.

Meanwhile, two other researchers, Carole Comerton-Forde of the University of Melbourne and Barbara Rindi of Bocconi University, concluded in 2022 that the apparent reversal of European stocks may have been due to noise at the opening of the market rather than distortion, and intraday liquidity was not affected by the closing auction. They wrote that regulators currently have no reason to worry, “but they should continue to focus on this area to prevent the situation from changing.”

A Euronext spokesperson acknowledged that prices will be corrected after the index is rebalanced, but said, “The observed reversals are generally mild, and market overreactions are common after major liquidity events.”

A spokesperson for the German Stock Exchange said that although market participants have different opinions, closing auctions are generally not seen as a problem.

In the US, even though the trading volume is concentrated before the end of the trading day, the role of retail investors is increasing, which has prompted many brokerage firms to offer certain securities24-hour trading,to provide them with maximum trading opportunities. For institutional professionals, however, the last few minutes are increasingly important.

“When I spoke with portfolio trading clients who are more sensitive to changes in liquidity, I found that they will definitely wait (last minute),” said Mark Montgomery, Head of Business Development at Big XYT.

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