When large institutions like hedge funds and pension funds trade, their decisions make a difference to the direction of prices and volatility according to AbleMarkets.com. First, the prices rise on days when the institutions buy throughout the day. Prices fall on the same day when the institutions sell during the day. Second, following institutional buying of a particular financial instrument, volatility decreases for several days with 99% probability, according to the latest research from AbleMarkets.
The latest analysis uses institutional buying and selling activity, as a percentage of total buyer- and seller-initiated trades as measured by the AbleMarkets Institutional Participation Index. The index, developed using proprietary research and technology of AbleMarkets, presently reports institutional buying and selling activity every 30 minutes, although more frequent updates can be made available. The index is derived from anonymous exchange order data by reconstructing commonly used execution algorithms. Since the exchange data sources typically do not include the identity of the executing institution, AbleMarkets is able to pinpoint the flow, but not the trading entity or, possibly, entities generating the flow.
As expected, large institutional buying bids up prices and large institutional selling depresses prices. Since large trades are typically processed over extended of the day, AbleMarkets Institutional Trading Index is highly predictive of short- and medium-term price movements, be it 30 minutes or a couple of hours, following the observation of heightened institutional trading activity.
In addition to predicting short-term price movements, large institutional buy orders tend to stabilize the markets for days to come, reducing intraday volatility in the traded instruments with 99% confidence over at least the following 5 trading days. Every 10% increase in the participation of institutions for buyer-initiated volume, averaged at the end of the day across that day's all 30-minute periods on a given day, results in 0.2%-0.3% reduction in intraday volatility of that security for the following 5 days for the particular security. In this case, the intraday volatility is measured as a range volatility, equal to (HighLow)/Open prices for that security on each day following the measurement of institutional buyer participation.
In simple regressions of range volatility on T+1, T+2, ..., T+5 day following the AbleMarkets Institutional Buyer participation, the explanatory power of the AbleMarkets Institutional Trading Activity ranged from 5% to 6%, as measured by adjusted R2. The index is uncorrelated with VIX, and can be used to improve upon VIX predictability.