Liquidity and order books during volatile intraday conditions

Intraday liquidity risk can arise when the financing element of the chain, for example, an investor or bank, cannot make cash available for intraday trading, which can cause knock-on effects across the rest of the market. 

This can often occur when forecasters recast funds, causing what are known as price air pockets, typically due to forecasting errors in the amount of renewable energy expected to be generated compared to actuals. 

In this article, we'll explain how intraday volatility affects liquidity, execution quality, and realised P&L, showing why being “right” is not always enough.

How liquidity behaves in intraday power markets

Normal intraday liquidity patterns tend to follow a U shape, with most activity at the start and close of generation and delivery. This means increased activity near maturity, with order-book activity ramping up as delivery time approaches. Can the time of day or even the year affect liquidity? Seasonal temperatures can affect liquidity levels, and as a delivery period approaches, liquidity costs decrease. Auctions also play a role in volatility levels: continuous markets tend to have lower liquidity, while auctions tend to feature higher liquidity. 

But how does liquidity behave in volatile intraday power markets by comparison, and how do traders generally respond to these volatile periods? These price air pockets, which sometimes occur and cause prices to spike or drop with little warning, especially in unpredictable renewable markets, can mean that liquidity disappears. However, this can be rebalanced after a shock occurs. Usually, more affluent market participants will help build liquidity back into the market by taking risks on orders that other smaller players would be hesitant to take a risk on. The market can then rebalance, stabilising trading conditions. It's worth bearing in mind that the unpredictability of renewable energy can mean trading occurs very close to the end of the day, which can still negatively affect liquidity. 

What volatility does to order books

Renewable energy is an unpredictable source of power, so it can often be difficult to forecast output levels. When errors occur, volatility can increase, affecting the amount of energy available at different price levels or order books. This thinning out of order books can cause widening spreads and make trading more expensive to execute. This can be combatted by increasing initial orders, though this doesn't always stabilise prices. 

Fragile liquidity and sudden price jumps

Liquidity collapses often occur when intraday volatility becomes very high. Factors that influence this volatility include widening spreads, unexpected price drops, or spikes. Market participants often respond to this volatility by withdrawing orders, reducing liquidity across the market. This can cause a liquidity grab as readers cancel limit orders, thereby systematically increasing trading costs during these periods. If  liquidity providers overreact to shocks, this can exacerbate market conditions further.’ 

Traders can detect when these price increases occur by looking out for noted differences between sell and buy orders, which are typically influenced by new energy generation information reaching the market. 

Execution strategies in volatile conditions 

When prices increase and liquidity decreases, the gap between the asking and bid prices widens as market participants seek to mitigate their own risk in the open market, further widening the overall spread. Traders must employ very specific strategies to weather these storms as market depth becomes shallower. One effective method is to limit larger orders and break them into smaller, more palatable orders to regain control of costs. 

Execution tactics for volatile hours might include controlling execution costs by using limit orders or limiting the number of orders to more manageable chunks in a thin market. Another approach traders can take is to bide their time: Absorption can occur when interest in the market picks back up, reducing volatility, or by examining strategies that project over a longer timeframe rather than focusing solely on intraday tactics. 

Portfolio-level liquidity awareness

When managing different types of renewable energy from an industry-transformation perspective, it’s crucial to have portfolio-level liquidity awareness across the entire asset portfolio. This can be achieved by utilising real-time dashboards for full visibility into all expected end-of-day positions, currencies, and the current state of balances. It’s also important to have full visibility into the state of all liquid assets to support incoming trading activity. Some traders also incorporate historical trading data using predictive analytics to determine when payments will arrive from an inbound perspective. Other technologies to incorporate can include automation and artificial intelligence. Digital payments can be automated, freeing up trapped incoming cash, while AI can help identify patterns in trading behaviour, identifying ideal timings for pricing adjustments and strategy alterations.  

Many traders will try to avoid forced execution because they aren't aware of the well-thought-out executions that benefit the trader. Traders suffer from a lack of time and consideration to make favourable trades, which can result in forced executions that aren’t always as profitable as they would like.