Stock Market Trading: Auctions, IPOs, and More
Market Order-Driven vs. Quote-Driven
Markets are typically order-driven, where supply and demand determine the price. However, some stocks and markets are quote-driven, with a trader setting the price. This is an open and semi-transparent marketplace based on a rolling auction model.
Price and Timing Priority
- PRICE PRIORITY: Orders with the best prices (highest buys, lowest sales) have priority.
- TIMING PRIORITY: At the same price, the earlier an order is entered, the higher its position.
Market orders are always executed against the best available price.
Phases of Daily Trading
Pre-Opening and Opening Auction
A 30-minute pre-opening period (8:30-9:00) allows traders to enter buy and sell orders before the market opens. These orders are collected but not matched. The system determines the equilibrium price, where the greatest volume of buyers and sellers match (supply equals demand). This price ensures fairness and efficiency. No new orders can be entered once the system calculates the equilibrium price to prevent disruptions or manipulation. The auction has a random end, varying by up to 30 seconds, to prevent manipulation. Unmatched orders at the equilibrium price remain in the system, forming the basis of the open session order book.
Open Market
Between 9:00-17:30, orders can be entered, modified, or canceled. When buying and selling orders coincide at a determined price, the system matches them, and the trade occurs. The order book is semi-transparent; all participants can see the orders, but not the person behind them. Brokers may hide the full quantity of the order.
Market Close and Closing Auction
Between 17:30 – 17:35, an additional closing auction follows the same rules as the pre-opening. The resultant price is the closing price for each stock that day. Established in 2000, this auction provides a fairer closing price fixing mechanism. If fewer than 500 shares trade during the closing auction, the closing price will be the price closest to the weighted average of the last 500 shares traded in that session. If fewer than 500 shares are traded throughout the entire day, the closing price remains the same as the previous day’s closing price.
Fixing System for Less Liquid Stocks
This system facilitates trading for smaller companies with less market activity.
- Why Use This System?
- Smaller companies often have low trading volumes, leading to little market activity.
- The system uses two auctions instead of continuous trading.
- First Auction: At 12:00 noon. Traders can enter orders from 8:30 AM.
- Second Auction: At 16:00 (4:00 PM). Orders are counted from the close of the first auction. The second auction price becomes the closing price.
- Minimum Volume for Price Setting: The minimum volume required is 200 shares.
Block Market
The Block Market is a parallel trading system for executing large-volume trades (“Put-throughs”).
- Purpose: Trading large blocks of stock outside the regular market.
- Eligibility: All stocks listed on the S.I.B.E. (the primary market) can trade here.
- Trading Hours: 9:00 AM to 5:30 PM.
- Minimum Volume Requirement:
- Minimum trade sizes vary:
- From €15,000 for illiquid stocks.
- Up to €650,000 for highly liquid stocks, with a sliding scale in between.
- Minimum trade sizes vary:
IPO (Initial Public Offering)
Public sale of shares in a company. This can be a sale of existing shares, new shares (to raise capital), or a combination.
Timing and phases:
- ✓Communication to Regulator and registry of the prospectus
- ✓Management Roadshow to explain the business to investors
- ✓Indications of demand
- ✓Price fixing
- ✓Allocation of shares and likely pro-rata in function of demand
- ✓Shares start trading
- ✓Payment and settlement of IPO shares
IPO Participants
- Global Co-ordinator: Controlling bank/broker that sets supply and gauges demand. Responsible for price fixing and distribution of shares.
- Managers & Co-Managers: Banks/brokers that organize marketing and sell the shares to their clients.
- ✓ Underwriters: Guarantee the transaction’s success by promising a minimum income to the issuing shareholder. They buy any unsold shares directly.
Short Selling
Designed to allow investors to profit when share prices decline.
- Custodian banks “lend” shares to investors, principally hedge funds, for a rental fee.
- Shares are then sold in the market, hoping the price will decline so they can be bought back cheaper.
- The short seller profits (or loses) on the price difference between the sale and repurchase. Borrowed shares are then returned.
Losses can be exponential, unlimited, and unjustified for any fundamental reason.
Floating Capital vs. Captive Capital
- Floating Capital: Shares open to free market transactions (actively traded).
- Captive Capital: Shares held as permanent holdings or owned by Board Members. These are not actively traded.
Companies with higher free float percentages receive a higher weighting in the equity index. Companies with lower free float have reduced weightings to reflect their limited market liquidity.
Secondary Market
Issue of new shares by a listed company, similar to an IPO.
- ✓ Shares are typically discounted to attract demand and raise funds for new investment.
- ✓ Existing shareholders receive preferential rights to buy new shares, and these rights may be traded separately.
Stock Splits and Contra-Splits
Management may decide on a “Split” when the share value has risen to make an individual share easier to buy. This makes NO difference to the company’s value, as the share price should adjust by the same multiple as the split. The inverse is a Contra-split.
Dividends
The dividend is the portion of a company’s profit that management distributes proportionally among all shareholders. Dividend payment is voluntary and subject to management decisions and policy; it may be paid in cash or new “bonus” shares.
Buybacks
Buybacks are also considered part of shareholder remuneration, as the company uses excess cash to buy shares and cancel them, increasing the stock price and shareholder value.