Although obligated to provide sufficient liquidity for investors to be able to transact in the securities of quoted companies, market makers are not expected to offer quotes that are firm up to an unlimited size. This is where the term, Exchange Market Size (EMS), comes in to force.
What does Exchange Market Size (EMS) mean?
Previously called Normal Market Size (NMS), Exchange Market Size represents the number of shares market makers are compelled to trade at the price they are currently offering. In other words, this is the number of shares you can safely trade without the market maker being allowed to charge you extra by widening the spread significantly.
How is Exchange Market Size (EMS) calculated?
On the London Stock Exchange, the EMS is set differently for each individual stock. For SETS securities, it is 1% of average daily turnover (ADT) of shares divided by the average share price for the period of ADT calculation (subject to an upper cap of around £25k and a lower cap of £2.5k). For SETSqx and SEAQ securities, EMS consists of 2% of ADT divided by the average share price for the period of ADT calculation.
Based on the above, it makes sense that larger, more liquid securities should have a higher EMS, and smaller cap companies with lower levels of ADT should have a smaller EMS.
What does EMS mean when making a trade?
For example, say you wanted to buy shares in Company A with a current share price of 11.5 pence and an EMS of 50,000, multiplying the share price by the EMS, you would determine that the quote you receive should be true up to the value of £5,750. Anything above this, and the market maker would be within their rights to offer a worse price by widening the spread.
Why is EMS an important consideration?
Under normal circumstances, you can typically trade up to three or four times the EMS without being charged extra. However, when the market for a particular security suddenly changes, the market maker may decide to only offer quotes in EMS size. In this instance, investors run the risk of being charged a bigger spread if they decide to buy or sell above this.
Investors are also often stung by gradually building up a sizeable position in a particular company and then all of a sudden wanting to sell the shares quickly and having to a accept a lower price than anticipated.
Why is EMS so pertinent to smaller cap companies?
As already mentioned, due to the way in which EMS is calculated, smaller cap companies are much more likely to have a lower EMS. Combine this with the fact that the large majority of AIM companies are traded on the SETSqx system, where market makers have no maximum spread requirements, should you decide to buy or sell a volume of shares above the EMS for any of these companies, then there is a high risk of being charged extra to do so.
Therefore, unless you have Direct Market Access and can circumvent market makers, then you either need to trade within a reasonable range of EMS or ensure your strategy won’t ever need to be too reactive. To develop this point further, so long as you’ve done your research and trust the fundamentals of the company over the longer-term, then you shouldn’t ever need to trade during periods of volatility and where market makers are quoting only in EMS size.