Although only accounting for around 3-5% of the eight and a half hour trading day, auctions are an important trading mechanism that investors need to properly understand. This article covers what they are, why they take place, when they take place, and how relevant they are for the trading of smaller cap companies.
What are auctions?
During the trading day, the matching of buy and sell orders takes place on a real-time, continuous basis known as regular trading. Auctions differ from regular trading as matching is paused for a period of time, during which orders are collected from the market, which is known as the Call Period.
At this point in time, where the electronic order book is effectively frozen, the matching algorithm considers the orders that have been entered and calculates the price that the maximum amount of shares can be executed. The goal here is to find the most popular price, rather than the highest or lowest price.
At the end of this Call Period, orders that can be matched are executed in an event referred to as an uncrossing, which takes place within a randomised 30 seconds of the end of the Call Period – meaning it could start after 1 second, after 2 seconds, after 3 seconds, and so forth.
Notably, a very large proportion of the daily volume of shares traded are executed during an auction due to the large number of participants that focus their trading during these intervals.
When do auctions take place?
There are three types of auctions that take place for securities traded on the SETS trading system:
- 07:50 – 08:00 (Opening Auction)
- 12:00 – 12:02 (Intra-day Auction)
- 16:30 – 16:35 (Closing Auction)
Should any of these auctions fail to generate a reliable price (one within a predetermined percentage above or below the reference price, which is the price just before the stock went into the auction), then a Price Monitoring Extension RNS is automatically released to the market, and the Call Period is extended by another 5 minutes.
Should this additional period still fail to generate a reliable price, then a second Price Monitoring Extension is released, and the Call Period is extended by a further 5 minutes. On this occasion, though, should the additional period also fail to generate a price within tolerance levels, then this price will be taken forward and the orders that can be matched will be executed in the uncrossing.
Following the closing auction, there is a short, modified regular trading session called the Closing Price Crossing Session (CPX), where executions can only be made at the closing auction price.
When it comes to companies traded on the SETSqx trading system, along with the closing auction already discussed, there are three other intra-day auctions that take place during the trading day:
- 08:50 – 09:00 (First Intra-Day Auction)
- 10:50 – 11:00 (Second Intra-Day Auction)
- 13:50 – 14:00 (Third Intra-Day Auction)
- 16:30 – 16:35 (Closing Auction)
Combining both SETS and SETSqx trading systems, auctions can be considered, then, a very regular occurrence during the trading day on AIM.
When were auctions introduced?
With regards to SETS, an opening auction was introduced in 1997, followed by a closing auction in 2000, and an intra-day auction in 2016. With regards to SETSqx, the auctions that currently take place were introduced in late 2014.
Prior to the introduction of auctions, the London Stock Exchanged used a number of other mechanisms to open and close the market, such as the first or last price, or the average price over the first or last 5-10 minutes.
What benefits do auctions provide?
As well as established the opening, mid-day, and closing price for companies listed on the London Stock Exchange, auctions promote a more orderly market.
The reason being, by freezing the order book, the Call Period helps remove volatility from the market by slowing down trading, and encouraging the market to reach a more considered level rather than moving around on individual trades. For instance, a Price Monitoring Extension provides participants the chance to review the prices of the orders that have been entered and if appropriate add, delete or amend.
Not only this, by bringing together a large number of participants, auctions help focus liquidity, helping to determine a single price for a stock that can be perceived as a fair valuation at a given point in time. As such, they are often used by fund managers to value their portfolios, as well as by index providers to calculate indices.
Fund Managers wishing to put through a larger order, may also prefer to use an auction rather than regular trading, as the aggregation of buyers and sellers means that the market impact of the large order can be minimised.
How significant are auctions when it comes to AIM?
When discussing auctions in a presentation in 2015, Brian Schwieger, Head of Equities at LSEG, made the interesting point that as you go down the market cap curve you start to see auctions become less popular in terms of the percentage volume of shares traded.
Providing rationale for this, Brian goes on to state as you go down the market cap curve, you also start to see that the percentage of the market traded by individual investors goes up – whereas individual investors only represent about 2% of trading volume on the FTSE 100, they represent up to 20-25% of volume on AIM.
The reasoning behind auctions being less popular with smaller cap companies, then, is that individual investors are less aware of auctions and, therefore, less likely to utilise them.
Nevertheless, when it comes to the AIM Market, when you consider the frequency of auctions and the relative volatility of shares traded, then it starts to make sense why Price Monitoring Extensions are released so frequently.
Should you be using auctions to trade smaller cap companies?
The answer to this depends on the length of time you intend to hold the shares, your understanding of what price point to target, and whether or not you have Direct Market Access or a broker willing to place an order during an auction.
For instance, you may really like the potential of a particular company and want to hold shares for several years to see how the company and industry develops. In the near-term, though, you have no idea whether or not the current price is good for their current operations. In this instance, placing an order during an auction would probably be the closest you’re likely to get to a fair price as things stand during that day.
Alternatively, you may know the exact price that you want for a particular company, with the goal of selling at a profit in the short- to mid-term. In this instance, it would make no sense to wait till the auction if that price was currently available during regular trading.
Nevertheless, all of this is futile unless you have have a broker who is willing to place your order for you during an auction, or Direct Market Access and able to place your own buy and sell orders (rather than going through a Retail Service Provider via an online broker).