Electronic Trading, Prime Brokers and IR

If your stock acted crazy on Thursday October 11th, you were not alone.

As a refresher, ModernIR tracks trading volume (execution), which is the opposite of stock surveillance (settlement data).  We catgegorize the execution data to identify the forces at work in equity trading. If the equity markets don’t surpass early October highs, we think the source of the rupture will be traced to trading on October 10th and 11th. There are three primary order flow currents behind a stock's daily volume: a) electronic order-matching, b) program trading, and c) speculative arbitrage that occurs around these two other forces. It’s not unusual for the three to drive 90% of volume. In order for equity markets to maintain efficiency and support both trading and investment, equilibrium among these forces is desired.

Around October 8th, electronic trading began to increase and by the 10th accounted for 44% of total order flow, about 20% more than either programs or arbitragers. On Thursday, the dominant Prime brokers behind programs essentially said, “All right, everybody, out of the pool.” Whether these order totals were the result of the broker-dealers pressing the reset button themselves or responding at the behest of large institutional clients is unclear. Whatever the reason, the markets have not been the same since – and options expire this coming Friday right during the midst of third-quarter earnings reports.

So what's going on and why should you care, IROs? It appears that large primes like UBS Securities are able to watch order-flow imbalances across multiple asset classes and perhaps even intervene for the sake of regaining institutional order flow. After all, if the buyside chooses to skip brokers and go directly to the markets through electronic systems, that eventually translates to lower revenues and earnings for broker-dealers. We also have a suspicion that speculators in currencies (“forex”) and commodities leveraging off equity platforms got ahead of their own models. Maybe this is why oil continues to make new highs?

Regardless, these actions impact the responses of institutions to fundamental business performance. If you don’t fathom their role in your equity market – call us redundant to the point of exasperation – you can waste precious IR time, money and effort working at results that can’t be achieved.

And if you’re blessed with great business catalysts, the current market conditions are quite favorable.