The Minutes that Move Markets: Understanding Opening/Closing Auctions
All investors who manage their own portfolios need to be aware of how trading dynamics shift at different times of day. These patterns are especially vital to comprehend for news-based traders, whose capacity to earn market-beating profits is tightly connected to their ability to use data to understand not only how but when markets will react a new piece of information.
For instance, while the opening and closing minutes of the market remain volume hotspots, the close has recently become a bigger factor in the overall volume of trading than ever before. The Wall Street Journal reports that: “Last year, 26% of all trading activity on the NYSE’s flagship exchange took place in the last trade of the day, up from 17% in 2012, exchange data shows. Last year, trades at the close accounted for more than 8% of trading volume in S&P 500 stocks, nearly four times what it was in 2004, according to Credit Suisse .”
What do they mean by the “last trade of the day?” Rather than simply cut off all orders arbitrarily at 4:00, the NYSE utilizes a mechanism called the closing auction to provide, as they describe, “a centralized, large-scale liquidity event that permits institutional investors to establish sizeable positions without undue complexity. The Closing Auction brings all buyers and sellers together into one common trade that establishes a clearing price for all interest.” The auction takes places in the minutes immediately after market close at 4:00.
Yesterday, we took a look at some of the fundamental types of orders used when purchasing stock. A distinct (though logically parallel) series of orders exists specifically for the closing auction.
- Market-on-Close (MOC) orders constitute a firm commitment to trade in the closing auction, no matter the price. Those using a MOC order will have certainty that their order will be executed. Though if the closing auction causes dramatic price movement for a stock (as it readily can), an investor utilizing an MOC order could be left buying a stock at an unplanned price point.
- Limit-on-Close (LOC) orders are used to transact a set number of shares, but only if the closing price falls within a predetermined limit. If the action of the closing auction sets a price outside the limit, no transaction will be completed.
Analogous order types exist for opening auction: Market on Open (MOO) and Limit on Open (LOO), available beginning at 7:30 AM each day.
Investors need to understand that these auctions (especially at the close) are more than devices to solve the sudden cutoff time for the market: they solve big liquidity problems that would otherwise render stock prices even more volatile than they already are. For instance, imagine you run a mutual fund that tracks a given sector. Shifts in a given stock’s value dictate that you acquire 500,000 shares by the end of the day. Such a large purchase could readily buy up the entirety of the stock’s intraday float in a matter of minutes—driving up the price dramatically right at the time your fund is trying add to its position.
In the final auction, an entire day’s worth of close orders is aggregated, creating more liquidity and unified price information than at any other time during the 24-hour cycle (during the day, NYSE-listed stocks change hands on many different, decentralized exchanges). Traders representing big institutional investors are given a special role in this process, deciding how the day’s orders should be transformed into a singular closing price. Vitally, these “market makers” will actually intervene if the closing action appears to be resulting in an overly dramatic action for a given stock, buying or selling some of their own holdings to stabilize the closing price.
One final detail to keep in mind: the opening and closing prices as discovered in these auction processes are a very specific piece of data. Many free resources purporting to give this information are actually just taking the price at 4:00 PM or 9:30 AM—not quite the same thing. NYSE and NASDAQ are a great, reliable source for this info, (as well as stockbrokers). If you’d like to get into the gritty details of the timelines for each auction, the exchanges themselves also have more detailed information: NYSE provides a useful document here.
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