CPD: The importance of Pre-open Pricing

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Pre-open Pricing: how it works and why it exists.

Managing an orderly market and ensuring that share prices cannot be manipulated are essential to the smooth operation of securities exchanges globally. In Australia, the securities exchanges operate from 10:00am through to 4:00pm, however there are periods before and after during which buy and sell orders can be placed on the Australian Securities Exchange (ASX).

In this article, OpenMarkets look at market phases and explains Pre-open Pricing, how it works and why it exists.

The Australian Securities and Investments Commission (ASIC), in conjunction with Australia’s securities exchanges, is responsible or managing an orderly market. In August 2010, ASIC took over responsibility for supervision of real-time trading on Australia’s domestic licensed markets, a responsibility previously held by the Australian Securities Exchange (ASX).

The arrangements for the opening and closing of markets are particularly important to the management of an orderly market. The closing price of securities can determine margin calls, the terms of exercise of derivatives contracts, the pricing of some capital raisings, and the calculation of market indices.

Consequently, as with several overseas markets, special procedures have been developed to permit buy and sell orders to be placed before and after normal trading hours. This also allows for any orders that match or overlap to be settled at prices established differently from those applying to orders placed during a normal trading day.

Market phases

Both the ASX and Chi-X Australia operate market phases, although as highlighted in figures one and two, there are points of difference. Importantly, Pre-open pricing is not undertaken by Chi-X.

 

 

Chi-X Australia allows trading between the hours of 10:00am and 4:12pm and, unlike the ASX, does not operate an opening and closing auction. When Chi-X Australia opens at 10am it does not have a staggered start; interfaces such as IRESS have a ‘queued Chi-X’ functionality that allow advisers to put trades on Chi-X before market, where it will release them into the market at 10:00am. Therefore, it may be possible to trade some stocks on Chi-X before it’s possible to trade them on ASX.

 

 

Pre-open Pricing Auction and the Match Price

The Pre-open Pricing Auction is overseen by the ASX and sets the opening prices for the day, irrespective of which exchange is used to trade listed securities.

The Auction balances out the bids and offers according to an algorithm, which calculates a weighted ‘auction price’ based on the quantities on each side. Only bids and offers inside the match area participate in the opening auction.

Because orders can be entered during pre-open but trades do not take place, orders may ‘overlap’ – this means that the highest buy orders may be at a higher price than the lowest sell orders.

Calculating the Match Price

To calculate the single Match Price, four principles are applied in order. Each stage acts as a filter for the next, so that only those prices that are not filtered from the first stage are considered in the second. If only one price is possible after applying the rules at any stage, that price becomes the match price.

The principles applied are these:

1. The price should be the one that provides the maximum volume of executed trades

Example: there are 70,000 buy orders at a price of $10 or less, and 30,000 sell orders at $10 or more, 30,000 shares would trade if the price were $10. If there was a price at which a higher number of trades would take place, that becomes the Match Price under this first principle.
If the same volume of trades would be executed at more than one price, then the second principle is applied.

2. The price should be the one that leaves the least quantity of shares in unfilled orders

Example: using the above example, 30,000 shares would trade if the price was $10, and 40,000 buy orders would remain unfulfilled. If another price could in fewer unfulfilled orders, then it would become the match price.
If the same quantity of shares in unfilled orders would arise at more than one price, then a choice is made by applying the third principle.

3. The highest potential price should be used if market pressure is on the buy side, the lowest if the pressure comes from sellers

Example: Using the same scenario, where two prices remained from principle two, then the higher price would become the match price; this is because the unfilled orders are on the buy side. If pressure comes from both sides, the final principle will be applied.

4. The price should be set with reference to the last traded price

If the last traded price is within the range of potential prices that are still possible after applying Principle three, then that will be the match price; otherwise, the match price will be the potential price that is closest to the last traded price.

The algorithm is only applied when an even or overlapping market exists. In a situation where buy orders for a particular security are lower than the sell orders, an opening price cannot be struck. It can only occur once a buyer lifts their price to meet a seller, or a seller lowers their price to meet a buyer – at this point a trade is executed and an opening price is generated.

The method used to calculate the Match Price is also applied in the same way to establish:

  • closing prices at the end of the trading day
  • float prices
  • prices following a trading halt or suspension
  • prices of new listings.

This approach enables optimal opening prices to be established, maximises order matching when the regular trading session begins, reduces the load on the ASX’s Trading System (ITS) and helps manage price fluctuation and manipulation at the beginning and end of the normal trading session.

The arrangements for the opening and closing of markets are particularly important to the management of an orderly market and, as outlined, result from a series of steps. Although it might seem complex, automation and the existence of algorithms make this is a quick and seamless process, to ensure that trading gets underway each day the minute the market opens.

 

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This article provides general information only and has been prepared without taking account the objectives, financial situation or needs of individuals. The information contained in this article reflects, as of the date of publication, the views of OpenMarkets Australia Limited ABN 38 090 472 012 AFSL 246705 (OpenMarkets) and sources believed by OpenMarkets to be reliable. We do not represent that this information is accurate and com­plete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither OpenMarkets, its related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article. Past performance is not a reliable indicator of future performance. Investing involves risk including loss of capital invested. ©2017 OpenMarkets Australia Limited.

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