How exactly traders “provide liquidity” in the markets
I am reading “How the Trading Floor Really Works” by Terri Duhon and my question is in regards to the trading that goes on between a bank and their clients.
According to the text, when a client of the bank (fund manager or whatever) wants to sell a large block of shares they will call the banks trading desk to execute the trade; because the size of the trade, if sent directly to the exchange, would distort the market price of the shares. I get that.
While I get the concept, I find holes in my logic when I think about HOW this all happens. Specifically with regards to how and when these transactions hit the exchange
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The text says that if a client wants to sell a large block of shares the bank will buy it from them (hence take a risk) at a quoted price that it deems profitable. Then, it says, banks find others to sell it too through “central market platforms” which it describes as exchanges, interbank brokers, or electronic trading systems.
Now, if Client ABC want to sell 1 million shares of GS which trades on the NYSE, and Bank XYZ is providing liquidity for the client, then it is my understanding that Bank XYZ will buy it from them with intentions of winding down the position with others in the marketplace.
Here are my questions with this
Does the order between Client ABC and Bank XYZ hit the exchange?????
I want to say yes because I can’t see how a stock that trades on the NYSE can exchange ownership without going through it.
If a stock has the last traded price of 10$ with a Bid of $9 and Ask of $11 (not tight enough spreads to be realistic i know), and some client wants to sell boatload of shares for which the bank quotes them a bid at $8.80, will the market price shown on the exchange dip to $8.80?
If the bank desires to get rid of this position, doesn’t this mean, at a theoretical and abstract level, that when a client wants to sell a stock two sell orders get placed on the market??? First when the client sells to the bank and when the bank sells to whomever wants to buy it from them??? Would both these hit the exchange???
How do these large block trades between clients and banks affect the level 2 quotes that I picture in my mind as demand and supply as a small time trader??? I tried looking at some intraday 1 minute charts to help me solve this but then I had to tell myself even in one minute so much shit goes down that this is useless.
I am at odds with the systematic process of how things change hands from Client to Bank to whoever the banks sells it to who winds down the position through what the text calls “central market platforms.” If someone could provide a systematic process for me that would be great. Far too many threads simply say that S&T people have jobs because clients can’t go straight to the exchange and get rid of the stock itself without going in depth.
If you’ve read this thank you very much. I want to make sure that anyone who answers really sees where I am missing a piece of logic. Perhaps I am making it harder than need be?
Coming from a commodity background, so forgive me if it's a tad diff (I know in equities there's a lot more regulations
Depends on the product. If it's an exchange-traded product, it will be shown.
No, because OTC and exchange are not linked like that. The different quotes reflect the fact that if the client trades on the exchange, they'll have market impact and won't get a steady fill like that.
They'll be shown on the tape, yes.
Because of liquidity and depth....If the market is 9/11 with 200 on the bid and 300 on the offer, you'll have a hard time doing 2000 lots and getting a consistent fill.
For instance, take a calendar strip. All same strike options through a bunch of diff months. It's hard to find liquidity on the screen (or, as you're saying, "on the exchange") for the size some people want to do.
I've also heard that there are internal systems that would try to match a client's orders with what has been placed in the banks by other clients... so an order (or maybe a part of it?) is filled within the bank. Is that true? Or did I horribly misunderstand what the trader was trying to explain lol.
I do this every day
First we quote a price to the client. Let's say the market is trading at 40-40.20 with okay bids and offers. I give the client 40 for 1mm shrs. He/she accepts and you'll see a print on the tape, 1mm @ 40. I, now, have the risk position to off load in the market. Here's where the whole machinery of salestraders come into play, they know where my axe is and all they need to do is find buyers while I try to unwind my long position.
It starts out as a client sell order, and my awesome quoting skills makes me long. I'm now the one unwinding my position, semantics would now call it 2 sell orders (1 filled and 1 working).
How we make money, you might ask... well, first there's the comm on the client sell order and comm on all the buy orders we find plus whatever I can sell for a profit in the market.
Anytime there's a big block being printed on the exchange pricing may change. People are unsure if it was the beginning of a bigger sell or buy order getting a fill and they try to pull the trigger.
We good?
thank you very much for this.
what at first made me iffy about all of this was what happens when these institutional orders hit the market.
could you comment on this as well?
for example,
GS last traded price is 100 with a bid @ 99.99 and an ask @ 100.01 and a client comes in and wants to sell 1mm shares worth and you quote him 99.95, for example, you are saying that the last traded price (ON THE EXCHANGE???) will drop down to 99.95 as a result of you accepting the trade????
What happens to all the other bids on the exchange (99.98,99.97,99.96 for example)?? They can't just go away. Will they only be absorbed if the asks come down??
Perhaps me worrying about how this will all affect the level 2 quotes is clouding my reason?
Regarding your GS example: If I print the block at 99.95, daytraders, hft and other brokers will understand that we didn't have demand for 1mm at market level. What happens is that they'll understand that I need to unwind 1mm and will start to hitting the bid harder than Ray Rice.
What happens on the exchange is that I send they them a print of 1mm at 99.95 and match my buyer and seller inhouse (where I'm one of the sides). In other words, the block didn't reach the market I only sent the exchange info about an inhouse trade.
thanks a lot for this kind sir.
all the best
Np, let me know if you need something in greater detail. Have a good one!
Harder than Ray Rice, well played haha
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