Those of us who have traditionally invested in small cap AIM listed stocks are familiar with the SEAQ trading system, where the share trader/investor buys from and sells to a market maker, via his stockbroker. The market maker is the middleman. His job is to do exactly as his name suggests - make a market. Without a market maker, if you wanted to buy some shares, you would have to ring around other shareholders and find one willing to sell to you at a reasonable price. If you wanted to sell you would have to find a willing buyer.
But the market makers relieve investors from such drudgery by providing a point at which - within specified limits set by the LSE - we can buy or sell as many shares as we wish. If the market maker doesn't have any shares, then it's up to him to find some when we want to buy. He is also obliged to take in shares, even if he has more than he really wants, if we wish to sell. This exposes market makers to risk, and in return for shouldering that risk, market makers expect to be paid. Their payment is the difference between the price they are willing to sell at and the price they are willing to buy at.
In any one stock there will usually be several market makers. Each will have his own set of buy and sell prices. For the purpose of deciding what price investors can buy or sell at, all prices from the individual market makers are set alongside each other, and the "best" price rules. i.e. the lowest "offer" (the price at which the MM will sell shares to you) and the highest "bid" (the price at which the MM is prepared to buy shares from you). The gap between the two prices, often quite large, is known as the "spread" and the so-called "mid" price is halfway between them.
When an investor buys or sells stock from/to a market maker, the transaction is reported to the stock exchange. Each transaction is, of course, both buy and sell. You are the buyer or seller, and the market maker is the other party in the transaction. However, only one trade report is required. The transaction reports are published by the stock exchange with a trade type of O, and services such as ADVFN,iii and MoneyAM, who have a "feed" of information from the exchange, will list the transactions on their Monitor/Watchlist and Trades pages. Some years back, all the online services thought it would be a good idea to attempt to list these transactions as buys or sells, and devised a guesstimate system - if a transaction is executed at a price above the mid-price, it is placed into the buy column. If executed below the mid-price it is placed in the sell column.
Now, unless trading is intense and prices moving rapidly, these buy/sell columns are fairly accurate, and represent a reasonable estimate of the amount of buying/selling BY investors FROM/TO the market makers. Some large trades which are multiples of the Average Daily Turnover are published up to three days after execution, which can distort the numbers. (See the LSE website for the post-MIFID parameters re: the new reporting regime.) But by and large they enable a reasonable overview of supply and demand.
So that's SEAQ. Love it or hate it and its big spreads, most punters are familiar with it and some even understand how it works. You could describe it as "the devil you know"!
In the meantime, on the main market, for the big boys, there has been another trading system. Known as SETS - the Stock Exchange Electronic Trading Service - it was introduced at Big Bang time in 1997, when the LSE moved from its traditional trading floor, where brokers and market makers met in the flesh to do their deals, to an automated system run by computers. Used for the trading of shares in large companies with high liquidity (i.e. lots of buying/selling activity) SETS cuts out the middleman.
In simple terms, those who have access to the SETS order book and have shares for sale will enter a sell order on to the book. Those who wish to buy will enter a buy order into the order book. The system will automatically match up buyers and sellers who match on price - often one large order will be matched up with several smaller orders on the "other side". The matched orders are removed from the book, and a transaction is executed between buyer and seller. Again, each transaction is both buy and sell, and again, only one transaction report is required. These automated trades have a trade type of AT.
The LSE recently decided, in its wisdom, to extend the SETS system to less frequently traded shares, and to ensure permanent liquidity, they combined the SETS order book with the continuous liquidity provided by firm two-way quotes from market makers. The result is SETSmm - "or the devil we don't yet recognise!"
SETSmm is gradually being extended further and further down the liquidity rankings, and now there are many AIM stocks - mostly those with market caps that are, or have been, £100 million or more - traded on the SETSmm system. More recently, post-MIFID, the parameters of SETSmm have been extended to the entire SETS system - thus providing liquidity via the order book AND firm two-way quotes from market makers across all stocks, even the FTSE 100.
And thereby lies the rub. Private investors used to SEAQ are finding it difficult to get to grips with SETSmm, and many do not even realise it is now a dual system: a SETS order-book driven system supported by firm quotes from MMs, running in parallel with a SEAQ-like off-order-book system.
The way it works is this:
Those with Direct Market Access can - and do - enter buy and sell orders at specified prices on the relevant side of the SETS order book. Orders on each side of the book are listed by price, with the best at the top, and where there is more than one order at a given price, in order of the time the order was placed. Orders are matched against each other using these priorities. Order matching and trade execution, followed by the single transaction report, are carried out exactly as per SETS. However, because there may not be sufficient activity on the order book in the less liquid stocks to enable a fair price to be set and to enable trading on demand, MMs also show their firm quotes on the order book. Their "buy orders" and "sell orders" - familiar to us from SEAQ as the volume and price at which they are each prepared to trade - are treated the same as any other orders, except that their ID code is placed alongside their orders, whereas other orders are anonymous.
Where buyers and their brokers do not have access to the order book, shares are bought and sold away from the order book using the familiar investor-broker-market maker chain as under SEAQ.
All well and good. The trouble starts when the transaction feed from the LSE hits any of the online services used by most retail investors. We have described above how each transaction carried out on or off the order book is both a buy and a sell, for which only a single trade report is required.
Trades with a type of O are the same as they have always been - an off-order book transaction between an investor and a market maker. As such, each individual trade can be said to represent a buy by an investor or a sell by an investor.
But AT trades, as we have just seen, are trades directly between buyers and sellers, without the intermediary of the middle-man. So what are they? The online services will tell you they are buys or sells, depending on whether the execution price was above or below the current mid-price. But in fact, they are neither one nor the other - they are BOTH. Hence the way AT trades are treated by all of the online services such as ADVFN, MoneyAM and iii is misleading, both in terms of total volume and in terms of buy/sell balance.
Let's try an example.
I want to buy 50,000 shares in Acme Widgets Ltd. You want to sell 25,000 shares. Your wife also wants to sell 25,000 shares. Our brokers do not have direct access to the order book, so when we have placed our orders with our brokers, they approach the market makers and get us quotes, which we accept. The transactions are then executed. My buy will generate a trade report. Your sell, and that of your wife, will each generate a trade report. All will have a trade type of "O". We will see on our monitor or watchlist a total volume of 100,000 shares, 50,000 buys and 2 x 25,000 sells.
Now suppose we all have direct market access via our broker, and can instruct him to place our buy and sell orders direct on the order book. Let's say the current price is 24 - 25p. I want these shares quite badly, so I am willing to pay up to 24.5p and my buy order goes on to the book with a limit price of 24.5p, and becomes the new "best price". Your sell order, and your wife's sell order, both go into the sell column "at best". My buy order of 50,000 is matched against your two 25,000 sell orders. A trade is executed and a trade report generated showing a trade type of AT. The trade report will be for 50,000 shares at 24.5p.
When that transaction hits the online services it will probably be put in the buy column, as my "best price" of 24.5p has now been taken out, and "best" is back to 24p. We will now see total volume of 50,000 shares, all buys.
As you can see, although we have all bought and sold exactly the same numbers of shares in each scenario, what we see on our PC screens is only telling half the story re: the AT trades which have been executed on the order book. In these circumstances, it's not surprising that traders and shareholders used to the SEAQ system are misleading themselves ? and therefore putting themselves at a serious trading disadvantage - about (a) total volumes and (b) buy vs sell activity as shown on ADVFN, MoneyAM, iii etc.
There is little that the online services can do about it, to be honest. Although they could ensure that all AT trades were automatically placed in the ??? column to differentiate them from the O trades.
In the meantime, for every AT trade that appears in the buy or sell column on any watchlist or monitor, it's vital to remember that there is an equal and opposing volume in the opposite column. O trades do represent a fair picture of buying and selling by investors. AT trades only show the half of it! Literally.
