Settle Investment Trades Only Daily an improvement? True or False
post by jmh · 2020-05-11T21:56:04.882Z · LW · GW · 8 commentsThis is a question post.
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Allowing people to make offers and bids for stocks throughout the day, but then clearing and settling at a set time each day at the day's clearing price would be at least as efficient and more fair to small investors. Moreover, it may reduce some forms of volatility without reducing returns.
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comment by habryka (habryka4) · 2020-05-12T00:30:29.220Z · LW(p) · GW(p)
Note: We don't have formal rules about this since this has never come up, but I think questions should actually have something concrete about the question in the title, and should avoid being names something like "True or False" or "Is it true?" or anything in that reference class.
Replies from: jmhcomment by Decius · 2020-05-11T23:15:08.402Z · LW(p) · GW(p)
Daily seems arbitrary, at least as compared to hourly and weekly settling. Hourly settling would seem to provide the same fairness to small investors while still allowing the market to transact during the entire day, instead of only once per day.
If responding to new information during the day is not desired, then less frequent settling is indicated.
Replies from: jmh↑ comment by jmh · 2020-05-12T02:13:39.005Z · LW(p) · GW(p)
Well pricing can be assessed though out the day, and reassessed as well via the submitted bids and offers. The change his is about the actual price the security trade at. In this approach everyone selling or buying on a given day gets the same price (very much like the standard economic auctioneer model).
While I would be more interested in hearing what thoughts others might have, one though might be that such an approach eliminates a bunch of little welfare loss triangles that are the result of the individual trades occurring throughout the day by requiring the day's supply and demand curves to be fully reveled.
Replies from: Decius↑ comment by Decius · 2020-05-16T11:38:28.501Z · LW(p) · GW(p)
If the end-of-day price is above my bid or below my ask, the stock couldn't trade, and the transaction never happens. For that reason there is a moderate incentive not to trade FCOJ futures right before the crop report is revealed, because your offers will have to stand but other parties can wait until after the news is out in order to meet them, and the future actors have an insurmountable information advantage.
It also results in some stop-loss order situations being metaconsistent; the trade price is below the stop-loss trigger point IFF the stop-losses trigger, resulting in multiple market clearing prices.
Replies from: jmh↑ comment by jmh · 2020-05-16T12:48:54.419Z · LW(p) · GW(p)
I don't understand either of these points.
Stop-loss is merely a special form of limit price and would certainly fit into a end of day clearing/settlement process for supply and demand. Here I don't see where the multiple clearing prices can emerge due to stop-loss orders but not from other limit orders. And, even if there is a spread between the limit bid/offers that might produce a gap, so indeterminate price in that range, it would be rare where the market price orders were insufficient to close the gap.
The fact that the end of day price might be above or below the price you will trade at is not different if it's end of day only or tick-by-tick. If no one was willing to sell at your bid or buy at your offer you are not part of the market in that period of time. That is now we think markets should work. The concern here seems related to my next paragraph.
One thing that has motivated my musing here is the market argument about maximizing surplus generated by markets -- the area between the supply and demand curves. End of day trading allows those two curves to be known and match the trades that allows that maximum surplus to emerge. Random trades as they show up throughout the day does not. Some of the trades my well be pure transfers generating zero surplus.
I do think it's fair to ask is the lost of surplus is meaningful and I'm not 100% sure. But if not then there is a lot of welfare economics that needs to be rethought and a certain amount of market philosophy to reconsider. Is a society just as well of under the standard free market outcome with producer and consumer surplus as it is under a regime of perfect price discrimination (i.e., only producer surplus)?
Replies from: Decius↑ comment by Decius · 2020-05-21T04:43:06.165Z · LW(p) · GW(p)
Yes, other orders which are conditional on the price can also result in the market clearing price being undefined.
How do you determine what price to trade at? Is it the market clearing price with lowest/highest volume?
I don't see how you've explained how batching transactions is positive-sum; would it reduce transaction costs? Would it somehow provide net benefit to both buyers and sellers as compared to executing trades as they can be, rather than randomly benefiting some buyers at identical cost to the sellers?
Would the magic surplus be greater if trades were only executed quarterly, or if they were executed hourly- why daily, and not more or less frequently? It's certainly a solid Schelling point, but the math doesn't care about when NYC wakes and sleeps.
Replies from: jmh↑ comment by jmh · 2020-05-21T13:55:22.129Z · LW(p) · GW(p)
We'd have to look into the specific rules here. The only thing I do know is limit orders trade before market orders do and orders are time stamped. In other words, the current institutional structure is more about managing order flow than establishing the clearing price when supply and demand are considered in the larger context -- such as buyers and sellers who want to participate today but will be sending the orders at much different times during the period the market is open.
Draw a simply Supply and Demand picture, and assume those curves do represent the true price quantities of the market participants that exist during the given period. The intersections would then be the standard economic model clearing prices. Let those curves represent one day.
Currently, under the order flow regime, the when ever the orders come in at attempt to find a matching order on the other side occurs. But that would allow a supplier that has a price in the supply curve that is above the intersection to be pairs with buyer on the demand curve that is at or above the ask price.
The difference between the transaction price and that implied market clearing price when considering the days actual supply and demand characteristics seems to represent the loss of value the buyer would have saved if they could have bought at the theoretical market clearing price, which is only known when the day closes. This also represents a transfer to the seller with the above market price. This seller, on some pretty standard market logic, really should not have been able to get that trade as the price asked was too high.
Changing the rule about matching trades (supply and demand) at the end of the day rather than as the orders come in prevents that type of inefficient pairing of buyer and seller.
To my knowledge that is what happens in the morning for all trades, and why sometimes when unusual events occur the opening for a security is delayed while the market or market makers try to figure out just where the open clearing price really is.
Large institutional and large investors will also use some slightly different orders and pay something or an weighted average price for the shares they sell on a give day. This appears similar to my suggestion and I would suggest lends support to the underlying thought.
You are correct that the duration of the period might matter and a day may not be the right one. I picked that because generally information is fairly consistent over a day so revision to orders places should me small.