Automation and Information Produce Efficient Price Discovery in Nasdaq’s Auction Process
This story was originally published by Curatia.
The Net Order Imbalance Indicator (NOII), available through Nasdaq TotalView, gives auction participants a look at the supply and demand for a stock prior to the opening and closing crosses. Participants who incorporate the NOII into their workflow can enhance their decision-making and place orders more intelligently. In addition, the analysis of order imbalances allows participants to be better prepared to offset liquidity demands.
Nasdaq has been disseminating the NOII widely for about 15 years but has enhanced the rules and processes governing it over time. In the last three years, the exchange changed the time and frequency at which the data is disseminated in the opening and closing auction process to further increase transparency, efficiency, and flexibility.
Moreover, the exchange has an Extended Trading Close (ETC) proposal pending with the SEC to leverage the NOII data format after the 4:00 p.m. close and enable market participants to continuously trade at the closing price until 4:05 p.m.
Effective Performance in a Competitive Environment
The NOII includes the number of opening or closing shares that are paired off as well as imbalanced shares that would remain unexecuted at the current reference price. It also includes the current indicative price of the auction that would satisfy all eligible demand.
The NOII is calculated and updated continuously, beginning five minutes before the market opens and 10 minutes before the market closes. And it’s used to disseminate indicative auction information for both the quote-only period of an IPO cross and a regulatory halt cross reopening.
The largest liquidity events of the day on the Nasdaq Stock Market typically occur during the opening and closing auctions. The activity in the opening represents about 4% of Nasdaq volume, and the activity in the close represents almost 16% of Nasdaq volume. In other words, about a fifth of the volume on the exchange happens in an opening or closing auction. The NOII provides users with invaluable details about the opening and closing orders and the likely opening and closing prices of a security. As such, it can have a positive impact on participants’ ability to perform effectively in a highly competitive environment.
Let’s say over the weekend, traders learn some positive news about a company, and they submit opening buy orders on Monday morning to establish positions in that security. Those orders may result in a temporary supply and demand imbalance during the auction. In this case, the NOII makes participants aware that there are more buyers than sellers in the market. Contra-side parties then have an opportunity to enter the auction process and provide liquidity to those who demand it and help balance the book, which improves overall auction outcomes. Participants who don’t incorporate the NOII data may miss an opportunity to transact at prices they deem favorable.
Earlier Insights Lead to Better Outcomes
To increase transparency and efficiency in auction price discovery, Nasdaq decided to disseminate the NOII earlier and implemented the change in two stages. In Q4 2018, the time at which the NOII is disseminated on the close was moved five minutes earlier, from 3:55 p.m. to 3:50 p.m.
Then in spring 2021, the time at which the NOII is disseminated on the open was moved three minutes earlier, from 9:28 a.m. to 9:25 a.m. In addition to the earlier dissemination of information, the frequency of the dissemination was increased from five seconds to every second. Having more information earlier allows traders to participate in auctions more effectively.
Market participants value the NOII information, and they have embraced these changes. Today, algorithms drive a significant amount of institutional trading. Previously, algorithms began trading after 9:30 a.m. because they couldn’t participate in the opening auction in a deterministic way. Now that Nasdaq disseminates the information earlier and more often, algorithmic traders may choose to participate as liquidity providers earlier in the day at potentially more advantageous prices and with less market impact.
Pending SEC approval, the ETC will provide firms additional opportunities to trade at the established closing price. Each day, Nasdaq calculates the closing cross auction price for all securities with eligible orders. Some participants may have missed an opportunity to trade at the closing price, or they may have wanted to trade in a larger size. There is often a flurry of activity immediately following the 4:00 p.m. close, with about 1% of daily volume in Nasdaq-listed securities taking place in the five minutes after the close.
However, trading in the after-hours can be difficult with low liquidity and light volume. The new ETC order type will allow for Nasdaq-listed securities to be matched continuously at the Nasdaq Official Closing price until 4:05 p.m. The ETC NOII information will make it easier for participants to advertise their own interest, see eligible interest in all Nasdaq-listed stocks, and ultimately access or provide liquidity.
Nasdaq’s Commitment to Innovation
Nasdaq is committed to establishing innovative products and processes and continuously improving them. We are particularly proud of Nasdaq’s automated auctions, which are used to establish the opening, closing and IPO pricing for all types of securities, including ETFs. In fact, the Nasdaq auction process has been copied in markets throughout the world. Importantly, Nasdaq’s approach to disseminating the NOII levels the playing field and empowers all participants to execute their trading strategies with the best possible outcome for investors.
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Market Infrastructure Data and Analytics
Ed Coughlin
Nasdaq
Ed Coughlin currently serves as the Director of Trading Services and has over 30 years of experience in the securities industry and securities-related matters. He oversees the Nasdaq trading desk, where he is responsible for the day-to-day operational activities
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