The opening and closing auctions hide far more complexity than most realise. In this piece, Michael Taylor breaks down how they work and why knowing the mechanics can make all the difference to your trading.
I sometimes get asked why I don’t trade US stocks, as the volatility can be higher and liquidity far superior.
It’s a good question. The answer is simple.
I would feel like liquidity food coming into a market I know nothing about.
I started trading UK stocks as I stumbled onto a bulletin board, saw a stock that was massively down, and foolishly thought that it must be cheap, and it’ll go back up again.
It turned out that stock was still hugely expensive as it went bust within a few months.
This sent me down a rabbithole of working out why it happened as I wanted to understand and also wanted an opportunity to make my money back. The volatility of the stock was huge before it went bust and I knew some people must’ve been doing very well out of it – it’s just I wasn’t one of them.
There are a lot of intricacies in the UK that the majority of people don’t know about. If you’re reading this, it’s quite likely you’ve never dealt in an auction.
Most brokers don’t actually allow you to do so.
You can only deal in an auction if you have Direct Market Access. This is available with only a handful of UK brokers. Most brokers only allow you access to the RSP (Retail Service Provider) which is the quote system that connects you to the market makers via the broker.
For SETS stocks, the uncrossing trade will be the first trade of the day (and potentially the last – we’ll come back to this later).
It’s an opportunity for everyone to lay out their wares and prices, and for all participants in the auction to come together in a single trade, known as the uncrossing trade.
You will see this on a Level 2 with the code “UT” which stands for Uncrossing Trade.
It’s important to know how auctions work in order to be sure you’re not getting ripped off on prices.
What actually are SETS auctions?
SETS stands for Stock Exchange Electronic Trading Service – the London Stock Exchange’s flagship trading platform and the platform for the FTSE 350 and some other more liquid shares. Most of the trading day operates as a continuous auction where buyers and sellers are matched in real-time. But at least twice twice a day, the market operates differently: during the opening and closing auction periods.
The opening auction runs from 7:50 to 8:00, with a random 30 second end time between 8:00:00 and 8:00:30 to prevent gaming.
The first ten minutes from 7:50 is known as the ‘call period’.
This is where everyone with DMA is able to submit, modify, and delete orders.
Very often you will find people placing their orders in the last few seconds in the call period.
Why?
Because there is no upside to showing your hand too early. Only if you want to influence the price (and influence other market participants), which is a whole other article.
The closing auction runs from 16:30 to 16:35, again with a random end between 16:35:00 and 16:35:30.
The random period of up to 30 second periods following the call period – this is known as the ‘uncrossing period’.
The random 30 seconds exists because it means nobody is able to game the book. If you knew the exact second that the uncrossing would take place then you could just pull your order at the last nanosecond and try to influence the price.
By keeping it random, any order that carries over from the call period into the uncrossing period must be prepared to be a firm order as uncrossing could happen at any point.
After this random period of 30 seconds has passed then the uncrossing trade takes place. This price is the one where the highest volume of shares can be matched and executed.
Think of it like a silent auction at a charity event. Everyone submits their bids throughout the bidding period, but nobody knows the final price until the hammer falls. The auctioneer then matches all the buyers and sellers at one price that clears the maximum volume.
Why auctions exist
The LSE probably didn’t create auctions to be unnecessarily complex and create parts of the market that most people simply don’t know about.
They serve a legitimate purpose: price discovery.
When the market is closed lots of things can happen.
Overnight and over the weekend and any Bank Holidays, information can accumulate. Company announcements, US market movements, geopolitical events – all of this needs to be reflected in UK stock prices when trading resumes.
The auction mechanism aggregates all this overnight information into a single opening price, theoretically more accurate than if trading simply resumed with the previous day’s close. The closing auction serves a similar function, establishing an official closing price for index calculations, fund valuations, and derivatives settlement.
Institutions and funds use auctions strategically. They accumulate or distribute large positions during auction periods when there’s natural liquidity. They may also use other types of orders such as VWAP (Volume Weighted Average Price) but often auctions are a great way to get a decent amount of volume done in the more liquid stocks (this is not the case in thinly traded stocks).
How to deal in an auction
Dealing in an auction is simple.
You will need to use a broker that has access to DMA.
You can then place a Limit order to buy or sell during the call period.
In the dealing ticket, you input the amount of shares you want to deal and the highest price you’re willing to pay.
A word of warning here.. Do NOT use a market order. This is dangerous.
Why?
Because you are essentially giving the market a signed blank cheque.
You are saying to the market: “Fill me at any price”.
There will always be a price in the market. You just might not like it.
Any astute trader who sees a novice place a market order can manipulate that order so that they match you at the highest price possible.
Now, whilst it’s true that markets are competitive, and any arbitrage is often ironed out to thin margins, that doesn’t mean you can’t get stuffed.
Here’s how I took advantage of someone snoozing at the open to make £192 in two seconds. I highlighted this on Twitter during the call period to educate people, assuming that someone would arbitrage it out.
Nobody did! So I pocketed the £192 instead.
Don’t use market orders or orders that are left overnight as the market shifts and if you forget, you can end up feeling robbed.
The indicative uncrossing price
During the call period, you will see an ‘indicative’ uncrossing price in the yellow strip on a Level 2 screen.
This is the price and size that the auction would uncross at right in that moment, hence ‘indicative’.
The indicative price will adjust accordingly as orders are entered, modified, and deleted during the call period. It can even change the second before the auction actually uncrosses as orders are still being altered, entered, and removed during the uncrossing period.
Therefore, it’s not as simple as saying “I’ll enter my order at the indicative to get the best chance of a fill”.
Now that you know what auctions are and how they function, in part 2 we’ll cover how to use them effectively.
Michael Taylor
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This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
