I hope you can read it from that link... I get Matt Levine's Bloomberg "Money Stuff" column by no-cost email subscription, but when I tried the regular link it appears as if this content is also available from the website without a subscription. The link to subscribe to the no-cost email newsletter is Money Stuff no-cost newsletter signup; the newsletter contains ads; I have no connection with Levine or Bloomberg other than being a fan of the column.
It's interesting, not just for an explanation of a something that happened, but for his excellent explanation of how the NYSE trading system works.
The main thing I had had no idea about is that the market functions very differently at the open than it does a minute later. According to Levine, the opening moments are the real auction, where price discovery really happens, and market makers are not involved because there are enough participants all at the same time that they can just work it out between themselves. For the rest of the day, the market is operating as, he says, a "central limit order book (CLOB)" in which everyone is actually trading with market makers, but the market makers have no real opinion on the stock and are just almost-mechanically intermediating to keep trading orderly.
It's really hard to trim this down and you should really read the whole article. But, he says:
According to Levine, what happened yesterday is that due to a "system issue," they neglected to conduct the opening auction, causing "wild price swings and a temporary trading freeze in stocks of major companies such as Exxon Mobil Corp., McDonald’s Corp. and Walmart Inc." Levine thinks thatThe basic problem of the stock market is that a lot of people want to buy a lot of stock, and a lot of people want to sell a lot of stock, but not at the same time.... In theory, there are about three ways to deal with this: 1) I could just wait.... 2) There could be market makers.... 3) The exchange could get us all together at the same time. The stock exchange could say: “Hey, everybody who wants to buy or sell Wells Fargo shares, we’re gonna do a big share swap at 9:30 a.m. tomorrow.
Method 2 is sort of the standard paradigm.... It is sometimes called a “central limit order book,” or “CLOB.” .... I do want to mention one complaint that people sometimes have, which is that liquidity in the stock market is somehow illusory or fleeting or “not real.” Part of what this means is that, if the national best bid and offer for Wells Fargo is $44.99/$45.01, you could go to a market maker and buy Wells Fargo for $45.01, or sell it for $44.99, but you couldn’t buy or sell very much of it.... the limit order book does not represent the true economic supply and demand for a stock. It just represents the supply and demand for the stock right now, mainly from risk-averse high-frequency electronic market makers....
...Method 2 is the main procedure, but Method 3 is also really important. In fact there are some obvious times when lots of people all want to trade at the same time: The US stock market’s main opening hours are 9:30 a.m. to 4 p.m., and people naturally gravitate toward trading at the open or the close, at 9:30 or 4. And so the big listing exchanges, the New York Stock Exchange and Nasdaq, run opening and closing auctions for the stocks they list. The rough idea of the auction is:
...The opening auction is where the day’s price discovery happens: All the “real” investors, pension managers and hedge funds and retail traders on Robinhood, have updated their views on value overnight, and then they meet at 9:30 in the opening auction and work out what the market-clearing price is.
- Everyone who wants to buy or sell stock at the open or the close puts in orders to buy or sell, in the minutes leading up to 9:30 or 4.
- Some of those orders are market orders (“I want to buy/sell stock at whatever the auction price ends up being”), while others are limit orders (“I want to buy stock in the auction if the price is $44.95 or less”).
- The exchange’s computers find a price that matches up the most orders and chooses that as the auction price.
- Everyone who put in an order to buy at the auction price or more (or with a market order) buys, and everyone who put in an order to sell at the auction price or less (or with a market order) sells....
Notice that in Method 3 you don’t really need market makers... Also, market makers probably don’t want to trade in the opening auction. A market maker does not have a deeply informed view about the fundamental value of a stock; it just tries to turn over inventory quickly and do trades at pretty close to the previous trade. At 9:30 a.m., there is no previous trade....
And so there’s an opening auction among mostly real investors, and it sets the opening price, and a bunch of shares trade at that price, and then a millisecond later normal trading starts. And when normal trading starts, the market makers put in their orders to buy and sell stock... and the market operates with a central limit order book for the next 6.5 hours.
Since I don't trade individual stocks, none of this affects me, but I thought it was really interesting.If you woke up at 7 a.m. and put in an order with your broker to buy 500 shares of Walmart at the open, and then you went off to work at your job and forgot about it, your broker probably put in a market order to buy 500 shares in the opening auction. And then there was no opening auction. So your order got sent to the central limit order book to execute as a normal trade, instead of executing in the opening auction.
There are two big problems with that. One is that, at 9:30:00, the central limit order book is empty.... The other problem is that the orders in the opening auction can be big.
I usually operate under the illusion that the stock market offers perfect liquidity and smoothly varying prices, and that I can see a "market price" continuously in real time and buy or sell whenever we like at a price very close to that price. What this exposes is that there really are humans and auctions behind it, and that the almost-perfect liquidity is the result of centuries of experience and a complicated web of regulations and practices.
I think it also underlines that a small retail investor is not participating in price discovery when the decide whether to trade individual stocks or ETFs during the day. They are not even a hangnail on the Invisible Hand. The Invisible Hand is the institutional investors trading 10,000 shares at the open. And that when the popularity of index funds takes me, and a million like me, out of making individual stock trades during the day, it does not interfere with the work of the Invisible Hand. It only interferes with the people who want to sell me stuff that isn't index funds.