Although the transformation of the London Stock Exchange into the computer age has made trading simpler, faster and cheaper, it has meant that different trading platforms are required according to how heavily traded shares in a particular company are.
Market makers
Initially after Big Bang, all shares had market makers. These were stockbrokers willing to guarantee to buy or sell shares in particular companies – they were never expected to cover all companies on the stock exchange as that would have tied up too much capital.
They posted their buy and sell prices on the stock exchange’s electronic system and kept some shares of each company on their books to fulfil any buy orders they received. Prices would rise and fall according to demand from buyers and sellers as market makers attempted to balance their books, buying and selling roughly equal numbers of shares in each company each day.
Market makers, like jobbers, have been largely overtaken by history as the LSE improved its trading system, although they still create a market in the most illiquid stocks, ensuring that there is always a buyer and a seller available.
Different forms of trading
Because companies of all sorts and sizes seek to have their shares quoted on the stock market, the London Stock Exchange has created different trading platforms (different ways in which buy and sell orders are matched up).
These are based on how liquid the shares are. Liquidity, as mentioned earlier in the book, refers to how active trading in a particular share is. The most liquid shares, such as those in huge firms such as HSBC, BP or Vodafone, see a trade go through every few seconds throughout the day. Illiquid shares may see a whole day go by without a single deal being struck.
Shares in smaller companies may be illiquid – in other words, there are fewer buyers and sellers around, perhaps because there are fewer shares in issue, or the company is little known and does not attract the interest of investors, or because large blocks of shares are in the hands of a few major investors who rarely sell.
While AIM stocks tend on the whole to be smaller and less liquid than those on the main board, we are seeing increasingly that companies at the top end of AIM are larger and their shares are more liquid than fledgling stocks with a full listing.
A full list of the various trading systems can be found on the London Stock Exchange website (www.londonstockexchange.com) under Products and Services > Trading Services. You can also see a full list of the stocks traded on the various trading platforms.
SETS
SETS, as briefly covered earlier, is the LSE’s flagship electronic order book: the Stock Exchange Electronic Trading System. Companies have been added to it a few at a time, starting with the largest and most liquid, so that it now accounts for all companies with a full listing except the very smallest.
The larger, more liquid stocks with an AIM quotation are also now traded on SETS.
All shares included in the FTSE 100, FTSE 250, FTSE 350, FTSE Small Cap and AIM UK 50 indices are traded on SETS. Indices are explained in the next chapter.
If you want to buy, your broker will post your bid price and the number of shares you are looking for onto the trading system from its office computer. If you want to sell, your offer price and number of shares for sale are similarly posted.
When a buyer and a seller post the same price, the two are automatically matched up. If, say, the buyer wants 2,000 shares and the seller is offering 3,000 shares, the deal is struck for 2,000 shares (the lower figure) and a sale offer for 1,000 shares remains on the computer system.
Anyone with access to the trading system is able to see not only the best buying and selling prices available but also how many buy or sell orders have been posted and at what prices.
A clear picture can thus be gained of whether one side outnumbers the other, and the sort of levels at which buyers would start to bail out if the share price rises, or where supporters would pile in if the price falls.
A number of stockbrokers and investment websites allow private investors access to this information but you will have to pay for the service. It is known as Level 2 and a list of providers is given on the London Stock Exchange website at www.londonstockexchange.com/level2.
The spread
Note that there will always be a gap between the highest buying price on offer and the lowest selling price. This is known as the spread.
The moment a seller matches the highest buying price, or a buyer agrees to pay the lowest selling price, a deal is done instantaneously. The second-best price immediately replaces the order that was fulfilled as being the best on offer and the gap is re-established.
Highly liquid stocks will tend to have a spread of 0.5p or even 0.25p. There will always be new buyers and new sellers piling in to close the gap between the best prices on offer. The less liquid the stock is, the wider the spread is likely to be.
When you read a share price in a newspaper you will see the ‘middle price’, which is half way between the lowest selling and highest buying prices on offer.
SETSqx
SETSqx (Stock Exchange Electronic Trading Service – quotes and crosses) is an electronic trading service for securities that are less liquid than those traded on SETS. In October 2007 it replaced various other trading platforms that had been established after Big Bang to create markets in less liquid shares.
This system is slightly more complicated than SETS as it involves market makers and there are five auctions each day at 8am, 9am, 11am, 2pm and 4:35pm, at which market makers can square up their books. There is no need to understand fully the intricacies of SETSqx as you can place orders with your broker in exactly the same way as for SETS stocks.
However, you should be aware that the spread between the buying and selling price is likely to be wider for SETSqx stocks.
SEAQ
SEAQ is the land where market makers still roam free, the non-electronic alternative to SETS and SETSqx.
Only illiquid AIM stocks are traded on the Stock Exchange Alternative Quotation (SEAQ) system. They cannot be traded on SETS because there would be times when no buy or sell offers were posted and trading would grind to a halt.
Instead, at least two market makers guarantee to post buy and sell prices throughout stock exchange trading hours. Spreads on SEAQ stocks will be wider than for SETSqx, with 2p or more the norm. It means that if you buy any of these stocks the share prices have to rise further to put you into profit.
International Order Book
Since the turn of the millennium, the London Stock Exchange has been developing an electronic trading platform for companies quoted on overseas stock exchanges. This has, sensibly, been expanded gradually and it covers about 50 countries, including Central and Eastern Europe, Asia and the Middle East.
The market operates in the same way as SETS and is highly liquid.
It is sensible for UK beginners to learn to trade and invest in UK stocks first, but it is worth bearing in mind that it is possible to invest in foreign companies. Such investments, carried out sensibly in stocks traded on well-regulated foreign exchanges, can spread risk over a wider geographic area or provide the opportunity to invest in sectors that are under-represented on the London stock market.
Share certificates and CREST
Shareholders have traditionally held pieces of paper called share certificates that record the name of the company whose shares were bought and the number of shares held. Under this arrangement you hand your share certificate back to the broker so that it can be cancelled and a new certificate is issued to the person buying the shares from you.
But this is a cumbersome system. It can take several days for the paperwork to be done and the certificate to be delivered to the new shareholder. Certificates may get lost and without them you cannot prove you own the shares. Replacement certificates can be issued but you have to pay the cost of producing them. In short, the system is awkward, time-consuming and expensive.
To improve matters, the London Stock Exchange set up an electronic settlement service, called CREST, so that share sales and purchases can be recorded more easily and more quickly. Investors who fear the electronic world of the 21st century can be assured that this system does work. It was heavily tested over many months before it was launched and share registers were added one or two at a time, starting with the largest companies, so the system was never overloaded.
Shares held in the CREST system are referred to as being in dematerialised or electronic form. That just means they are not printed on paper.
One drawback of CREST is that shares are normally held by your stockbroker in a nominee account – that is, an account in the broker’s name. The broker has already paid for the right to make transactions through CREST and can easily set up a nominee account for all your transactions, which are kept separate from the broker’s other clients.
Unfortunately that means you lose your rights as a shareholder, as the shares will be recorded on the share register in the broker’s name, not yours.
You can ask the broker to register shares cleared through CREST in your own name in order to retain your rights to have accounts posted to your home address and to vote at shareholder meetings, but you will have to pay a fee for the privilege. Charges vary, so ask your broker how much it will cost.
This option may not be available if you trade through an online broker, where keeping costs to a minimum is paramount. Check with the broker if this is the case.
Whichever system you use for buying and selling shares, any deal you make takes place immediately, irrespective of how long the deal takes to be processed.