Liquidity At The London Stock Exchange

As we have seen on other pages, there are different trading procedures at the London Stock Exchange. Liquidity is the main reason for these procedures.

In practice, although listed, many companies shares are not actively traded. This lack of activity can lead to higher costs (via the 'spread') or at times no market at all.

Liquidity is the ease at which individual shares can be traded and this has a very large influence on current prices. The liquidity will usually depend on

(i) the number of shares issued

(ii) the number of investors actively buying and selling and

(iii) the number of market makers who are prepared to quote a price.

As activity levels fall, prices become more volatile and therefore risk levels rise. As a general rule, the larger the company is, the more liquid it's shares will be.

Therefore, most FTSE 100 companies will be quoted and dealt in by virtually every broker. The amount that can be earned per trade is not necessarily high - this is where the competition is - but volumes can be very big.

Just in case it needs to be said, the biggest companies on the LSE are traded in massive quanitites. Literally millions of shares change hands in many of these companies every day. In terms of a monetary amount, that means that billions of pounds worth of stock market assets are traded daily. In those companies, liquidity is rarely a problem...

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In contrast, there are many FTSE Fledgling companies (those with the smallest of market capitalisations) that have only one or perhaps two market makers dealing in their shares. The spreads are large, which means more profit for the brokers and market makers, but they might only execute a few trades each week, so income is much lower.

Too Many Sellers Lowers The Price

As mentioned above, when there are few or no willing buyers it might be impossible to complete a trade. In these circumstances expect prices to be soft (lower) than might be quoted in the daily newspaper or online.

The price being quoted will be the last completed transaction, and if there are no other buyers and a person plans to sell into that 'market' the actual price of the next transaction might be several percent lower. In very small capitalised companies, a move of perhaps as much as ten percent of the price might be needed to complete a transaction!

Too Many Buyers Bring Profits!

In the opposite direction, I can recall back in the late 1990s watching BSkyB shares soar because of liquidity issues. The shares were rising more strongly than the market during a very strong market!

The reason as I later discovered was that only about 4% of the share capital was not held by big funds, institutions or majority shareholders. It meant that the rising price attracted interest and more and more investors chased fewer and fewer shares. The result? They rocketed!! When you next analyse a company, it's certainly something to look out for.

At the London Stock Exchange, in the quote driven market, shares are quoted in terms of price and also in terms of the number of shares dealt at that price. This is known as the NMS or Normal Market Size. Should the number of shares be greater than this number in a transaction, the price will often change - sometimes by a considerable margin.

Here is's definition of liquidity.

The most accurate place for the casual investor to receive his or her London Stock Exchange prices is in a daily paper. The most highly regarded of these is obviously the London Financial Times. Companies apply for and have to pay to be listed in the FT 'London Share Service'.

Unless indicated, the price of shares is shown in pence. The prices are taken at the mid-market at the close of the previous days business. Mid-market is the price point half way between the buying and selling price of the share.

+ or - is used to show the movement of the share price compared to the previous day.

High and Low figures are used to show the highest and lowest price over the preceeding 52 weeks.

Yield. This is shown net of the tax credit. Yields are based on mid-market prices and allow for the value of declared distribution and rights.

Volume '000s. This is designed to to show the number of shares (in thousands) traded during the previous day. More liquid shares usually have a much higher turnover.

For the more sophisticated investor, the internet hosts myriad websites that show up the minute quotations of all listed companies.

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Those with a desire to really follow the market can choose what is known as "Level 2" information, which must normally be paid for monthly by the investor. This enables an investor or trader to watch individual transactions as they happen and see the amounts of orders waiting to be made.

Running to the front

However, at this level of sophistication the modern day stock market is a Machiavellian world of bluff, counter bluff, advantage, high powered computers and algorithms. This report explains that the average share trade lasted just 22 seconds in January 2012.

With computers searching out minor advantages and executing trades faster than we humans can say "Done" over the telephone, getting the best prices is now much more difficult than it once was.

When we consider the size of modern markets and their daily turnover, it is possible to see just how much money some of these - mostly hedge - funds are making.

Take a look at the turnover of a company like BP, Lloyds Banking Group or Vodafone to see truly enormous numbers. Then multiply that number by the share price to see just how valuable stock exchange trade really is, and imagine what must be for those with secretive black box trading algorithms!

To get the greatest level of advantage, these "high frequency trading" funds are using very powerful computers and co-location - the hosting of these computers in the same building as the stock exchange computers to lessen the time it takes for information to reach them, enabling trades to happen even faster automatically.

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