Trading and exchanges larry harris pdf

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Harris - Trading and Exchanges. Report Download. Outline I 1 What does this book oer? What does this book oer? IntroductionOutline I 1 What does this book oer? Market microstructure is a branch of finance concerned with the details of how exchange occurs in markets. While the theory of market microstructure applies to the exchange of real or financial assets, more evidence is available on the microstructure of financial markets due to the availability of transactions data from them.

In most markets, traders can only use prices that are an integer multiple of a specified minimum price increment. The size of the increment, measured as a fraction of price, varies considerably across markets.

In Chapter 11 Order Anticipators , we show that the increment is an extremely important determinant of market quality in many markets. Price Clustering Traders do not use all possible prices equally. Instead, their usage clusters on round numbers. In markets with fractional prices, they use whole numbers more often than halves, halves more often than odd quarters, quarters more often than odd eighths, and eighths more often than odd sixteenths.

In markets with decimal prices, prices that are integer multiples of 1. The clustering of prices is most pronounced when the minimum price increment is a small fraction of price, the market is highly volatile, and the instrument is thinly traded. They frequently place their orders just above or just below a round number to take advantage of the fact that many other traders may place their prices at the round number. The two types of trading sessions are continuous market sessions and call market sessions.

Trading is continuous in the sense that traders may continuously attempt to arrange their trades. In practice, they usually trade only when a trader demands liquidity. Continuous trading markets are very common. Almost all major stock, bond, futures, options, and foreign exchange markets have continuous trading sessions. The market may call all securities simultaneously, or it may call the securities one at a time, in a rotation.

Markets that call in rotation may complete only one rotation per trading session, or as many rotations as their trading hours permit. Markets that call in rotation were once very common. Now only in the stock markets of a few small countries call in rotation. Many continuous order-driven exchanges open their trading sessions with call market auctions and then switch over to continuous trading.

These markets also use calls to restart their trading after a trading halt. Open-outcry futures exchanges, however, start continuous trading immediately when they open. Call markets are used as the exclusive market mechanism for many instruments. Most governments sell their bonds, notes, and bills in call market auctions. Some stock markets also use calls to trade their least active securities. In pari-mutuel betting, bettors receive a share of the total money bet on all horses—less a fixed percentage for the track and the state—if their horse wins.

Bettors can place their bets anytime until betting closes a few moments after the start of the race. The track totalizator system displays the projected winnings for each bet while the betters place their bets. Pari-mutuel betting is a call market auction in which the totalizator simultaneously prices all bets on a race.

The price of each bet is the amount bettors must bet to receive a dollar if their horse wins. The call occurs when betting closes. Since the system only allows market orders, many traders wait until the last moment to bet so that they can see what the prices will be. These markets include oral auctions, single price auctions, continuous electronic auctions, and crossing networks.

You will learn how these markets work, and how trading strategies depend on market structure. Order-driven markets are quite common. Almost all of the most important exchanges in the world are order-driven markets. Most newly organized trading systems choose electronic order- driven market structures. Despite the great variation in how order-driven markets operate, their trading rules are all quite similar. All order-driven markets use order precedence rules to match buyers to sellers and trade pricing rules to price the resulting trades.

Variations in trading rules distinguish order-driven markets from each other. The trading strategies that work best in one market may work poorly in markets with different rules. Traders therefore need to know how trading rules affect optimal trading strategies. If you trade in order-driven markets, the principles introduced in this chapter will be of immediate and obvious value to you.

These principles will also help you understand front- running and block trading strategies that we will consider in later chapters. The topics in this chapter should also interest you if you are interested in market structures. Most recent innovations in trading technologies involve order-driven market structures. To evaluate new trading technologies, you must thoroughly understand how they work. We will first discuss how oral auctions work.

In these order-driven markets, traders arrange trades by negotiating on a trading floor. Since many readers may already be acquainted with these markets, they provide us with a familiar context for introducing various trading rules.

We then will turn our attention to rule-based order-matching systems. These systems include single price auctions, continuous order book auctions, and crossing networks. This market, which the Chicago Board of Trade organizes, regularly attracts floor traders. It may be the most liquid market in the world. The smallest oral auctions may include only two traders. In an oral auction, traders arrange their trades face-to-face on an exchange trading floor.

Some traders cry out their bids and offers to attract other traders. Other traders listen for bids and offers that they are willing to accept. Most traders do both. Buyers and sellers often take turns bidding and offering until they agree on a price and quantity to trade.

Traders offer liquidity when they make bids or offers to trade. Traders take liquidity when they accept bids or offers. These rules organize trading to ensure fairness for all traders and to provide for the efficient exchange of information necessary to arrange trades.

The trading rules also help protect brokerage customers from dishonest brokers. The first rule of an oral auction is the open-outcry rule. Traders must publicly express all bids and offers so that all traders can act on them. This requirement ensures that all traders can fairly participate in the market. The first trader to accept a bid or offer generally gets to trade. The open-outcry rule also requires traders to express their acceptances publicly so that all traders are aware of the trades that they arrange.

This information helps traders evaluate market conditions. It also protects customers from dishonest brokers who might try to arrange trades privately to benefit their friends instead of their clients. In oral auctions, the primary order precedence rule is always price priority. The secondary precedence rules depend on the market. Futures markets use time precedence. US stock exchanges use public order precedence and then time precedence. Traders cannot accept bids or offers at any inferior price.

Buyers can accept only the lowest priced offers and sellers can accept only the highest priced bids. Price priority is a self-enforcing rule because honest traders naturally search for the best prices. Exchanges therefore do not have to adopt special procedures to enforce it. They keep the rule on their books so that they can prosecute dishonest brokers.

Most oral auctions do not allow traders to bid below the best bid or offer above the best offer. Since only the best bid and offer interest traders, bids and offers behind the market only create confusion and noise. Traders acquire price priority by bidding or offering prices that improve the current best bid or offer.

Any trader may improve the best bid or offer at any time. While they have time precedence, no other traders may bid or offer at the new best bid or offer. Traders retain their time precedence as long as they maintain their bid or offer, or until another trader accepts it.

Afterwards, anyone may bid or offer at the new price and all traders at that price will have equal standing. In oral auction markets, bids and offers generally are good only for a moment. Traders may repeat their quotes continuously in large, very active markets. The time precedence rule encourages traders to improve prices aggressively.

Traders who want to trade ahead of a trader who has time precedence must improve the price. Time precedence rewards aggressive traders by giving them the exclusive right to trade first at the improved price.

The time precedence rule thus encourages price competition among traders. Leapfrog The orange juice concentrate futures market is currently Traders quote prices per pound for 15, pound contracts.

Guy is the bidder at He has time precedence at that price, and he is defending it. If you want to buy at If you want precedence, you must improve the bid to You then would have price priority over his bid and time precedence over all subsequent bids at If Guy then wants to reclaim his precedence, he would have to improve the market again by bidding Good traders carefully consider their leapfrog strategies. For example, if you are willing to bid If you bid In which case, he will trade immediately and you will still have time precedence at Of course, if you are quite impatient to trade, your best strategy may be to immediately take the offer at Time precedence is only meaningful when the minimum price increment is not trivially small.

The minimum price increment, or tick, is the smallest amount by which a trader may improve prices. It is the incremental price that traders must pay to acquire precedence, through price priority, when they do not have time precedence. If it is very small, the time precedence rule gives little privilege to the traders who improve price. The effect of the tick on price competition varies by tick size. If the tick is too small, it decreases price competition by weakening the time precedence rule.

If this tick is too large, traders are reluctant to improve prices because of the expense. Since the minimum price increment significantly affects market quality, exchanges and regulators pay close attention to it. The Common Cents Stock Pricing Act of In March of , Republican Representative Mike Oxley and others introduced a bill to require that US stock markets trade on dollars and cents rather than on dollars and fractions of a dollar. The bill had wide popular support because most people find decimal pricing simpler to understand than fractional pricing.

The bill never passed. Instead, the exchanges decided to switch to decimals by themselves. The bill was somewhat remarkable because it represented an attempt by the US Congress to micromanage trading rules in the stock markets. The exchanges probably decimalized at least in part to prevent the passage of this bill. Clients usually pay brokers commissions for their services. Many brokers are also financial advisors who advise their clients about their investments or their financial plans.

They may also provide their clients with investment information. In these capacities, they often influence the trading decisions that their clients make.

Unless you arrange your own trades, you will use the services of a broker when you implement your trading strategies. You therefore must understand what brokers can do for you—and to you—to trade effectively. This chapter describes what brokers do and the problems that traders may have with lazy or dishonest brokers. You also need to know what brokers do if you want to be a broker yourself. The discussions in chapter will allow you to better understand how brokers compete with each other for business, and how the best brokers win these competitions.

You must understand what brokers do to predict when electronic order matching systems will be successful. Automated order-driven execution systems are essentially electronic brokers. Since traditional brokers and electronic order matching systems both match buyers to sellers, they compete with each other. To fully understand either system, you must understand the economics of both trading systems. Finally, you must understand what brokers do if you are interested in the distinctions that regulators make between automated order-driven execution systems and traditional brokers.

Some automated order-driven execution systems are regulated as exchanges whereas other nearly identical systems are regulated as brokers. If you are interested in these distinctions, you must ask how the order matching done by traditional brokers differs from the order matching done by automated systems.

We begin this chapter by considering how brokers serve their clients, how they organize their operations, and what determines their profits. We then discuss how the most important management problem—the principal-agent problem—affects brokers and their clients.

The chapter closes with a discussion about problems that traders can have with dishonest brokers, and how traders can prevent these problems. Brokers conduct these activities in various types of markets. In order flow markets, brokers take orders that their clients give them and match them with orders and quotes made by other traders.

Exchanges, dealers, or the brokers themselves may operate these markets. In block markets, brokers take large client orders and try to find other traders to fill them. Brokers often must search among traders who have not expressed interest in trading to discover those traders who are willing to trade. In offering markets, brokers distribute new issues and seasoned issues to traders. Brokers must often market these securities to generate buyer interest.

Finally, in merger and acquisition markets, brokers help firms buy other firms. Brokerage firms that engage in large capital transactions are called investment banks. Table summarizes the different types of brokered transactions. Types of Brokered Transactions Market type Trades Market structure Brokerage role Order flow Small to medium sizes Order-driven or Brokers receive orders and match in seasoned securities quote-driven them with orders and quotes made and contracts.

Block Large sizes in Brokered Brokers receive an order on one side seasoned securities and must search for traders who will and contracts. Brokers occasionally identify both sides. New and Large size offered by Brokered Brokers sell securities to buyers on seasoned an issuer or one or behalf of issuers and large holders.

Mergers and Company to company. Brokered Brokers find one or both parties. Most brokerage firms specialize in only one or two of these markets.

Their clients tell them what trades they want to make, and under what terms they will trade. The brokers then try to arrange the best trades that they can subject to the constraints imposed upon them.

Generally, clients expect that brokers will seek the lowest possible prices when buying and the highest possible prices when selling. Clients use brokers to arrange their trades because brokers usually can arrange trades at a much lower cost than can their clients. We examine these points in the remainder of this section. Clearing and settlement problems can arise whenever traders do not settle their trades immediately after they negotiate them.

During the time between arrangement and final settlement, traders risk that their counterparts may not acknowledge their trades, may refuse to settle their trades, or may be financially unable to settle their trades. Traders therefore are reluctant to trade with people who they do not know are trustworthy and creditworthy.

Without the assistance of brokers, traders would have to check the credit of every trader with whom they trade. Brokers assist traders by helping them avoid this expensive problem. If a client fails to acknowledge a trade, the broker must resolve the problem with the client. The broker thus protects the trader on the other side of the trade.

Brokers solve the settlement problem either by guaranteeing that their clients will settle their trades, or by staking their business reputations on whether their clients will settle their trades.

When the brokers simply vouch for their clients, they risk losing future business if they acquire a reputation for representing clients who do not settle their trades. In both cases, brokers must ensure that they only represent trustworthy and creditworthy clients. Otherwise, undesirable clients will impose significant costs upon them.

The credit function that brokers provide is especially important in order-driven markets since such markets generally arrange trades among total strangers. Multiplying Credit Checks When traders arrange trades that they intend to settle in the future, they must be confident that their counterparts can and will perform.

Traders routinely perform credit checks to determine whether their counterparts are creditworthy. In a market with no brokers, each trader must be prepared to check the credit of every other trader.

If exactly one million traders trade in such a market, the total number of potential credit relationships is ,,,, or slightly less than one quad-trillion. In such markets, traders will only check the credit of traders with whom they intend to trade. They will naturally prefer to arrange trades only with traders whose credit they have already checked. Three types of credit relationships are present in this economy: 1.

Brokers must check the credit of their clients to protect themselves. The clients must check the credit of their brokers to ensure that they can trust them. These credit checks may be perfunctory if everyone knows that a broker is creditworthy. Each broker must check the credit of every other broker with whom he or she arranges trades. Chapter 8 explains why traders trade. We introduce 32 different types of traders and identify the benefits that they each obtain from trading.

Remarkably, traders often do not clearly understand why they trade. They therefore often trade when they should not or fail to trade when they should.

Traders who understand why they trade will generally trade more effectively. In Chapter 9, we consider how well functioning markets benefit the entire economy. The primary benefits come from informative prices and from market liquidity.

We explain how well functioning markets help market-based economies use their resources most efficiently. We also consider a framework for evaluating public policy. We consider each of these objectives in this chapter and explain how markets help traders achieve them.

You must understand why people trade to use markets effectively. Markets provide many valuable opportunities. To take advantage of them, you must first recognize them. By considering why people trade, you will better understand why you trade and whether you should trade. Many traders do not fully recognize the reasons why they trade.

Consequently, either they pursue inappropriate trading strategies, or they trade when trading is counterproductive to their true interests. The optimal trading strategy for a given trading problem depends on the problem. You cannot trade well if you do not know why you want to trade. Knowing why people trade may also help you determine whether other traders understand why they are trading. This skill is very important because you can usually distinguish a good money manager from a poor one by whether they understand well why they trade.

It is also important because traders who do not fully understand why they trade often trade foolishly. If you can identify such traders, you may be able to profit from their foolishness. If you engage in any trading strategy that depends on the volume of trade, you must understand why people trade to interpret volumes properly. Many factors cause people to trade.

If your trading strategy depends on one of these factors, you will want to examine volumes carefully. However, you must be careful to recognize when other factors may cause people to trade. Otherwise, you may misinterpret volumes and trade when you should not. Markets are successful only when people trade in them. If you want to design new markets, or if your business depends on trading in a successful market, you must understand why—and how— people trade.

Trading is a zero-sum game in an important accounting sense. In a zero-sum game, the total gains of the winners are exactly equal to the total losses of the losers. Trading is a zero-sum game because the combined gains and losses of buyers and sellers always sum to zero.

If a buyer profits from a trade, the seller loses the opportunity to profit by the same amount. Likewise, if a buyer loses from a trade, the seller avoids an identical loss.

Successful traders must understand the implications of the zero-sum game. To trade profitably, traders must trade with people who will lose. Profit-motivated traders therefore must understand why losers trade to know when they should trade. Finally, you must understand why people trade to form well-reasoned opinions about market structures. Different structures favor different trader types.

If you intend to influence a decision about market structure, you should consider first how the decision affects various traders.

The benefits that traders obtain from markets depend on why they trade. Regulators and other interested parties must therefore understand these reasons. We will refer to them throughout the rest of the book. Pay close attention to the distinctions between investing, speculating, and gambling. When traders confuse these important concepts, they often trade poorly. When regulators confuse them, they often adopt policies that hurt the markets. Consider also why liquid markets benefit most traders.

When you understand why people trade, you will appreciate why all market participants care about liquidity. For expository clarity, we will associate a stylized trader with each reason for trading, and we will assume that that stylized trader trades only for that reason. In practice, traders often trade for many reasons. The complexity of their motives explains why many traders get confused and fail to fully recognize why they trade.

By considering stylized traders, we simplify our discussions and ultimately make it easier for you to identify the different reasons why people trade.

Multiple Identities Many traders simultaneously invest, speculate, and gamble. They invest when they need to move money from the present to the future. They speculate when they try to use information about future security prospects to obtain a better return on their investments.

They gamble when they focus more attention on favorable outcomes than on losing outcomes. Their multiplicity of interests often compromises their judgment. Investors often speculate without thinking about whether they would be good speculators, and speculators often gamble without considering whether their emotional needs have influenced their judgment. Our stylized traders are profit-motivated traders, utilitarian traders, or futile traders.

Profit- motivated traders trade only because they rationally expect to profit from their trades. Speculators and dealers are profit-motivated traders. Utilitarian traders trade because they expect to obtain some benefit from trading besides trading profits. Investors, borrowers, asset exchangers, hedgers, and gamblers are utilitarian traders. Futile traders believe that they are profit-motivated traders. Although they expect to trade profitably, their expectations are not rational.

They have no advantages that would allow them to be profitable traders. Utilitarian traders and futile traders lose on average to profit-motivated traders because trading is a zero- sum game.

Readers will learn about investors, brokers, dealers, arbitrageurs, retail traders, day traders, rogue traders, and gamblers; exchanges, boards of trade, dealer networks, ECNs electronic communications networks , crossing markets, Trading and exchanges book pink by: Trading and exchanges book book is about trading, the people who trade securities and contracts, the marketplaces where they trade, and the rules that govern it.

Related Book. Trading Options For Dummies, 2nd Edition. By Joe Duarte. There are six option exchanges in the United States, which is pretty amazing for a security that just started trading in the s. Two of these were launched sinceand all six offer some form of electronic execution. Exchanges course. Their interest in trading encouraged me to first offer the course in This book grew out the lectures that developed to present the course to them. The lessons that I learned from my students while teaching Trading and Exchanges greatly influenced the organization and presentation of the topics that appear in this Size: KB.

Click Download or Read Online button to get trading and exchanges book now. This site is like a library, Use search box in the widget to get ebook that you want. Accompany us to be participant here. This is not as the other. Trade Orders - Trading Trade orders refer to the different types of orders that can be placed on trading exchanges for financial assets such as stocks or futures contracts. The presence of the real-time order book allows traders to take advantage of limit and stop pricing that will.

Readers will learn about investors, brokers, dealers, arbitrageurs, retail traders, day traders, rogue traders, and gamblers; exchanges, boards of trade, dealer networks, ECNs electronic communications networks , crossing markets, and pink sheets.

What does this book o er. I A very large block stock trade. Stocks are shares in public companies and have been traded on European exchanges for hundreds of years. Speculators Order Anticipators Front runners Front runners collect information about trades that other traders have decided to arrange. They then trade before those traders complete their trades Front running strategies depend on the type of trader that they front run.

Front running Passive traders - Use quote matching strategies to extract option values from passive limit orders. Front runners make prices more or less informative based on whether they front-run informed traders or uninformed traders. Speculators Order Anticipators Sentiment Oriented Technical traders These traders try to predict the trades that uninformed traders will decide to make.

They then try to trade before the uninformed trader does. Beware of Value traders Sentiment oriented technical trading can be quite risky because it involves front running uninformed traders. The impact that uninformed traders have on prices often move prices away from their fundamental values. Such movements attract value traders to the other side of the market. If the value traders trade aggressively, they may drive prices back towards fundamental values, and sentiment oriented technical traders then will lose.

Hence these traders must be skillful in closing out their positions. To avoid value traders, these traders trade hard to value instruments. These traders make the prices less informative and market less liquid. Speculators Order Anticipators Squeezers Squeezers try to monopolize one side of a market so that anyone who must liquidate a position on the other side must negotiate with them.

If they successfully corner the market, they can demand any price. Squeezer can employ gunning the market strategy to push prices up or down to active stop orders.

The stop orders then accelerate those price changes. Front runners front-run orders that other traders have submitted. Sentiment-oriented technical traders anticipate the orders that other traders will submit. Squeezer anticipate traders that other traders must make. Traders who are aware of stop orders may manipulate them. Liquidity suppliers can lose money if they do not adjust prices up or down at the same rate per quantity traders, regardless of whether the quantity traded is large or small.

Liquidity Suppliers Dealers Introduction Dealers buy from and sell to their clients. All dealers face the same problems regardless of what they trade. They must set prices, they must market their services to acquire clients, they must manage their inventories and they must be careful that they do not trade with informed traders.

They generally do not know whom they are going to sell the stock that they have bought and whom they are going to buy the stock that they have sold. Dealers are passive traders. Liquidity Suppliers Dealers Who are dealers? The liquidity service they sell is immediacy. Dealers are known by many names, scalpers, day traders, locals or market makers.

They must speculate. Realized spreads are usually smaller than quoted spreads because dealers often trade at better prices than they quote. Dealers who quote both bid and ask quote a two-sided market. Their quotes make a market. Dealers who quote only one side quote a one-sided market. The inside spread is usually much narrower than the average spread. This is not the case for soft quotes. Liquidity Suppliers Dealers Trading with dealers Many institutional traders trade directly with dealers as they do not charge commissions.

Instead they incorporate in to the net price. Wholesales are dealers who trade primarily with traders introduced by retail brokers. The most important decisions that dealers make concern their quotations. Liquidity Suppliers Dealers Dealer Inventories The position that dealers have in the instruments they trade are their inventories. Target inventories are the positions that dealers want to hold. Dealer inventories are in balance when they are near their target levels and out of balance otherwise.

When dealers want to decrease inventories, they decrease their bid ask. When dealers want to increase inventories, the increase the bid ask levels.

They expose dealers to inventory risk. Dealers try to discover the prices which ensure buying and selling quantities are just in balance. In a sense they are trying to determine market values.

If they are inversely correlated, the risk is an adverse selection risk. Dealers face adverse selection risk when they trade with informed traders. The risk is not benign. Informed trading causes dealer inventories to diverge from their target values. Dealers can avoid adverse selection risk by shunning away from informed traders. But it is not always possible. Liquidity Suppliers Dealers Dealer response to adverse selection Raise or lower bid ask prices depending on whether the informed trader has bought or sold stocks.

Avoid informed traders by setting bid ask close to fundamental values. Rarely do they know these values and hence must infer from the orders, prices and quotes. In general dealers cannot infer whether they are trading with an informed trader or not. Dealers are often proactive. The probability that the next trader is an informed trader is built in to the bid ask quotes. They base their ask price on their estimate of fundamental values conditional on the next trader is a buyer.

They base their bid price on their estimate of fundamental values conditional on the next trader is a seller. Dealers quote wide spreads for big orders as they assume that big orders are generated by informed traders. Liquidity Suppliers Dealers Pricing mistakes of a dealer Two kinds of mistakes when adjusting their quotes.

They may fail to adjust their quotes adequately when they have traded with informed traders. Liquidity Suppliers Dealers Summary Dealers sell immediacy the ability to buy or sell quickly when you want to- to their clients. Bid ask spread is the price of liquidity they sell.

Dealers sell immediacy the ability to buy or sell quickly when you want to- to their clients. Dealers lose to informed traders, who can predict the future price movement. Dealers adopt a number of methods to avoid adverse selection risk. When setting the bid ask, they estimate based on a conditional probability model. The adverse selection component increases with order size.

Impatient traders buy at the ask price and sell at the bid price. Spreads too narrow might drive dealers out of business. Transitory price changes regularly reverse. The outcome is uninformed trader regret. Thus they regret using limit orders. Uninformed traders lose to informed traders regardless of how they trade.

Time to cancel limit orders. Limit order management costs. Value of trader time. Degree of trader risk aversion. They therefore can quote more aggressive prices. Asymmetric Information : When traders are asymmetrically informed, liquidity suppliers set their prices far from the market to recover from uninformed traders that they lose to well-informed traders.

Volatility : Volatile instruments should have wide spreads. Spreads should be widest when limit order traders and dealers cannot easily adjust their orders. The adverse selection component will be large for volatile instruments. Utilitarian trading interest The more the interest, the less the spreads. Adverse selection spread component is small when utilitarian trading is strong.

Market condition reports. Information vendors. Major commodity contracts. Established vs Emerging industries. Insider trading rules. Firm Size. Risk replication. The most important are asymmetric information, volatility and utilitarian trader interest. In a market with informed traders, the dealers usually set the spreads wider so as to protect from adverse selection. Higher volatility implies higher spreads.

Utilitarian trader interest ultimately determines market trading activity. Actively traded instruments have narrow spreads because dealers can spread their costs of doing business over more trades. Measures of market activity such as trading volumes, trading, frequency vary inversely with spreads. Adverse selection helps us understand why uninformed traders lose whether they submit limit or market orders.

Uninformed traders thus lose however they trade. Asymmetric information is extremely important in trading. When all traders are identical, limit order strategies produce better prices on average than market order strategies because traders value their time and do not like risk failing to trade.

On average limit order strategies will execute at slightly better prices than market order strategies because market order traders must compensate limit order traders for the additional management time, price risk and timing options associated with limit order strategies.

Such orders generally demand more liquidity than is normally available at exchanges or in dealer networks. Block traders include block brokers and block dealers.

Trades are arranged in the upstairs block market. Traders who initiate block traders are called block initiators. Traders who supply liquidity are called block liquidity suppliers. Exchanges designate block trades based on the size.

Liquidity Suppliers Block traders Block trading problems Latent Demand Problem Traders who are willing to trade if asked, but who have not yet issued trading orders, have latent trading demands.

Block traders must discover the latent demands of responsive traders. Traders who are willing to trade but do not initiate their traders are responsive traders. Block initiators give price concessions to block liquidity suppliers so as to encourage them to trade. Liquidity Suppliers Block traders Order Exposure problem When looking for liquidity, block traders should be careful about disclosing the order size.

Traders who know about impending blocks often use that information when trading, to the disadvantage of the block traders. Block traders shop the block when they expose their orders while searching for liquidity. Widely shopped blocks hang over the market as information about them leaks out. Block traders spoil their market when prices run away from their orders because they have foolishly exposed them.

Strategies clever traders pursue when a block is hanging over the market Front running trade on the same side before the block trades.