Market Microstructure: TSX versus NYSE

April 5, 2015

By: Christian Kjølhede

Looking at the development on equities listed on the two different stock exchanges through from you Thompson Reuters Eikon trading screen, they both seem to act in the exact same way. However, being a broker even the slightest differences in the market microstructure have huge implications if not taken into account. Thus, here is an interesting short introduction to the different between the online auction markets (like the Toronto Stock Exchange) and the New York Stock Exchange.

Both markets have trading online and the equal precedence rules for trading, but there is one big difference, which has an implication on, how the order book on a certain security will look, and how an equilibrium price is found at the beginning and the end of the trading day. This difference is due to the specialists on the NYSE as it is the only major exchange in the world still having a physical trading floor. For each trading booth there is a Specialist responsible for managing the market making for a group of equities and ensure liquidity and adding the physical limit orders to the order book of that security along with the electronic added orders. Besides being an intermediate between different traders, the specialist can also deal for his own account. These two businesses might give concerns about agency problems. Thus, the specialists are heavily regulated. By being able to trade for her own account, the specialist can add liquidity to the market to ensure a more smooth book of limit orders due to both the width (bid-ask spread) and the depth (amount/size of orders in the order book).
The biggest difference in possible price between the online only exchanges and the NYSE is the way that the opening and closing price is determined. The opening price for online markets is an equilibrium price reached by a call auction, where traders submit orders before the market opens. These orders are not continuously executed, as in the open market, but filled in the call market order book. Then an algorithm will determine the optimal equilibrium price based on these orders after the following criteria (go to the next step, whenever more prices both fulfill the criteria included above):
The equilibrium price that maximizes the trading volume.

The equilibrium price that minimizes the imbalance between accumulated supply and demand of orders.

The equilibrium price that maximizes the market total supply and demand at that price.
If more prices fulfill all above criteria the equilibrium price is a simple average of those price.

Then all orders, which are not filled at the equilibrium price is included in the order book, when the market opens. This procedure is the same when the market closes.
The difference from the electronic markets is that the specialist can participate in this opening auction for either own account or for the brokers, for whom he execute orders. The specialist is the only who can see the order book, which is very valuable information giving inside knowledge that he is not allowed to trade on. The opening price is set manually by the specialist. The specialist should not allow the opening price to differ a lot from the trades done shortly after the exchange opens. For this reason, the specialist has to try to open the market at what he think is the right equilibrium price. By adding his own orders, the specialist can minimize access demand or supply in the market at the equilibrium price he chooses. At the NYSE, there is no closing auction.

These differences in the style of operations between the NYSE and electronic exchanges as TSX or NASDAQ seems like something, that you do often not pay attention to, but which will have important implication if trading on market microstructure like a broker or as an arbitrageur trying to profit from price differences on securities listed on more exchanges. For this reason these insights about, how the different exchanges function, are very valuable.


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