Published June 19, 2009

Level the field by disclosing house trading volumes

By R SIVANITHY

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IT'S a fair bet that the liquidity-driven rally of the past three months would have attracted all sorts of players back into the stock market. Regulators, meanwhile, would probably have had their hands full sifting through the thousands of daily transactions to detect unusual patterns via their surveillance system, which - if anecdotal evidence is reliable - is reputedly among the most sophisticated available.

The goal, of course, is to avoid 'a false market' as far as possible, to facilitate a 'fair and orderly' market offering all investors a level playing field. It all sounds well and good, except: what exactly is a 'false market'? A useful working definition is: a false market exists when a mistaken impression is created in the public's mind that a certain stock is in active demand or is a superior investment.

This leads to another interesting question: what about house trading or trading by in-house dealers who pay little or zero commission?

Yesterday, for example, almost 60 million Digiland shares were traded, of which 59 million were transacted at 0.5 cent and only one million at one cent. Also yesterday, some 26 million shares of China Hongxing Sports changed hands - but the share price barely budged, trading between 15 and 16 cents.

There's more, but you get the picture. Every day for the past few months, many penny stocks have recorded large daily volume with little or no price movement. Digiland, for example, has hardly budged from 0.5 cent for almost one year. Does this sort of high-volume-no-price-movement trading mean a false market exists for Digiland or, for that matter, any other stock that exhibits the same characteristics?

Most industry insiders would say 'no', mainly because this pattern is not new and can be found in dozens of stocks (mainly penny) every day. It is most likely the work of day traders, including proprietary or house traders looking to make a quick profit if the price traverses the narrow bid-ask spread - traders who, it is correctly argued, provide the market much needed liquidity and sometimes welcome volatility keeping interest in the market alive. As a result, it is said they perform a valuable service for the market and their actions should not be construed as helping to create a false market.

It's likely the authorities share this view and their surveillance systems would have backed this up whenever house traders get more active. This would explain why sudden surges in low- priced stocks volume with no accompanying price movements quite rightly do not usually lead to queries from the Singapore Exchange (SGX).

But it is also correct to say that, in such cases, the volume is not 'real', since it is from players who pay minimal or zero commission (and thus hold a fee-based advantage over their retail counterparts), have no interest in holding the stock beyond a few seconds or minutes, and are not trading on its fundamentals. You could thus argue that, technically, such volume does convey a mistaken impression of demand.

How to find a useful middle ground? Through disclosure. SGX's surveillance system is able to capture the proportion of daily volume in an individual stock that comes from house or proprietary trading accounts, and it would be fairly easy to disclose this on SGX's website after each session ends.

It wouldn't have to be for all stocks - say, for the top 20 most actively traded, followed by an aggregate fraction for the whole day's business. With this information, investors can then gauge whether activity is 'real' and decide whether to participate, while analysts who cover those stocks can fine-tune their revenue and profit forecasts.

Such disclosure would also be consistent with the current disclosure- based, caveat emptor regime which the authorities are striving for. It's time to look seriously into this as it would help level the playing field for small investors.