Trader Talk

One key thing to understand from Tuesday's reversal

Traders work on the floor of the New York Stock Exchange (NYSE).
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There's a new bogeyman in town: market on close orders (MOCs) which most traders blamed for the big decline in the last hour of trading yesterday. But what are they? Who is buying and selling at the close? Let's take a look.

What is a MOC? A market on close (MOC) order is a market order executed at the close. That means the order gets executed at the final price, regardless of what the price is.

Who places MOCs? All professional traders can put in MOCs: institutions, mutual funds, hedge funds, ETFs.

Why put in orders to buy and sell exactly at the close? Some may simply want the last trade because they want the price of the stock before the next morning's open.

Many accounts will judge their performance (for the day, week or year) against the close.

Mutual funds, for example, typically only price their assets once a day, at the close. If you put in an order in the middle of the day to buy or sell a mutual fund, the price of that fund will depend on the closing prices of the underlying stocks.

Likewise, if you put in an order to buy or sell a mutual fund after the market closes, the price of that fund will depend on the closing prices on the following day. You do not get the opening prices, since almost all mutual funds only price once a day, at the close.

How do they know how much there is to buy and sell at the close? Brokerage houses send in orders to buy and sell individual stocks at the close throughout the afternoon. At 2 PM, the NYSE aggregates the data and publishes an imbalance feed for individual stocks that have buy or sell imbalances in excess of 50,000 shares. Floor brokers can see these indications, but they are not public.

These indications are updated continuously. On a typical day, there might be buy or sell indications on a few hundred stocks, though typically there are only a few dozen that are really large and might affect the closing price.

At 3:45 the NYSE publishes the MOCs to the public. NASDAQ publishes at 3:50.

The NYSE does not publish an aggregate of all the buy or sell orders. However, some floor brokers will aggregate all the orders and float informal buy or sell imbalances for the whole market.

CNBC will often mention these informal indications going into the close. You might hear, for example, "There's $400 million to sell at the close."

You get this by adding up the dollar value of all the buy orders, the dollar value of all the sell orders, and then subtract. For example, if there is $1 billion to sell, $600 million to buy, you have a $400 million sell imbalance.

Why publish MOCs? The purpose of publishing the imbalance in individual stocks is to attract liquidity. For example, if there is a buy imbalance of, say, $50 million on Pfizer, that is a signal for sellers to come in and offer stock, and vice-versa.

How are MOCs executed? At the NYSE, the designated market maker (DMM) sets a closing price for the stocks that he or she is responsible for at or just after the close.

What are average aggregate MOCs? At 3:45 PM, it is fairly typical to see a buy or sell imbalance of $300 to $600 million. $1 billion is on the high side of typical.

What happened yesterday? At 2 PM, there was roughly $1.5 billion in aggregate for sale (numbers vary depending on who is doing the estimate), a large number. But it got worse from there, and by the close there was roughly $3 billion for sale, a very large number.

The NYSE does not break out the numbers by who is buying and selling. However, the MOC is traditionally weighted with institutional orders, most of which represent mutual fund flows from retail investors.

Do MOC orders tell us anything about the close? There have been many attempts at this. With the advent of big data, there has recently been attempts to aggregate the orders and see if any trading patterns could be ascertained.

However, there are certain days when orders are so imbalanced that it's clear the final closing prices would be higher or lower.

Yesterday was one such day. It wasn't just that the aggregate orders worsened going into the close, it was the size of the sell imbalance was so great there was no chance that "buy" orders coming in at the close would be sufficient to move any of the indices to the upside.

When traders realized this, they sold ahead of the close.