How is liquidity removed?

[SanMiguel]

The crash in the US markets on Thursday was caused by removal of liquidity from the system when the NYSE shut down and removed all bids from the market.
I realise this removes buyers from the system but there are still buyers at the ECN brokers.
How does this remove liquidity from the system and lead to a downfall?
When the NYSE was closed, does that mean ECN buyers were making only offers to sell?

 

[Rhody Trader]

By definition, if a big batch of potential buyers (or sellers) step away from the markets you have a decline in liquidity. In a fragmented market this can be felt much more acutely than were it the case in a singular market because you add that much more complexity in placing and filling orders and can potentially see choke points develop.

 

[SanMiguel]

By definition, if a big batch of potential buyers (or sellers) step away from the markets you have a decline in liquidity. In a fragmented market this can be felt much more acutely than were it the case in a singular market because you add that much more complexity in placing and filling orders and can potentially see choke points develop.

For example, when the NYSe slowed orders on Thursday and therefore removing bids from the system (presumbale they removed the sell offers as well?), how did that allow the price to keep crashing as trading was still occuring at ECN brokers?
Of course, all the liquidity is supposedly provided by the big firms GS, etc. in the NYSE.
Basically, there weren't enough big buyers in the market because they couldn't buy?

 

[Rhody Trader]

I don't know the details of what happened, so I can't provide any specifics. If, however, the primary market is on pause and there is still trading going on elsewhere you run the risk of the lessened volatility resulting in very quick movements just as happens in the thin markets around holidays. Keep in mind that all it takes for the market to fall is a lack of bids.

 

[SanMiguel]

I don't know the details of what happened, so I can't provide any specifics. If, however, the primary market is on pause and there is still trading going on elsewhere you run the risk of the lessened volatility resulting in very quick movements just as happens in the thin markets around holidays. Keep in mind that all it takes for the market to fall is a lack of bids.

If the market is thin, how come the movements are more rapid?
Let's assume the order size remains the same, shouldn't the market move the same distance? A thousand shares or contracts or whatever should be the same whatever?

The lack of bids, I can understand, it means there are no buyers. However, if there are no buyers then who are the sellers selling to?

 

[rathcoole_exile]

just think of it like an auction, but in this case in reverse.

The auctioneer offers a painting for $10,000 but there are no bids
so he drops his offer to 9,800; 9,600; 9,400 - still no bids
so he drops to 9 even; 8,5; 8 - still no bids, he is not selling to anyone, but the price is dropping in his desperation to find a buyer
Bids are still on the sidelines, so auctioneer gets more desperate now:
7,5; 7; 6; 5
until finally a buyer steps in and says 'yep I guess I think 5,000 is just about decent value"

 

[Rhody Trader]

The lack of bids, I can understand, it means there are no buyers. However, if there are no buyers then who are the sellers selling to?

rathcoole_exile's example is a good one. No transactions need to take place for market prices to change.

 

[SanMiguel]

rathcoole_exile's example is a good one. No transactions need to take place for market prices to change.

How so?
Someone must be liquidating positions or shorting for the price to go down?
Otherwise, it would just be bids/offers moving lower and lower with noone actually filling positions?

 

[N Rothschild]

if you sell at market, you will get filled where there is a bid. this could be a tick away, or 1,000 ticks away.

 

[Rhody Trader]

Someone must be liquidating positions or shorting for the price to go down?

No. All markets are all based on indicative prices - the bid and ask/offer. Bids and offers can move without trades be executed.

Otherwise, it would just be bids/offers moving lower and lower with noone actually filling positions?

Exactly! Market prices must, basically by definition, move to find the point at which participants are willing to execute trades. If there's no one willing to buy a current price, the market will move down until it reaches a point where they will. Likewise, if no one is willing to sell at a current price, the market will move up to the point at which the sellers come in. Usually, it's either one side or other other moving which causes directional action. Sometimes, though, neither buyers nor sellers are interested in the current price. That causes the bid/ask to widen. This is what happens when volatility is expected.

 

[SanMiguel]

No. All markets are all based on indicative prices - the bid and ask/offer. Bids and offers can move without trades be executed.



Exactly! Market prices must, basically by definition, move to find the point at which participants are willing to execute trades. If there's no one willing to buy a current price, the market will move down until it reaches a point where they will. Likewise, if no one is willing to sell at a current price, the market will move up to the point at which the sellers come in. Usually, it's either one side or other other moving which causes directional action. Sometimes, though, neither buyers nor sellers are interested in the current price. That causes the bid/ask to widen. This is what happens when volatility is expected.

I had always assumed that the price reflected what had been bought/sold.
For example, shares in a stock, the more people that hold the stock, the price moves up and therefore the bid price is always set at however many people had bought the stock.
The above is a little eye opener that I still have to get my head around even though the analogies make sense

I think the spread during the crash low was something like 10 SNP pts as opposed to the usual small 0.5pt spread or less.

Does this not mean that in an extremely illiquid stock, traders could wipe out positions intentionally. Let's take an extreme. I buy stock ABC at £1.
Tomorrow there are only 2 traders in the market, one wanting to buy at £0.01, the other wanting to sell at £5. Does that crash the stock price?

 

[gooseman]

depends how the exchange do their settlements.

 

[Rhody Trader]

I had always assumed that the price reflected what had been bought/sold.

Exchange price feeds often are traded price, but that's historical and not necessarily reflective of where transactions can get done at the present.

For example, shares in a stock, the more people that hold the stock, the price moves up and therefore the bid price is always set at however many people had bought the stock.

There is effectively a finite amount of stock in the market at any given point in time. Trading does not create or destroy ownership. It just transfers it. Prices move based on the willingness of participants to own or purchase the stock.

Does this not mean that in an extremely illiquid stock, traders could wipe out positions intentionally. Let's take an extreme. I buy stock ABC at £1.
Tomorrow there are only 2 traders in the market, one wanting to buy at £0.01, the other wanting to sell at £5. Does that crash the stock price?

It certainly crashes the value of your position if it's marked to market at the bid price. If you're trading on margin it would be problematic.

 

[SanMiguel]

Just to add a little article to the above posts that I found:

How Markets Can Fall Without Actually Trading
by John on May 11th, 2010 // Filed Under » The Basics

One of the things many market participants fail to realize is that prices do not require transactions taking place to move. In fact, they tend to move most rapidly in the absense of trades. Why? Because when transactions are taking place it means buyers and sellers have come to at least a temporary agreement on value. Prices move most aggressively when there is no agreement, when one side has to give in to the other and alter its perception of value.

The confusion about all this comes from the fact that the most commonly known exchange price feeds show only transacted prices, not the bid/offer indicative prices which actually underly everything. Forex traders don’t suffer this problem, of course, as they are used to see an indicative market. Most options traders are also well aware of this issue as thinly traded options can show last trades that are vastly different than the current price at which a trade could be done.

So here’s the deal. When all the buyers disappear from the market – meaning they pull their bids – the market falls until it finds a level at which the buyers are willing to come back in. That means market orders can get filled WAY below where they were expected to be filled. That seems to be at least part of what happened during the market plunge last week.

Here are a couple of good examples (hat tip to Wall St. Cheat Sheet)

“Of all the mysteries of the stock exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. October 24, 1929 showed that what is mysterious is not inevitable. Often there were no buyers, and only after wide vertical declines could anyone be induced to bid … Repeatedly and in many issues there was a plethora of selling orders and no buyers at all. The stock of White Sewing Machine Company, which had reached a high of 48 in the months preceding, had closed at 11 on the night before. During the day someone had the happy idea of entering a bid for a block of stock at a dollar a share. In the absence of any other bid he got it.”
John Kenneth Galbraith, 1955, The Great Crash

“I started accumulating stocks in December of ‘74 and January of ‘75. One stock that I wanted to buy was General Cinema, which was selling at a low of 10. On a whim I told my broker to put in an order for 500 GCN at 5. My broker said, ‘Look, Dick, the price is 10, you’re putting in a crazy bid.’ I said ‘Try it.’ Evidently, some frightened investor put in an order to ’sell GCN at the market’ and my bid was the only bid. I got the stock at 5.”
Richard Russell, 1999, Dow Theory Letters

This leaves one with the very legitimate question as to whether it is a good idea to use market orders or standard stops, which become market orders when their trigger price is met or passed.