What is an upstairs market?
An upstairs market refers to the network that exists between massive firms and institutional investors. It involves enormous trades or block orders. They cannot be submitted using the typical stock exchanges. So, other market participants are not able to see them. In a sense, there’s exclusivity with this kind of transaction as they are not available to the public. Instead, these transactions happen directly between the buyers and sellers. Also, there will always be brokers who will act as an intermediary for the two parties. These orders are nothing ordinary. Upstairs market accounts make massive trades and take up a significant portion of the market’s trading volume.
Upstairs trades and markets
In upstairs markets, networks of trading desks work to make a considerable volume of trade we call an upstairs trade possible. And since these orders are massive, we already know that these are spearheaded by institutional investors like banks, mutual funds, pension funds, brokerage companies, insurance companies, and the like.
These trades do not happen on the trading floor. Instead, they happen online or are settled over a phone call. Hence, even though these trades involve a considerable amount, they do not disrupt the market and do not cause significant price swings to securities’ prices.
Professional intermediaries like brokers can make these kinds of trade possible away from the public’s eyes. It will prevent situations like front running. Some brokers who have inside information might also be tempted to take advantage of the situation. Hence, the stock price will be affected. Front running will negatively affect the price or trade execution.
Dark pools and upstairs trading
There are high-profile investors and institutional investors who want to trade anonymously. So, they will look for a platform to do that, and a dark pool is one of those. These are also financial exchanges, networks, forums, and the like where investors can also trade. The parties involved are the ones that will privately organize the transaction. Dark pools make it possible to trade huge amounts without the public knowing it. While dark pool might sound illegal for some, it is entirely legal.
Yes, upstairs trading and dark pools are legal, but regulators are always on the lookout. In fact, the upstairs market cover at least 15% of the entire trading activity in the US as of 2014. It’s all the more reason regulators should always stay alert as this type of trade continues to grow.
Why would people engage in an upstairs market?
Hedge funds who want to unload positions in security will submit a massive sell order to the stock exchange. Other market participants might think that this move by the hedge fund is a bearish signal for that security. Many participants tend to follow what the hotshots do, so this may result in bidding down on the security’s price. Hence, this will be a damaging blow for the hedge fund because the price will be less favorable.
On the other hand, the upstairs market is beneficial for institutional investors, as we mentioned earlier. This will reduce their transaction fee. Placing a block order in a single or few institutional counterparties means that they can pay cheaper commissions or other fees. This is a better option than trading many smaller counterparts. However, there are times when program trades require several and simultaneous transaction executions through professional intermediaries in the upstairs market. It may be the only way to carry out the strategy.