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Number Cruncher

Locked and crossed: Why stock prices confuse Add to ...

What are we looking for?

This week, we're taking a look at what makes the market tick.

If you've traded a stock before, you will be familiar with the bid/ask spread. Basically, it shows you how much buyers are willing to pay (the bid) and how much sellers are willing to accept (the ask). The asking price is generally higher than the bid and the highly evolved business of matching up that imbalance makes for an efficient market.

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But sometimes it doesn't work out that way.

More about today's screen

Alison Crosthwait, head of research at ITG Canada, has been digging through the data on stock pricing for the S&P/TSX composite index in the first quarter. One of the things she's been looking at is what happens when the bid/ask spread breaks down.

There are actually two different things she's been keeping tabs on: how often the bid and ask are identical (what's called a locked market); and how often the bid is actually higher than the ask (a crossed market).

Locked markets usually happen when there are a lot of electronic participants (i.e. high-frequency traders). Locked markets can be good for a retail investor since there is no spread to pay, but sometimes the volume of shares trading hands will be more a sign of how much the arbitragers can wring out of a locked market than a reflection of demand for the company's stock.

Crossed markets, meanwhile, are never a good thing - as Ms. Crosthwait put it in an e-mail, "no one wants to pay more than the current offer."

A crossed market almost always happens because of a technological lag. With Canadian shares moving on various alternate trading venues and price feeds lagging ever so slightly behind one another, sometimes a buyer doesn't know there's a cheaper price out there.

What did we find?

You see a lot more locked markets than crossed markets.

The market for Gabriel Resources was locked 18 per cent of the time in the first quarter and all the names in the top 10 were locked more than 15 per cent of the time. There was a rule change in February to eliminate intentionally locked markets that should reduce how often this occurs, but it will continue to happen by accident and it will continue to particularly affect volume data.

Looking at the most frequently crossed markets, one of the things that stands out is how frequently Quadra Mining shares were crossed. One possible explanation for this would be that it's a name traded more often by a broker with less of a focus on trading technology. Inter Pipeline Fund's presence on both lists likely reflects similar technological disadvantages somewhere in the chain - a slow data feed or a lack of sophisticated smart order routers to search out the best possible price for a client are likely to blame.

If you want to find out what all this might be costing you, try asking your broker if you are getting the best price available.

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