When you hear that your favorite stock closed at a record high price, have you ever considered how that price was reached? The calculation effort is far more complex than you might expect. To understand the process, known as "the closing cross", it helps to know a little about the National Association of Securities Dealers Automated Quotations (Nasdaq).
Nasdaq is an automated securities auction where buyers and sellers are matched and securities trades are executed through an intermediary known as a dealer. During most of the trading day, buyers place bids on securities they would like to purchase, and sellers post the asking price for securities they would like to sell. Because both buyers and sellers can see the bid and ask prices in real time, they can adjust their offers accordingly. When a match occurs, a trade is executed. This transparency results in an efficient, effective auction.
Nasdaq Official Closing Price
As the trading day comes to a close, Nasdaq prepares to calculate the Nasdaq Official Closing Price for each security. The objective of this effort is to come up with a price that results in matching the maximum possible number of buyers and sellers. Three notable types of trade requests that take place only as the market closes are used to help reach this goal. Two of these requests, known as Market on Close (MOC) and Limit on Close (LOC) orders, are placed by investors seeking to trade at specific prices. With MOC orders, these investors are seeking the day's closing price. In the case of LOC orders, investors are seeking a specific closing price. This predetermined price is referred to as a "limit". LOC trade requests are executed only if a match can be made at the specific limit price, while MOC trade requests are executed at the closing price for the specified shares once that price has been established.
The third trade type is known as an Imbalance-Only Order (IO). IO trades are placed by the various firms that are members of the National Association of Securities Dealers specifically to facilitate trading. These member firms work together to create a liquid marketplace where securities can be bought and sold through efficient matching of orders. With this in mind, these firms actively place IO trades to maintain a functional market. These trades are designed to make sure there is an active buyer to match against sellers or an active seller to match against buyers when there is an imbalance between orders to buy and orders to sell.
MOC and LOC orders can be placed, changed or canceled until 3:50pm. This gives investors an opportunity to place orders, gauge which direction prices are moving and then adjust their orders to achieve a match. At 3:50pm, Nasdaq begins to release a data stream with details about the current state of prices including the highest potential purchase price, the lowest potential sales price, the volume of potential trades and other details on the status of current orders. This information is known as the Net Order Imbalance Indicator (NOII). As investors review the information provided by the NOII, they place additional trades. The new trades help to shape the closing price calculation.
Trades made during the normal course of the business day are also included in determining the closing cross. This includes a variety of order types such as good for the day, good 'til canceled and market orders.
At 4pm, all closing trades are executed. This includes MOC, LOC and IO trades as well as any regular session trades that match the closing price. After the closing cross price is set and trades are executed, any remaining close orders that have not been matched are canceled.
The Numbers
To calculate the closing price, matches are made using a 10% threshold. For example, if a seller wants to be paid $110 per share for a given stock and a buyer wants to pay $90, the offer's midpoint would be $100. The midpoint number is then multiplied by 10%. The resulting $10 is then added to the seller's price, bringing it to $120 and subtracted from the buyer's price, bringing it to $80. This information lets buyers and sellers know that closing price for the security in question would currently fall in the range between $80 and $120. The gap between the two is narrowed as additional trade requests are placed.
As the market close approaches, the price and the volume of trades are factored into the closing price calculation. For example, an order to sell 5,000 shares at $100, an order to sell 4,000 shares at $100.10 and an order to sell 100 shares at $101 would result in a closing price closer to $100 than $101. In similar fashion, an order to buy 10,000 shares at $90, an order to buy 2,000 shares at $90.01 and an order to buy 200 shares at $89.90 would result in a closing price closer to $90 than to 89.90. Of course, the actual calculations are far more complicated than these simple examples, because the volume of buy and sell orders is enormous and all orders must be taken into account together.
Imbalance orders also come into play. For example, if there is an offer to sell 1,000 shares at $10 per share and an MOC order to buy 1,000 shares, the trades could be matched and executed. On the other hand, an MOC order to buy 2,000 shares would not create a match and would therefore not be completed. Then again, this is a simple example designed to help explain the concept. Actual trading is a significantly more complex and nuanced endeavor, and an IO order could be executed to complete the match and make the trade. The last actual trading price of a given security must also be taken into account, as it is crucial to set a closing price that reflects the actual reality of the marketplace. To keep track of all the numbers and trade requests and determine the closing price, Nasdaq employs a detailed set of rules and complex algorithms in calculating the closing cross.
The Bottom Line
The closing cross in an important mechanism for investors. Not only does it set the day's final price for individual stocks, but those prices are then used to calculate the closing prices for mutual funds. Benchmark index values are based on these prices as well, enabling investors to evaluate the performance of their portfolios. Investors also use these numbers to calculate their net worth, which can then drive future investment decisions and strategies, decisions about major purchases and (for some lucky investors) the decision to retire.
A look at the volume of shares traded at the closing cross helps to provide some perspective on the importance of the calculation. For example, a record in volume traded was set on April 29, 2011 when 329.21 million shares were bought and sold in 779 milliseconds. That's $12.7 billion moved in less time than it took you to read this sentence.
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