What’s your regular trading day like? “Visit your demat at 9:15 am and then..”, oh wait; you said ‘9:15’? What if we said you can actually place orders before that?
You didn’t know that, right? And even if you did, perhaps you thought that space is only for high net worth investors and not for retail folks like us. So, there’s, obviously, more than what’s apparent. Oh, and by the way, have you ever wondered.. if a share closed at a particular price yesterday, how did it open at a different price today? And how this price was discovered in the first place if there weren’t any trades before the markets opened?
Uh, oh, so many questions. But, don’t worry, we’ve got you covered.
What is the Pre-open Market?
The time period between 9:00 am, and 9:15 am on any trading day is called Pre-open Market. So, the pre-open market commences at 9 am, whereas the normal trading day begins 15 minutes after that.
And why is there a 15 minutes’ gap, you ask?
You see, there are a number of economic and corporate events that take place after the market closes. Most of the announcements are done post-market closure to prevent volatility during market hours. For example, the company’s quarterly results or a Merger & Acquisition proposal or stock delisting or debt restructuring, etc. There could also be some changes in a company’s credit ratings, some RBI meetings, changes in the government policy or any such changes in the economic indicators. There is also this system of After Market Orders (AMO) where you can place orders post-market closure. And all these events could, directly or indirectly, affect the opening price of the share(s), the next day.
Now imagine what would happen if such an event significantly impacts a stock’s price. If it’s an unfavourable event, sellers will rush to get rid of their shares and thus, prices will witness a steep fall. And once prices fall, buyers will aggressively pile up the stock in their portfolio, which will push its prices higher. And this way, prices will fluctuate as if on a roller coaster ride. And when the market is in such a swing, investors will end up committing stupid mistakes and ultimately losing their valuable wealth.
To eliminate this volatility in stock prices, there is a time frame before the opening of the market to allow the share prices a little wiggle room so that by the time the market opens, the volatility effect of prices is stabilized. And that’s what we name ‘Pre-market Orders’. And this is actually the time when the opening price of each stock for that trading day is determined. How is it done, you ask? Well, hold on, we’ll explain it a bit later.
Timeline of the Pre-open Market
- 9:00 am to 9:08 am: Well, this is the time when you can actually place orders. And to make it clear, even we, the retail investors, can place orders. This period is for the collection of orders only. Meaning you can place and cancel orders. But there won’t be a settlement of any orders.
- 9:08 am to 9:12 am: So, this is the time for matching of orders. You can’t apply for new orders or cancel the existing orders during this time. Only the already-placed buy and sell orders are matched using an algorithm to reach at an equilibrium opening price. (oh yeah, we’ll tell you how it’s done, just a little more wait, we swear.)
- 9:12 am to 9:15 am: So, this is basically a cushion period. Like, normally, there’s no activity in these three minutes. However, in case any technical abnormalities peep in, this is the time when you address them.
And finally, at 9:15 am, the actual trading day begins. So, there you are.
How is the opening price of a share determined?
Well, it’s a tad bit complicated. Anyway, we’ll try our best to simplify the algorithm for you. To ensure that you connect the dots properly, some technicalities have been ignored. So, let’s begin.
Let there be a company in the telecom industry, Z ltd. At 3:30 pm yesterday, when the markets closed, suppose it was trading at Rs.4 per share, meaning yesterday’s closing price was Rs.4. However, there were a number of events post-market closure. The company declared its quarterly results and exhibited good numbers. On the flip side, the government announced additional regulations to regulate the telecom industry. There would obviously be mixed reactions, and you can’t be very sure which will outweigh the other.
Well, the price at which the shares show up in the exchange at 9:15 am is the equilibrium opening price. This price is determined during the order matching that takes place between 9:08 am, and 9:12 am. And how is it determined, you ask? Okay, first of all, refer to the table below and then, we’ll explain.
So, the above orders were placed in between 9 am, and 9:08 am today. A, B, C, D and E placed some buy orders for the shares of Z ltd. at Rs. -- 1, 2, 3, 4 and 5, respectively. Whereas F, G, H, I and J placed some sell orders for the shares of Z ltd. at Rs. -- 1, 2, 3, 4 and 5, respectively.
The price column represents various prices at which A to E placed buy orders, and F to J placed sell orders in between 9:00 am, and 9:08 am. The Number of buy/sell orders is also represented in their respective columns. This was easy.
But now, what are cumulative orders? (To understand it better, keep referring to the above-mentioned table along with the following explanation).
Okay, take it like this. Think of Mr E. He placed 10 buy orders at Rs. 5 each. Now, if you offer him the same 10 shares at Rs. 4 or even less, will he accept it or not? Well, obviously, he will, because now he is getting the same Number of shares at a lower price. Hence, his buy orders must also be added to calculate the total demand at Rs.4 and at all other prices below that. Similarly, anyone who is willing to buy the shares at a higher price will be more than happy to buy it at a lower price, and hence, the Number of buy orders are cumulated bottom-to-top to reach the total demand at each price. This gives us our cumulative buy orders column.
In the converse case, think of Mr. F. He placed 40 sell orders at Rs. 1 each. Now, if you ask him whether he’ll sell the same 40 shares at Rs. 2 or above, will he be ready or not? Well, common sense, he will, as now the same Number of shares can be sold for a higher price. Hence, his sell orders must be included to calculate the total supply at Rs. 2 and at all other prices above that. Similarly, anyone who is willing to sell the shares at a lower price will be more than happy to sell it at a higher price, and hence, the Number of sell orders are cumulated top-to-bottom to reach the total supply at each price. This gives us our cumulative sell orders column.
You get it?
Now that we have the cumulative buy and sell orders let’s think of how we arrive at the ‘Number of possible trades’ figures. Consider the price of Rs. 1, for example. The total demand at Rs. 1 is for 150 orders, and the total supply is 40 orders. Just ask yourself, at max, how many orders can be executed? Well, obviously, it’ll be 40. Because you can not buy more than what the sellers are willing to sell, similarly, consider Rs. 4, where the demand is for 50 orders, and the supply is 140 orders. Even here, the sellers can’t sell more than what the buyers are willing to buy. Hence, the Number of possible trades will be 50.
Now, this way, the minimum of cumulative buy orders and cumulative sell orders give the Number of possible trades for each price.
Once this is done, the Maximum Number of orders is traced from the ‘Number of possible trades’ column (because we want to maximize the Number of possible trades). And the corresponding price is taken as the opening price of that share. Here, the maximum Number of possible trades is 100 and hence, its corresponding price of Rs. 3 is the price at which the shares will show up in the market at 9:15 am.
Cool? Well, what if the maximum tradable quantity is the same for two different prices. For example, see below --
After doing all sorts of complex calculations (as discussed earlier), here, you find that the maximum Number of possible trades at Rs. 2 and Rs. 3 is the same. Then how to calculate the opening price?
Well, you see, the objective is to lessen the Number of unmatched orders (the Number of orders that cannot be executed). This is calculated as the difference between demand and supply or vice-versa. So, it’s a no brainer that, out of those with the same highest Number of possible trades, we trace the one with a lower Number of unmatched trades. The price corresponding to the row where the unmatched orders is minimum (here 30) is taken as the opening price of that stock (here Rs. 2).
Simply put, it’s entirely the mechanism of demand-supply matching.
Get it? Okay, but what if even the unmatched orders of the two are also the same. Then, take the equilibrium price that’s closest to yesterday’s closing price. And what if even both these prices are equidistant from yesterday’s closing price (like 3 and 5)? Then, simply take yesterday’s closing price (here Rs. 4) as today’s opening price. Huhh.. that’s it.
We know this entire process for just one share price might seem a bit tedious to you, let alone all those thousands of listed shares. But let us remind you, no human does this in reality. All these complex algorithms are processed by computers, and when you have AI at your fingertips, impossible is just an overstatement!
The bottom line
Eventually, if you had placed your buy order (between 9:00–9:08 am) at or above the equivalent price or your sell order at or below the selling price, then your orders will get executed at 9:15 am. So, there you are.
However, we would recommend you to use the various tools at your disposal (like Stop loss and GTT) to protect your downside and improve your chances of getting through.
Stay informed and invest wisely.