The upstairs market is a discretely operated network that connects large firms and institutional investors, facilitating substantial trades or block orders. Unlike traditional trades that pass through stock exchanges and are visible to the public, upstairs market trades are executed directly between buyers and sellers, often with professional brokers as intermediaries. The size of these transactions usually constitutes a significant portion of the market’s trading volume.
Key Takeaways
- The upstairs market is a network primarily utilized by large firms and institutional investors for massive trades.
- Trades occur off the trading floor, often preventing market disruptions.
- Professional intermediaries help in executing these trades, which reduces the risk of insider trading.
- The upstairs market functions apart from public stock exchanges, or downstairs markets.
- Regulatory bodies monitor upstairs markets to protect retail investors’ interests.
Understanding Upstairs Markets
The term “upstairs trades” often refers to transactions conducted through networks of trading desks. These trades, because of their significant sizes, are usually managed by institutional entities such as mutual funds, banks, pension funds, insurance companies, and brokerage firms.
These trades generally occur off the trading floor and are typically conducted electronically or over the phone. By operating away from public exchanges, these trades minimize sudden price swings or disruptions in the securities market.
Routing trades through professional intermediaries ensures fewer risks associated with activities like front-running, where brokers execute transactions based on pre-knowledge, affecting stock prices adversely.
Special Considerations
This market encompasses what are also known as dark pools—financial networks or forums enabling private trading activities. Despite their secretive nature, dark pools are entirely lawful and allow investors to perform large trades confidentially.
As of 2014, trades carried out in the upstairs market accounted for around 15% of US trading activity, with the number likely increasing since. Regulators closely scrutinize this market to ensure fairness for all. Stricter regulations are often enforced to minimize dark pool trading and ensure market transparency:
- Canada implemented tighter controls in October 2012, limiting the conditions for upstairs market transactions.
- Australia introduced similar restrictions in May 2013, significantly reducing such trading volumes in both countries.
In the US, the Financial Industry Regulatory Authority (FINRA) mandates the weekly disclosure of trades executed on an alternative trading system (ATS), ensuring greater market fairness.
Upstairs Market vs. Downstairs Market
Contrary to the upstairs market, the downstairs market signifies traditional stock exchanges. Here, trades generate market liquidity and are executed by small investors, market makers, and traders. Unlike the upstairs market, these trades, carried out in the open, are smaller in scale and publicly accessible in terms of pricing and volume.
Advantages of an Upstairs Market
Institutional investors like hedge funds find the upstairs market advantageous for several reasons. For instance, large sell orders openly submitted to stock exchanges may cause such traders to receive unfavorable prices as others bid down the security. Conducting these trades privately avoids this issue.
Furthermore, reduced transaction costs add to the appeal of the upstairs market. Executing a large block order with fewer institutional counterparts enables lower overall commissions compared to numerous smaller trades.
At times, executing complex trading strategies, like program trades involving multiple simultaneous transactions, is only feasible through the assistance of professional intermediaries in the upstairs market.
References
- NYSE. “NYSE’S Focus for U.S. Equity Markets: Quality, Transparency, Simplicity”.
- Nasdaq. “Upstairs market”.
- CFA Institute. “Regulatory efforts to reduce dark trading in Canada and Australia: How have they worked?”, Page 2.
- CFA Institute. “Regulatory efforts to reduce dark trading in Canada and Australia: How have they worked?”, Page 3.
- FINRA. “Can You Swim in a Dark Pool?”
- The College of Business. “The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects”, Page 2.
