Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Why the opening price of a share can be different from the previous close
There is no reason why a share must open at the previous night’s closing price. Daily price moves are determined by supply and demand for the shares and that in turn is affected by company news such as earnings updates, acquisitions, disposals, legal disputes, new product launches and so on.
In fact anything which changes the fundamentals or investor sentiment towards a company has the potential to ‘move’ the share price up or down.
For example, medical products company ConvaTec (CTEC) recently increased its full-year expectations for revenue growth and posted a positive third quarter trading update.
Investors who read the news at 7am and wanted to purchase shares were willing to pay more than the previous closing price because the prospects for the company had improved.
This resulted in the shares opening 2% higher at 8am when trading resumed from the previous day. Initial orders are processed in an opening auction around ten minutes before the open and there is a similar auction after the close at 4.30 pm.
Only people with access to the London Stock Exchange’s order book can participate and in general retail investors using an investment platform won’t have access to this service.
In addition to specific company news, overnight news in other markets can also impact how UK shares open.
For example, if US or Asian markets sell-off overnight, there is a good chance that UK markets will follow suit and open lower.
The London Stock Exchange operates an automated trading platform called SETS (stock exchange electronic trading system) for large liquid shares such as food giant Unilever (ULVR) and SETSqx for less liquid shares. The qx stands for quotes and crosses.
The automated system is used by institutions and brokers and their buy and sell orders are matched by the platform while on SETSqx market makers are obliged to make a two-way price in shares.
A market maker’s job as the name suggests is the make a market in the shares of a company. Let’s imagine the market maker didn’t exist for a second and you wanted to buy shares in late night bar operator Revolution Bars (RBG:AIM).
You would need to ring up existing shareholders to see if they were willing to sell you some shares at a reasonable price.
Market makers effectively provide that service and get paid via a spread which is the difference between the buying price or offer and the selling price or bid.
The spread in less liquid shares is higher which reflects the higher risk that market makers assume in making a market.
While market makers generally provide a useful service, investors should always check the spread before attempting to buy shares in less liquid companies.
It can be very wide, in some cases 10% or more compared with around three basis points for liquid shares such as Unilever.
Paying a 10% dealing spread means that a buyer would instantly incur a 10% paper loss and the shares would need to rise by 10% for the investor to reach breakeven.