The monthly magazine providing news analysis and professional research for the discerning private investor/landlord

Market Efficiency

Veteran international investor John Corey comments

I was listening to a podcast recently while walking to a meeting. I know the host of the program and I had spoken with the other person who was being interviewed. The discussion focused on using a number of disparate data sources to identify good investment opportunities - planning data, court filings involving properties in distress, and other information. As I walked along, I thought about how the information is both useful for finding profitable deals and an indication of future profit margin being reduced.

Some readers will know that I worked in technology for a number of investment banks. One fact of life at the banks is trading can be grouped into two different models. There are trades which take place through an exchange. ‘Exchange traded’ is the phrase. Deals are done with standardised in-vestment contracts. X shares of a company’s stock, a derivative contract (ETD) or something else which can be traded using units and contract terms everyone understands in advance. Legally, the trade is with the exchange when you sell or when you buy. Rather than have a broken trade (broken chain?) when one side wobbles the seller or buyer is actually transacting with the exchange. In ef-fect, three parties take part in every trade. The exchange is on the other side of each purchase or sale. You will not know who sold or who purchased as your deal is legally with the exchange.

At the other end of the spectrum is OTC. ‘Over The Counter’ trading where each deal is agreed di-rectly between the end buyer and the end seller. All the details are up for discussion or negotiation. Each deal is unique and cannot be easily substituted. There is no specific unit size, contract or other details. Conventions may develop yet OTC implies anything is possible if the two sides can agree to do the deal.

New markets, new things to trade, start from an emerging interest of a small number of traders to conduct business. As the market matures, more traders become active, the volume of trades goes up and the contract terms start to standardise. For risk and efficiency reasons, the trading will move from the OTC format to a recognised exchange. Volumes spike when trading moves from OTC to an exchange.

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