Overview on Pre-Arranged Trading
The bid-ask process executes trading orders across all market exchanges. In this process, trading systems and market makers match buyers and sellers to complete a given trade. The market forces of demand and supply help settle the price between the counterparties.
However, a pre-arranged trading doesn't deploy the bid-ask process to complete a transaction. As the name suggests, an investor executes the trade at a pre-decided price in a pre-arranged trading. 'Conditional orders' and 'Block deals' are primarily based on pre-arranged trading. Other forms of pre-arranged trading are considered fraudulent.
Conditional orders are based on pre-arranged trading. They are executed only when specific criteria are met. Examples of conditional orders can be limit, stop, stop-limit, and contingent orders.
Such orders do not guarantee an execution due to the criteria that must be fulfilled. In stark contrast to conditional orders are market orders. These orders are non-conditional and do not have any restrictions or conditions attached to them. They are placed at the first available price following the trade submission.
An example of conditional order
The shares of Company X are trading at INR 100.05. Mr X intends to buy 10 shares in a dip. He specifies a limit order of INR 98.20. This is a conditional order, the condition being that the purchase price of the 10 shares should be INR 98.20 and not the current market price. Most limit orders are cancelled at the end of the trading day if they remain unexecuted.
A Block deal is another transaction based on pre-arranged trading. It is a single bulk-sized order negotiated privately between two parties who are usually big institutional players or hedge funds. A block deal consists of a minimum quantity of 5 lakh equity shares or a minimum value of INR 5 crores.
A mass sell order on a stock exchange may have a massive effect on a company's share prices. A block trade is, therefore, executed in a separate trading window. It also often results in a discount on the market price for the buyer.
Illegal Pre-arranged trading
Pre-arranged trading is illegal when market makers enable securities exchange at pre-arranged prices. Market makers match buyers and sellers of their choice to facilitate the orderly exchange of securities in the open market. They profit from the spread of the trade.
An example of an illegal pre-arranged trade - An offer to sell along with a buyback offer. A market maker can arrange a buy order and a sell order with the help of another market maker at some pre-arranged price that results in a monetary benefit to both of them.
Prices in financial markets are supposed to be naturally discovered through the forces of demand and supply. Pre-arranged trading or conducting risk-free trades at predetermined prices is considered fraudulent, except when executing conditional orders and block deals.