CAPE TOWN – Over the past year, shares in life insurer Clientele have traded in a range between R14.00 and R19.75. However for a brief moment on Wednesday 21 April, the shares changed hands at 21c.
According to the JSE a limit order to sell the shares at 21c was entered by a client through an online stockbroker. This led to 488 shares being sold at that price.
Further investigation found that the order had in fact been a mistake and that the client meant to enter an order to sell at R21. However after looking at what happened, the exchange decided to allow the trade to stand.
“The resultant trades did not meet the requirements for a trade cancellation in terms of JSE rules,” the JSE told Moneyweb. “The price of Clientele shares recovered almost immediately.”
How was this possible?
The first question for anyone familiar with the stock market would be how such a trade would be allowed. If an order is made to sell a share at a price so far removed from its current level, doesn’t that compromise the integrity of the market?
This is precisely one of the reasons why retail investors can’t trade directly, but have to work through a stockbroker. Trade orders need to reflect reasonable prices so that the market is orderly.
The JSE also has rules to deal with exactly this sort of thing. Shares have volatility bands, which is a price range within which trades will be allowed to go through. If an order is made to sell at a price outside of that range, the trade will be stopped.
However, this only applies to the larger, more liquid stocks – those technically called ZA01 and ZA02 stocks. ZA01 stocks are those in the Top 40, while ZA02 are those outside of the Top 40 that are considered medium liquidity stocks.
“Clientele is however a ZA03 stock,” explains Mark Wilkes, the head of risk at online broker GT247. “ZA03 stocks have no price monitoring and no volatility bands, which means that they cannot breach a volatility condition. This is because usually these stocks are a few cents in value and can jump up and down by large percentages.”
Essentially this means that these smaller, less liquid shares will be allowed to trade at any price. This is because where liquidity in a stock is limited, it is dangerous to prevent trades from going through.
“If someone holds a penny share and they need to get out of it for whatever reason, you can’t stop them from doing that,” says Ridwaan Moolla, the head of digital and education at Absa Stockbrokers. “If I want to sell my shares at any price because I either need the cash or the share is collapsing and I need to get out, you can’t put breaks in place.”
The important lesson for investors
For, Moolla the real issue that came out of this episode is therefore that investors need to understand the risks of investing in more illiquid stocks.
“If you look at the difference between the bid and the offer on some of these stocks it’s not a 10% spread,” Moolla says. “It can be 40% or 50%. You can’t control it in that sense because that’s the market and the market is based on liquidity.”
This is why it is important not to underestimate liquidity risk. The critical thing is that any share is only really worth what you can sell it for.
With larger, liquid stocks, it’s easy to get the price reflected from minute to minute as there are always willing buyers and sellers. However where stocks are more thinly traded, you may have to move a long way from the last stated price to find someone interested in buying from you.
And that is why Clientele shares were allowed to trade at 21c. Where there are only a few people looking to buy or sell a particular stock, the JSE can’t be too strict about dictating the price at which they find agreement.
“If I hold 500 shares and I need to get whatever I can out of it, should they stop that trade from happening?” asks Moolla. “It’s very dangerous to do that. Take the case of African Bank, for example. Imagine if you had stopped those shares from trading the way that they did. People wouldn’t have been able to get out and get anything back.”