What is a Block Trade?
How does a block trade work?
What are the essential elements you should know!
In this article, I will break down the notion of Block Trade so you know all there is to know about it!
Keep reading as I have gathered exactly the information that you need!
What does block trade mean and why is it so important?
Are you ready?
Let’s get started!
What Is A Block Trade
Block trade is a term used to refer to the trading of a large number of securities at a specific price.
In other words, when an investor, company, or firm intends to trade a large number of shares at a preset price, its transaction will be referred to as a “block trade”.
Since block trades involve a large number of shares to be transacted, quite often several brokerage firms get together to each trade part of the block order.
Since a block sale or a block order involves a high number of stocks or an important sum of debt securities, you’ll typically see institutional investors, hedge funds, or large corporations transact this way.
When a large investment fund needs to buy or sell a large number of shares, it will solicit the help of an investment firm or other financial intermediaries to execute and complete the transaction.
To give you an order of magnitude, a “block” involves more than 10,000 shares of stock or $200,000 in bonds can be considered a trading block.
However, in practice, the volumes may be much higher than that.
As a side note, trading a large number of shares in penny stocks does not qualify as a block trade.
On a smaller scale, a “lot” of shares refers to 100 shares where a round lot is divisible by 100 and an odd lot refers to any other order size.
Block Trade Definition
According to Investopedia, a block trade is defined as follows:
A block trade is the sale or purchase of a large number of securities at a preset price.
This definition of block trades indicates that a block trade is:
- The sale or purchase
- Of a large number
- Of securities
- At a set price
Most of the time, institutional investors, hedge funds, or large corporations may trade in blocks (block purchase or block sale).
It’s quite rare to see individuals trading a share block for their own account unless they are heavily invested in the stock market or have a significant investment portfolio.
There is no “legal” definition of block trades.
The term block trade is a jargon used in the financial sector between traders, institutional investors, investment banks, and financial intermediaries.
How Dos Block Trades Work
A “block trade” consists of the purchase or sale of a large number of debt or equity securities at a price determined in advance.
In many cases, since the trade of a large volume of shares or bonds can result in price fluctuation or volatility, the transactions are done outside of the open market hours to minimize the impact on the security price.
Institutional investors or funds looking to buy or sell a large block of shares or bonds will generally work with financial intermediaries who specialize in block trading (these firms are called blockhouses).
The blockhouses will fulfill the transaction in such a way as to avoid triggering an important rise or fall in the security being traded.
To help facilitate the transaction, blockhouses will work with other firms with whom they have developed a trading relationship to help them execute the trade.
Here are the steps to perform a block trade:
- Step 1: an institutional investor decides to initiate a block order (block purchase or block sale)
- Step 2: the investor places the order with a financial intermediary to handle the order (blockhouse)
- Step 3: the blockhouse finds the best deal possible for its client in the block market
- Step 4: the blockhouse gets in touch with other brokers and traders specialized in block sales and block purchases (block trader)
- Step 5: The block traders execute the orders
It’s quite common for the trading firms to mask the actual volume of shares of stock being moved to avoid market disruption or undesirable attention (these masked orders are called iceberg orders).
Why Block Trading Is Important
One of the reasons why block trading is important is that traders can move a large amount of security without being adversely impacted by the movement of the stock price.
Imagine that you have an institutional investor that intends to buy 10,000,000 shares in a particular company.
Purchasing 10,000,000 may take time, involve many trades, and result in a price increase in the process.
However, if the institutional buyer were to place an order for a block of 10,000,000 with a blockhouse, it could purchase the 10,000,000 much faster, cause a more negligible impact on the stock price, and avoid any adverse consequences of artificially increasing the stock price.
When transacting a large number of shares in the market, it’s important to prevent unwanted volatility in the market price of the stock.
If you were to purchase 10,000,000 shares by buying them in the market, you may pay your desired purchase price for the initial 20,000 shares but then you may end up paying slightly more for subsequent transaction blocks.
By completing your entire 10,000,000 transaction this way, you may have purchased significantly more due to the upward pressure on the stock price.
Block traders use block trading strategies to prevent causing market volatility and reduce slippage.
Here are the main reasons why block trading is important for large investors:
- Through block transactions, traders are able to minimize the market impact
- Thye are able to purchase or sell large numbers of shares within a more narrow price range
- The client can potentially save in commission fees
- The transaction in block can be done outside of the market hours to avoid attracting unwanted attention
Block Trade Example
Let’s look at an example of a block trade to better understand the concept.
Imagine that you have a large institutional investor who is looking to purchase 500,000 shares in a company with its shares trading at $10 per share.
That represents a transaction of $5,000,000.
Imagine that the company’s total market capitalization is $100,000,000.
As you can see, the purchase of $5,000,000 worth of shares represents a large portion of the entire value of the stock.
If the institutional investor would place a straight order of 500,000 at $10 per share, it will put upward pressure on the stock price and unduly increase the acquisition costs.
To avoid stock price market disruption, the institutional investor will work with a blockhouse to facilitate the purchase of 500,000 shares at $10 per share.
In this case, the blockhouse may potentially break up the trade into smaller chunks (like 200 blocks of 2,500 shares at $10 per share) and work with other traders to help purchase the volume needed at the set price.
The blockhouse could even work with other financial intermediaries to find another institutional investor who may be willing to privately buy a share block allowing them to trade outside the open market hours.
Trade Block Takeaways
So there you have it folks!
What is block trade?
Are block trades good or bad?
How many shares in a block?
A block trade refers to a high-volume transaction of specific securities that is executed in smaller chunks or privately negotiated outside the open market.
For instance, imagine that you have a large hedge fund that wants to sell its entire stock position in a particular company.
If it were to place a trade to sell its entire position, it may potentially result in a significant drop in stock prices, lead to traders shorting the stock, affecting the normal supply and demand on the stock, and lead to other undesirable outcomes.
To prevent that from happening, the hedge fund will place a block order with an investment bank that will find buyers by minimizing the impact on the stock price.
In the United States and Canada, you have at least 10,000 in a block of shares.
If you are trading bonds or debt securities, a block consists of at least $200,000 of bonds.
Block trades are good in the sense that large institutional investors, hedge funds, or other large investors can purchase large volumes of shares without disrupting the market price.
The seller benefits in being able to offload a lot of shares in a relatively short period of time and the buyer benefits as it may be able to negotiate a purchase price at a discount off the market rates.
Most of the large broker-dealers offer block trading services (or “upstairs trading desks”) to their clients (mainly institutional clients) allowing them to trade large volumes of shares.
Get Started Trading Stocks
Investing in stocks or bonds can be a highly rewarding experience.
If you are looking to start trading, you should start by learning the stock market investing basics.
There are many investment strategies out there from conservative all the way to the aggressive pursuit of growth.
Depending on your risk tolerance level and your financial objectives, you should be able to find an investment strategy suited for you.
You can either speak to a financial professional to see what’s best for you or subscribe to my blog to learn more about investing, stocks, and how to get started!
You should also find the best online brokerage account to start trading.
There are many brokerage firms to choose from offering different products, services, commissions, and tools to help you trade successfully.
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