Guide to Block Trades

Block trades are high-volume trades that are carried out privately by institutional investors. Since large trades have the potential to move market prices, conducting them privately, typically through intermediaries called block houses, can help avoid market disruption. Because of the potential risk associated with these trades, block trades are subject to strict rules and regulations.

Retail investors aren’t directly involved with block trades, but it’s a good idea to know what they are, how they work, and their potential impact or risks.

What Are Block Trades?

A block trade is the sale and purchase of a large volume of financial assets. The criteria of a block trade can vary depending on the asset class, market, or exchange in question. A block, as defined by the New York Stock Exchange’s Rule 72(d), is a minimum of 10,000 shares of stock or any trade with a market value of at least $200,000. Though 10,000 shares is the operative figure, in this case, the number of shares involved may be higher.

Individuals typically don’t execute block trades. Rather, block trades are most often carried out by institutional investors, such as mutual funds, hedge funds, or other large-scale investors.

Why Do Block Trades Exist?

Block trades generally exist to allow institutional investors to complete large transactions without significantly impacting share prices. Block trades are often so large that they could move the market for a given security if handled as a traditional public trade.

If a pension fund manager, for example, plans to sell one million shares of a particular stock without sparking a broader market sell-off, selling all those shares on a public market would take some time.

During that process, the value of the shares the manager is selling may go down — the market may then see a drop in demand, and the value may decrease accordingly. Sometimes, the manager may attempt to sell even more slowly, but that creates the risk that other traders may identify the institution or fund behind the steady sale of the assets. Then those investors might short the stock or attempt to take advantage of the sell off in another way.

The same risks exist for a fund manager who is buying large blocks of a given security on a public market. The purchase itself may drive up the price, as the market sees an increase in demand. If the trade attracts attention, other traders may front-run the manager’s purchases.

How Block Trades Are Executed

Many large institutions conduct their block trades through intermediaries, such as block houses and dark pools, to avoid influencing the market. Most of those institutions typically have expertise in both initiating and executing very large trades without having a major — and costly — effect on the price of a given security.

Nonpublic exchange services may operate according to their own rules when it comes to block trades, but what they typically have in common is relationships with institutional investors, such as hedge funds and others, that can buy and sell large blocks of securities.

Investment banks and large brokerages may have block house divisions that run dark pools, which are called such because the public can’t see the trades they’re making until after they’ve been executed. By connecting large buyers and sellers, block houses and dark pools are capable of making big trades without disturbing the markets.

The number of reported dark pool trades in the U.S. varies, with some reports suggesting that about 15% or more of trades occur through dark pools and, more broadly, close to 40% of trades occur outside of public exchanges.

Strategies Used to Execute Block Trades

To help institutional traders conceal their block trades and keep the market from shifting, block houses may use a series of maneuvers to conceal the size of the trade being executed. Block trades may be executed in the primary market as new stocks or bonds are issued, through over-the-counter (OTC) transactions, directly between a seller and buyer outside of an exchange, or through an exchange such as NYSE.

At their most basic, block trade strategies often involve splitting up the block into smaller trades. For example, block orders may be broken down into a large number of limit orders. By using an automated program to make the smaller limit orders, block houses can hide the actual number of orders at any given time.

Block trades may be executed through “iceberg orders,” in which the public may only see a small subset of the total trades — i.e., just the tip of the iceberg.

Taken together, these networks of traders who make block trades are often referred to as the “upstairs market” because their trades occur off the trading floor.

Pros and Cons of Block Trades

As with most things in the investment field and markets, block trades have their benefits and potential risks. Here’s a look at each.

Potential Benefits of Block Trades

•   One of the most obvious advantages of block trades is that they can allow large trades to commence without shifting the market. While large trades can influence market values, it’s possible to avoid causing undue volatility by conducting them privately through block trades.

•   Block trades offer liquidity to large, institutional investors, which may also benefit the clients investing in funds, corporations, or other products. Block trades can allow transactions to transpire relatively quickly versus stretching out over weeks or longer.

•   Block trades enable buyers and sellers to agree upon a share price for the trade, which may help protect the parties from price slippage that could occur through public exchanges and transactions that are conducted over a longer period of time.

Potential Risks of Block Trades

•   While a block trade is made to help avoid a larger market shift, it may not necessarily always be beneficial for everyone in the market. Some note that agreed-upon block trade prices may be out of sync with market demand or misjudged, and may be perceived as unfair by retail investors. That said, there are regulatory guidelines in place to help protect consumers from unfair pricing.

•   While block trades are conducted privately, it’s possible that an imminent trade could be leaked or detected, which may result in volatility, short selling, front-runners attempting to make illegal trades, or failure to execute the trade.

•   Block trades can involve execution risk. A counterparty in a block trade may default, or an intermediary may struggle to offload shares if the share price of a block trade is misjudged.

Block Trade Example

A block trade could occur as follows: A large investment bank wants to sell one million shares of Company A stock. If it were to do so all at once, Company A’s stock would likely drop. If it were to sell somewhat slowly, the rest of the market may see what’s going on and sell their shares in Company A, too. That could cause the value of Company A stock to fall before the investment bank is able to sell all of its shares.

To avoid that, the investment bank may use a block house, which breaks up the large trade into smaller trades, which are then traded through different brokerages. The single large trade now appears to be many smaller ones, masking its original origin.

Are Block Trades Legal?

Block trades are legal, but they are subject to intense scrutiny from financial regulators including the SEC and FINRA. Dark pools, for example, are required to use public prices to inform the share prices used for block trades.

In addition, trades executed through alternative trading systems (ATSs), such as dark pools, are reported to FINRA. FINRA also reports aggregated over-the-counter trading information for each ATS on a delayed basis.

Further, block trades are not considered a form of market manipulation. They’re simply a method large investors use to adjust their asset allocation with the least market disruption and stock volatility possible.

How Block Trades Impact Individual Investors

Block trades are generally designed to help protect investors from the larger market volatility that could result from a large, public trade. They may be made by institutional investors or corporations for a number of reasons, and it can be difficult for retail investors to know what a block trade may indicate. A large trade that looks like the turning of the tide for a popular stock may just be a giant mutual fund making an adjustment.

The existence of a high-volume trade is considered sensitive, material information, however, and there are some concerns that the privately agreed-upon pricing may not always be aligned with market supply and demand. In addition, the leakage of a block trade could potentially have negative consequences, such as a significant price shift.

It is possible for retail investors to learn about or simply suspect the existence of block trades, however. Savvy traders may identify signals for block trades through data feeds, including real-time trade data provided by FINRA. Some short-term traders also use digital tools such as Nasdaq Quotation Dissemination Service (NQDS), Level 2 data, a subscription service that offers users access to Nasdaq real-time and delayed data feeds.

However, access to such tools doesn’t mean it’s easy to find block trades. As mentioned above, block houses implement strategies, such as the aforementioned iceberg orders, that make them hard to detect.

The Takeaway

Block trades are large movements of securities, typically done under the radar by institutional investors. It can be difficult for individual investors to detect them on their own.

These trades may have benefits for individual investors, such as possible protection from the market volatility that these high-volume trades may otherwise incur. It’s also helpful for investors to know that block trades have the potential to pose certain risks, such as information leaks, and are subject to strict rules and regulatory oversight.

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FAQ

What is the purpose of a block trade?

Block trades allow buyers and sellers, usually institutional investors, to make large trades outside of the public auction market, which may help to prevent these high-volume transactions from disrupting the market.

When are block trades executed?

Trading hours for block trades can vary depending on the venue or asset. Generally, they can occur at any time, including when the public market is closed, except for when the corresponding futures or options have expired.

How many shares is one block in a block trade?

What may be considered a block trade can vary depending on the asset class, market, and exchange in question. For example, for the NYSE, a block is typically defined as at least 10,000 shares of a stock. The criteria can vary for international markets, however, or for other assets such as bonds or futures.

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