What it means
The phrase comes from the mechanics of matching trades. An exchange or a market maker has to pair buyers with sellers, and when the two sides do not match in size the difference is an imbalance.
Whoever sits on the larger side has to concede on price in order to get filled. Imbalances matter most around the opening and closing auctions, when a whole session's worth of orders is matched in one event.
Exchanges publish indicative imbalance figures in the minutes before the close so that other traders can supply the missing side. Those few minutes often carry a large share of the day's total volume.
Imbalances are read relative to normal activity rather than in absolute shares. An excess of 250,000 buy orders is trivial in a stock that trades 20,000,000 shares a day and dramatic in one that trades 500,000.
The ratio to average daily volume is the figure traders actually watch. Predictable events create predictable imbalances.
Index changes, dividend reinvestment dates and the expiry of derivative contracts all force large passive funds to trade at a particular moment, and everyone can see it coming. That is precisely why the price move around those events is often smaller than beginners expect.
For a company's finance team the practical use is in timing execution. If the business is buying back its own shares or placing a stake, putting the order into a session where the natural imbalance already runs the other way reduces the price concession needed.
In practice
Real-world examples.
Example
An index provider announces that a mid-cap company will join a major index at the next review. Every tracker fund must own it by the close on review day, so the market is heavily buyers on balance in that final auction and the price gaps up before falling back over the following week.
Example
A market maker in a thinly traded investment trust sees sell orders of 180,000 shares against buy orders of 40,000. She is sellers on balance, so she quotes a lower bid to attract buyers and takes the rest onto her own book at a price that compensates her for the risk.
Example
A corporate finance team is placing a $30,000,000 block of shares and deliberately schedules it for a day when a large dividend reinvestment is expected to create natural buying. The imbalance already running their way means the placing clears at a discount of 2% rather than the 4% the bank had estimated.
Formula
Calculation
Order imbalance = buy orders in shares - sell orders in shares
Imbalance as a share of normal activity = order imbalance / average daily volume
In the closing auction of a listed retailer, the exchange reports 850,000 shares of buy orders against 600,000 shares of sell orders. The imbalance is 850,000 - 600,000 = 250,000 shares, and because the buy side is larger the market is buyers on balance. Average daily volume in the stock is 2,000,000 shares, so the imbalance is 250,000 / 2,000,000 = 12.5% of a normal day's trading. If traders stepping in to sell into that imbalance need the price 0.8% higher to do so, a closing price of $40.00 becomes 40.00 x 1.008 = $40.32, and the buyers pay about 250,000 x 0.32 = $80,000 more than they would have at the earlier price.Case study
Seen in the real world.
Mendip Index Partners is an illustrative, fictional manager running $600,000,000 of index-tracking money. Its policy was to trade every index change in the closing auction on the effective date, which is the simplest way to match the index exactly.
Reviewing two years of trades, the dealing team found that the fund had consistently been on the crowded side of the auction, buying when the market was buyers on balance and selling when it was sellers on balance, at an average cost of about 0.35% on the shares involved. On roughly $70,000,000 of annual turnover in index changes that was around $245,000 a year.
The team changed the policy to trade a third of each index change over the two preceding days, accepting a small tracking difference against the index in return. Measured over the next year, the average cost fell to about 0.19%, and the illustrative lesson is that being on the heavy side of a known imbalance has a price that can be measured and partly avoided.
Watch out
Common mistakes.
- Reading buyers on balance as a signal that the price will keep rising, when it only describes the orders waiting right now.
- Judging an imbalance by the number of shares alone, without comparing it with the stock's average daily volume.
- Assuming an imbalance means uninformed demand, when the most predictable imbalances come from passive funds that have no view on the price at all.
Questions
People also ask.
Why do exchanges publish imbalance information before the close?
To attract traders who will take the other side, which makes the closing auction fuller and the closing price more reliable.
Can an imbalance disappear without any trades happening?
Yes, because the published figure is indicative and participants can add, change or cancel orders right up to the cut-off.
How can a small investor use this?
Mainly by avoiding it, since placing market orders into a known imbalance is a reliable way to buy at the worst price of the day.
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