What Is Bunching?
Bunching is the combining of multiple odd-lot or round-lot orders for the same security so that they can all be executed at the same time. All affected clients must agree to the bunching before the order is submitted. Bunched trades may also be referred to as block trades.
Bunching also refers to a pattern that appears on a ticker tape when a series of same-security trades print consecutively, one after the other.
The Basics of Bunching
Most securities trade in a standard number of units. A round lot is usually 100 units (shares, contracts, etc.) of the asset or a number that's evenly divided by 100. An odd lot contains less than 100 units.
Often, bunching occurs on the floor of a securities exchange when traders and brokers roll up small or unusually sized trade orders into one larger order and then trade it in one single transaction.
The number of units in a round lot.
Bunching can be financially advantageous for investors with orders for less than 100 shares of a particular security, who would otherwise be charged extra fees for the odd-lot order, sometimes called an odd-lot differential. Odd-lot orders are difficult to match, and so additional charges for them are common. Bunching trades provides a means for traders to treat all clients equally, by aggregating odd-lot orders together for purchase or sale, and then breaking them down afterward into the various client accounts through a process known as the allocation process. Usually, the allocation is done electronically through order management systems (OMS), which helps streamline the process and avoid errors on the part of the trader.
Some unscrupulous day traders participate in a bunching practice known as cherry-picking, which seeks to take advantage of normal fluctuations in trading prices throughout the day to pick out winning or losing trades an allocate them in a manner that favors the trader’s own or his or her client’s accounts. This practice violates SEC regulations. For example, a 2018 case involving a Minneapolis commodities trading advisor found that the advisor, Christian Robert Mayer, was fraudulently cherry-picking winning trades from customer accounts and transferring them into his own account, by claiming that he had allocated them to the wrong accounts. The defrauded customers were ultimately reimbursed $105,090.
Rules Surrounding Bunching
In order to avoid cherry-picking, traders and advisors must carefully follow rules designed to avoid abuse. Regulators heavily scrutinize bunching and trade allocation practices in order to ensure that traders aren’t using cherry-picking to defraud customers. Firms must, therefore, review all allocations made each day, as well as any exceptions to the procedure. Irregularities must be documented to serve as evidence in the face of regulatory scrutiny.
In order to avoid cherry-picking, traders and advisors must carefully follow rules designed to avoid abuse.
There are no procedures for trade allocation established by regulatory bodies; these procedures are decided on a firm-by-firm basis. However, all traders and advisors must be careful to follow their firm’s procedures carefully. Current best practices treat all clients equally, without showing preference to any single client. Generally, allocations should be decided before an order is placed, and any partial fills should use a pro-rata allocation formula. Accurate and detailed documentation of bunched trades is also essential.