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Why Contra Trading Is An Even Worse Idea Now Than It Was Before

Singapore’s stock exchange operator, Singapore Exchange Limited (SGX: S68), recently announced that trade settlement for shares on the stock exchange will be cut from three days (T+3) to two days (T+2) after the transaction date. The change is expected to take place on 10 December 2018, meaning that if an investor buys shares on 10 December, which is a Monday, he would have to settle his trade by Wednesday instead of Thursday.

The reduction in the trade settlement days was made to align Singapore Exchange with other major markets – the European Economic Area’s securities markets moved to T+2 settlement in 2014, while the US Securities and Exchange Commissions (SEC) shortened the settlement window from T+3 to T+2 last year.

Much of the liquidity generated from equities trading comes from a practice known as contra trading. Contra trading refers to the purchase and selling of the same shares within the window period of the transaction and settlement date, either for a profit or loss. In this fashion, the investor (it’s a misnomer to call someone who engages in contra trading an investor, as he or she is more akin to a gambler to me!) need not put up any cash upfront and can simply collect the profits for free – or pay up for losses if any.

To give an example of how this works, imagine I intend to contra trade 10,000 shares of Singapore Exchange on a Friday. In a T+3 scenario, I need not settle the transaction until the following Wednesday (only business days are included). At Singapore Exchange’s current share price of S$7.28, I would have to cough up S$72,800, before trading commissions, if not for the ability to contra trade. In the hypothetical scenario where Singapore Exchange’s share price increases to S$7.50 between the transaction and settlement dates under the T+3 system, I would get to pocket the profit of S$2,200 (S$0.22 per share of profit on 10,000 shares)  without having to cough up a single cent.

From the above, it can be seen that the ability to contra trade encourages a gambling mentality as investors would not need to stump up any cash at all to trade shares. But, the practice is fraught with risks as there is no telling where a company’s share price would head to in a matter of days. With the window period shortening from T+3 to T+2 days, this means that the time window for speculators to make a quick buck has also narrowed considerably. Hence, contra trading would represent an even worse proposition than it was before.

The practice of contra trading is an archaic one which existed during times when physical share certificates needed time to be delivered from seller to buyer. With the advent of scripless share settlements and the ease of the Internet, contra trading should gradually be phased out altogether, in my opinion. Though some would argue that the presence of contra trading boosts Singapore Exchange’s trading volumes and contributes to its revenue, it also encourages imprudent behaviour among stock market participants and may result in severe losses to those participate.

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The Motley Fool Singapore contributor Royston Yang contributed to this article. Royston owns shares in Singapore Exchange.

The information provided is for general information purposes only and is not intended to be personalized investment or financial advice. The Motley Fool Singapore writer Chong Ser Jing does not own shares in any companies mentioned. The Motley Fool Singapore has a recommendation on Singapore Exchange.