Orders and Market Execution

Orders and Market Execution

1. Order types

   • Limit orders
     • Specifies a maximum/minimum price
   • Market orders
     • Large orders may cause market impact
     • Execution price uncertainty
   • Marketable limit orders
     • Marketable
     • At the market
     • Behind the market
   • Standing limit orders
     • "options" that offer liquidity
   • Stop loss orders
     • Destabilise prices by demanding liquidity when least available
     • Order activated when price rises/falls to stop price
   • Tick Sensitive Orders
     • Conditional on last price change
   • Market-not-held orders
     • Best possible execution decided by broker

2. Market Execution Structures

   • Quote-driven dealer markets
     • Posts quotes to buy or sell where ask price>bid price
     • Dealer profits from bid-ask spread
     • Examples: NASDAQ, FX, Bonds, Derivatives
   • Order driven markets
     • Use trading rules to arrange trades
     • Oral auctions
       • Open-outcry trading floors
       • Physical location
       • Easier to enforce rules
       • Rules: best bid/offer price accepted, first in first served, public orders first
     • Single price auctions
       • Uniform price used (uncertainty about true value of stock)
         • Fair to both informed and uninformed investors
       • For very illiquid stocks
       • For insufficient technology
       • Rules: uniform pricing (clearing price where supply=demand)
     • Continuous electronic auctions
       • Limit order book with bid and ask schedules for certain price and quantity
       • Investors submit orders with brokers who act as intermediary
         • Brokers
       • Rule: price and time precedence, discriminatory pricing, matching procedure
     • Crossing networks
       • Match buy and sell orders without knowing public quotes
       • OR Place orders anonymously so no-one knows who's trading
       • Rule: derivative pricing rule
         • But, can lead to stale prices, adverse selection
         • Tempts traders into price manipulation
   • Classification based on liquidity provision and frequency of trading
   • Brokered Markets
     • Broker's role in finding liquidity
   • Hybrid/multiple markets
     • Mix characteristics of quote driven, order driven and brokered markets
     • NYSE
       • Floor traders (order driven)
       • Electronic limit order book (order driven)
       • Designated dealer to provide liquidity (quote driven)