Deconstructing Order Types

Terry Flanagan

The number and complexity of order types has mushroomed in the years since automated trading systems have attained prominence, which has prompted trading exchange Direct Edge to create an interactive Order Type Guide, an interactive, online presentation designed to serve as a resource to better understand Direct Edge order types and trading scenarios. It includes detailed explanations, animated examples and videos to illustrate functionality featured on both the EDGA Exchange and EDGX Exchange.

“We believe that investor confidence can be improved by enhanced education regarding how stocks trade on our exchange,” said Bob Books, director of product strategy at Direct Edge. “It’s a much better way to learn about order types then being forced to read exchange rulebooks and SEC filings.”

An order type is used to communicate specific trading instructions for a particular order. Many order types are standard across all markets, buy some are unique to Direct Edge.

Some order types, such as market and limit orders, are fairly well understood by the investing public. Market orders are orders to buy and sell a specified quantity immediately at the best available price. A limit order is an order to buy or sell a specified quantity at a specified price or better.

Direct Edge has identified ten generic order types: stop orders, reserve orders, pegged orders, route peg orders, midpoint peg orders, midpoint match orders, discretionary orders, midpoint discretionary orders, intermarket sweep orders, and hidden orders.

“These ten order types are the parent or root order types from which all other combinations emanate,” said Books. “Some of the order types already exist elsewhere, and members have requested that we emulate order types on other markets. Other order types, such as midpoint discretionary orders, are unique to Direct Edge.”

The Midpoint Discretionary Order (MDO) is an order type on the EDGA Exchange (EDGA®) book that allows Members to display liquidity at the National Best Bid or Offer (NBBO) with non-displayed discretion up to and including the NBBO midpoint. As an incentive for being displayed on the book, EDGA offers a discounted fee when executed in the discretionary range.

Intermarket sweep orders (ISOs) were created as part of Regulation NMS. They allowed the exchange to immediately execute ISOs against special orders on the book without checking protected quotes on other markets. The order originator takes responsibility for sending orders directly to the other market centers to clear protected orders.

Hidden orders are designed not to display any order quantity, and can execute at prices that are better than the NBBO. Hidden orders are permitted to be placed on the exchange book at prices that lock with opposite-side displayed or non-displayed orders.

“A lot of the newer order types are clearly a result of automated markets, where people prefer that you reprise an order rather than reject it,” said Books. “Some older order types related to midpoint executions became more popular with automated markets.”

The Financial Industry Regulatory Authority is currently conducting a review of ATSs, including any system that’s utilized to route orders or other messages into or out of the ATS.

Richard Ketchum, Finra

Richard Ketchum, Finra

“We are looking at how orders are being handled,” said Richard Ketchum, chairman and CEO of Finra, at a conference this month. “In some cases we have identified issues around disclosure and order handling of certain ATSs, which led to a Finra sweep in 2012.”

Finra’s Trading Examinations Unit is requesting that ATSs provide a description of each order type, and to identity how each order type is market to subscribers and include any corresponding material used in such marketing. It’s also requesting ATSs to identify any order types that are not made available to all subscribers or other entities whose order flow interacts with the ATS, and to explain why the order type use is limited to certain parties.

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