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How The Order Book Works

By: Wayne Duggan

Buying a stock on an online trading platform is a bit different than paying for a gallon of milk at the store. Traders who expect to click and forget when placing orders with their broker could see surprising execution prices, unfilled or partially-filled orders or long delays before their order is executed.

Here’s a rundown of what actually happens when you place a buy or sell order.

The Broker’s Role

When you click “complete purchase” on Amazon.com, your order goes directly to Amazon. When you click “complete order” in your trading account, that order doesn’t go directly to the securities market. Instead, it goes to your broker, who must then determine the most appropriate action to take.

Your broker has several different options available to complete your order. The broker can choose to send the order directly to the floor of an exchange such as the New York Stock Exchange or a regional exchange. If the inventory is available, the broker can also choose to fill an order using shares that the broker already has on-hand. The order can also be sent to a third market maker to act as an intermediary between your broker and the exchange in which the order is directed.

There are also a number of electronic communications networks that automatically match buy and sell orders in markets comprised of major brokerages and individual traders.

Orders are prioritized by the order in which they are received, and orders received at the same time are prioritized by size, with larger orders executed first.

As you can imagine, the speed with which an order is executed varies widely depending on the method the broker uses to complete the order and the number of middlemen involved in the process.

Pricing

Traders always expect brokers to execute trades as quickly as possible, but they also want the best price possible on those orders as well. Brokers are required by law to give clients the best possible price on their orders, but “best” can be a particularly murky standard.

According to the SEC, brokers are required to choose the best price given the circumstances—such as the type of market for the security, the type of the transaction, the order size, potential fees, the number of available markets, and the terms and conditions of the order. In other words, the broker must constantly balance the potential opportunity to get a better price, the potential delay in executing the order and the risk the order will not get executed at all.

Setting Terms

If the order execution process above seems a bit chaotic and scary, the best way for an individual trader to control the process is to understand the different trade order types and set as many parameters as possible when placing the order. Market orders leave traders at the mercy of their broker’s ability (or lack thereof) to get the best possible price.

However, by placing limit orders, traders can ensure that any executed orders will be filled only if they meet a minimum price threshold. In addition, traders can often specify that they wish to avoid partial order executions by selecting “all-or-none.” All-or-none trades will only be executed if your broker can fill the order completely at the specified price.

This article is provided for educational purposes only and is not considered to be a recommendation or endorsement of any trading strategy. The author is not affiliated with Lightspeed Trading and the content and perspective is solely attributed to the author.

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