The stock market brings together traders who buy and sell shares. Brokers facilitate trades by linking up the two sides of the market and by executing orders. That said, it’s worthwhile to dig deeper. What are trade executions, and what options do brokers have when executing trades? This guide provides the answers.
Trade executions explained
As part of trading activity, investors offer to sell or buy stocks through a broker. For example, you may instruct your broker to execute a buy order for Apple shares at $95 per share. A stock like Apple is popular in the market, which means there are many buy orders like yours in the market. By the laws of supply and demand, such a stock tends to get more expensive. Further, that high demand shows that the stock is highly liquid.
In a liquid market, prices change fast, which can make trade execution more difficult. Trade execution entails the process where your broker settles your market order. Once you make a market order and send it to your broker, the broker decides how to execute that order. The broker’s decision is quite critical because it affects the execution price of the order and costs incurred during the transaction, costs which the investor shoulders.
In fast-moving markets, the speed of trade execution means the difference between profit and loss. For instance, take a stock like Uber. When Uber went public, it became one of the biggest IPOs in recent years. As such, Uber’s stock was in high demand and hence highly volatile. (It has since fallen sharply, further underscoring its volatility.) When dealing with an in-demand stock, the rate of trade execution and confirmation of orders could be slow. In addition, brokers are likely to execute the order at different prices from the quoted price in the market order.
Trade execution options
Once you send your market order to your broker, many things happen in the background before order confirmation. Notably, the broker has to choose how to execute the order. If you send a buy order, the broker needs to decide which market or market maker she wants to execute the order. The stockbroker generally has the following options:
Order to the exchange
In the stock market, public companies (like IBM) trade on exchanges. If you want to buy IBM shares, you send an order to your broker. The IBM common stock trades on the New York Stock Exchange. Once the broker receives the order, she has the option to send the order to the floor of the NYSE. Then, the floor broker will take charge of fulfilling your order.
Order to the market maker
Alternatively, your broker can direct the order to a market maker. Market makers have the capacity to fulfil orders at a moment’s notice, and hence, confirmation of your order could come in faster. Often, new or less connected brokers make use of market makers because of their limited access to exchanges like the NYSE. In addition, this could be an option if the stock is private.
Electronic Communication Network
Electronic Communication Networks (ECNs) provide a platform where brokers can execute orders quickly. When your broker routes the order to an ECN, the system facilitates a fast execution by matching buy and sell orders across the market automatically.
This is an option for established brokers. Such brokers have departments that hold inventories of shares for various companies. If your buy order matches their inventory at the quoted price, the broker goes ahead to execute and confirm the order.