Order Execution Systems: The How and Why Explained

Behind the scenes of every trade, there’s a fascinating web of technology at play.

Although they’re not always the center of attention in the trading world, order execution systems are the stars backstage, with significant responsibilities that affect every corner of the trading environment. 

Also known as order management systems (OMS), they handle order validation and routing to multiple execution venues, portfolio tracking and risk management, and offer reporting tools for governance and compliance.

Understanding the order execution process is important for brokers. It helps to identify reliable systems and fulfill their obligations to clients, stakeholders, and regulatory bodies. 

We’ve compiled six easy-to-digest questions and answers to bring you up to speed on the basics of order execution systems.

What is trading execution?

Trading execution is the following process: when investors buy and sell stocks, bonds, and other securities, they place orders (or trades); then, depending on the trader, these orders may be placed directly on an exchange or via a brokerage that directs them to the appropriate exchange or dealer network (routing). Depending on the venue and asset class being traded, the trade may need to be cleared and settled before it can be finalized (completed). The entire process is called “trade execution” or “order execution”. 

“Trade” and “order” can be used interchangeably in this context. 

The speed and accuracy with which this process is completed impact the final price paid by the investor. As you can imagine, investors are not pleased when they’re quoted one price and receive another, which can occur when a broker uses a system with latency or incorrect pricing data. 

What does an order execution system do?

An order execution system is a network of advanced technology and protocols that handle the placement, routing, and completion of trades. 

Order routing: Directing orders to the most appropriate liquidity provider, exchange, or dealer network.

Price matching: Executing orders at the best available price.

Confirmation: Letting the trader know the order has been executed immediately. 

Orders are processed at mind-blowing speeds—not seconds, or even milliseconds, but microseconds! For example, our proprietary order management system, DXOMS, is ultra-low latency, meaning it can execute and confirm orders in under 50 microseconds. Given the volume of orders these systems handle, we recognize the significant burden on trading execution systems.

What is the difference between market orders and pending orders in trading?

Market orders are convenient when speed is more important than precision. Pending orders are better suited to investors focused on price.

Order management systems utilize a range of order types that interact with one another in distinct ways. The first step in understanding order types is to distinguish between market and working orders.

Market orders: When investors place market orders, they want them executed as rapidly as possible, at the best available current price.

Working (pending) orders: Working orders, on the other hand, aren’t executed until their predefined conditions are met (e.g., quantity of assets when a given price level is reached). For this reason, they’re also known as pending orders.

Central limit order book: Traders set their conditions when placing pending orders, and the system logs these conditions in what’s known as the central limit order book (CLOB). This is a list of all pending buy and sell orders from traders, including the volumes they intend to trade and the prices at which they want to trade. 

How do market orders and pending orders interact?

Market buy orders are filled from the pending sell orders in the order book, and market sell orders are filled from the pending buy orders. The difference between the best available buy and sell prices in the order book is known as the spread.

To create a market, both market and pending orders are necessary. This is because passive pending orders in the central limit order book provide liquidity for market orders from traders seeking to buy or sell at the best currently available price.

As traders enter market orders, their trades are matched against the best available pending orders in the central limit order book. When this occurs, liquidity is removed from the order book, a new current price is established, and the best available buy/sell prices (along with the corresponding volumes) at the top of the order book are updated. 

What are the different types of pending orders, and how do they work?

Limit orders: An instruction to buy or sell a given asset at a specific price or better. They’re called limit orders because the trader sets a limit on how much they’re prepared to pay (buyers) or how much they are willing to receive (sellers). 

As with all pending orders, these orders are placed so that the trader can have their order executed if the market moves to a given level, even if they’re away from their terminal. 

Stop orders: An instruction to buy or sell an asset once the market trades beyond a certain price. This stop level is worse than the current market price for the trader (higher for buyers, lower for sellers). Stop orders are placed as a failsafe, allowing traders to enter the market even after it has begun moving in a certain direction. 

Because these orders do not set a limit, they can be filled at a significantly worse price than the trader may want. This can occur in highly volatile markets, when liquidity is patchy, or when a market gaps up or down between trading sessions. 

Stop-limit orders: A combination of both stop and limit orders. These orders add a limit to traditional stop orders to ensure that the price at which the order is filled doesn’t differ too much from that stop level. The limit part of this order type sets a price beyond which traders are unwilling to buy or sell. 

Stop-loss orders: These orders help traders limit losses when they’re away from their platforms. They instruct the venue to close a position once the price reaches a certain level. This allows the trader to sell at a slight loss rather than remaining in the market when it moves against them, thereby incurring a greater loss of capital.

Take-profit orders: These orders allow traders to secure profits when they’re not actively trading by instructing that a position is closed once it reaches a given level specified by the trader. This allows them to secure a defined profit without risking the market moving against them and compromising that gain. 

Trailing orders: A type of order that adjusts the target price at a fixed percentage, or monetary amount, below or above the market price. Trailing orders can be used for stop, stop-limit, stop-loss, and take-profit orders. 

For example, in the case of a trailing stop-loss, if the trader’s position is in profit and the market is continuing to move in a favorable direction, they can set a stop-loss within 1% of the current price, allowing the stop-loss to “follow” the price as it moves up. This allows profits to be locked in, even if the market eventually moves in the opposite direction. In this scenario, for a traditional stop-loss (set at a fixed level) to be triggered, the trader would have to give up all potential profits the trade would have earned before the price reached that fixed level.  

Can traders place more than one type of pending order at the same time?

Yes, by using OCO (one-cancels-the-other) orders, traders can place a pair of pending orders. When one of the two criteria is met, the other order is automatically cancelled.

For instance, traders can place both stop-loss and take-profit orders, ensuring profits are locked in if the market moves in their favor and losses are minimized if it moves against them. 

How long do pending orders remain active?

Modern order management systems enable traders to specify the duration of their pending orders. This is referred to as an order’s “time in force.” These options include:

DAY: Orders marked as “DAY” must be filled by the end of the session. If the order is not filled by the end of the trading session, it is automatically cancelled.

DAY+: DAY+ orders remain open beyond the standard trading session into extended trading hours; if the order is not filled by the end of that extended session, it is automatically cancelled. 

GTC (Good ‘til canceled): GTC orders remain valid until they are filled or canceled by the trader. 

GTD (Good ’til Date): GTD orders remain active until they are filled or until a specified date by the trader, at which point they are canceled.

IOC (Immediate or cancel): IOC orders must be filled immediately, in full or in part, or they are automatically cancelled. If they are partially filled, the remaining unfilled portion of the order is cancelled. 

Fill or Kill (FOK): FOK orders must be filled immediately; otherwise, they are automatically cancelled. Partial fills are not permitted. 

For more information on order types, check out this article: What are working orders and why are they used. 

Fractional and notional quantities

Investors can also fine-tune the specifics of their orders using fractional and notional trading. 

Fractional quantities: Buying or selling a fraction of a share rather than a whole share. 

Notional quantities: Placing an order for a defined amount (notional value) rather than the number of shares.

Equities execution systems ensure this is carried out accurately. For example, the Devexperts turnkey fractional OMS ensures zero risk exposure, substantial cost savings, and maximum efficiency thanks to the implementation of the Route as Received workflow and pre-allocated block orders.

What factors can influence trade execution?

Let’s look at the factors that impact how well the trade execution system can do its job. 

Market conditions

High volatility and low liquidity can impact the speed and price at which an order is executed.   In volatile markets, prices can change rapidly, increasing the risk of slippage, while low liquidity can make it harder to find a counterparty for the trade.

Order size

The order execution management system may need to break down large orders into smaller ones to execute them without significantly affecting the market price. Executing a large order all at once can significantly impact the market, potentially causing undesirable price fluctuations. 

Execution venue

Different exchanges and dealer networks may offer varying levels of liquidity and price improvement. Some venues may have more effective matching engines, resulting in faster executions and potentially better prices.

The quality of brokerage systems

The trading and execution technology used by brokers can impact the efficiency of market execution. Quality systems deliver faster processing times, more efficient routing algorithms, and advanced risk management tools, all of which contribute to effective trade execution.

What components does a good order execution system have? 

The two components are real-time exposure monitoring and execution settings.

First, let’s talk about real-time exposure monitoring. A reliable order and execution management system should offer automatic and manual hedging to monitor and manage client exposures and overall risk, with advanced filtering for individual groups or accounts. In the case of FX, it should also provide detailed views of exposures at both currency and currency pair levels and include tools to monitor broker hedging positions. 

The second is execution settings. Here is a list of important functions that order execution systems should include:

• Execution rules
• Smart order routing rules
• Exposure limits 
• Speed bump settings
• Tiered margining settings 
• Margin settings
• Price collars
• Kill switch

Learn what each of these rules and settings means here. 

Are market executions subject to regulations? 

Best execution is a regulatory requirement mandating brokers to seek the most favorable execution terms for their clients’ orders. This obligates them to consider factors such as price, speed, and likelihood of execution. Regulatory bodies, such as FINRA and the Securities and Exchange Commission (SEC), monitor adherence to this rule. 

Wrap-up

We can now understand why brokers place so much importance on trade execution systems. 

Trading and executions go hand in hand. There are regulatory repercussions if a broker’s order execution process isn’t up to scratch. Their clients rely on consistent, transparent, and fast trade execution at incredible speeds to retain them. Then there is risk management to ensure protection. 

The Devexperts Order Management System, DXOMS, stands out in the industry for handling the entire lifecycle of an order, with best-in-class speed and accuracy. If you’re a broker seeking an order execution system that provides peace of mind, please run your needs by our team. Our systems are backed by two decades of experience, and our account managers are knowledgeable, responsive, transparent, and ready to help.