Key Takeaways
- Execution refers to filling a buy or sell order in the market, subject to conditions placed on the order by the end client.
- There are several ways to execute a trade, encompassing both manual and automated methods.
- Brokers are required by law to find the best possible means to execute a client’s trade.
Understanding Execution
Brokers are mandated to offer investors the best execution possible. The Securities and Exchange Commission (SEC) enforces brokers to report the quality of their executions on a stock-by-stock basis and notify customers who didn’t get the best execution. The advent of online brokers has considerably reduced the cost of executing trade orders. Many brokers offer commission rebates to clients executing a significant amount of trades per month—an essential feature for short-term traders aiming to minimize execution costs.
Minimizing Execution Risks
A market order, or an order swiftly convertible into a market order, generally ensures a high probability of settlement at the desired price. However, large orders, which break into multiple smaller orders, introduce execution risk due to potential delays between placement and settlement, complicating execution at optimal prices.
How Orders Get Executed
- Order to the Floor: This manual method involves a floor broker processing the transaction, which can be time-consuming.
- Order to Market Maker: On exchanges like the Nasdaq, market makers provide liquidity, and the trade may be directed to them for execution.
- Electronic Communications Network (ECN): Quick and efficient, this method matches buy-and-sell orders through computer systems.
- Internalization: Brokers may execute orders internally if they hold the stock in question—a practice known as internal crossing.
Best Execution and Broker Obligations
Brokers must ensure their clients get the best execution prices, though some debates exist whether orders are routed for potential additional revenues. For instance, if you buy 1,000 shares of TSJ Sports Conglomerate at a current price of $40 through a market order and it gets fulfilled at $40.10, you incur an extra $100 cost. Brokers may claim to strive for better pricing, but it’s often an opportunity rather than a guarantee.
The SEC requires brokers to report execution quality, noting the execution price against public quotes and disclosing better prices achieved for limit orders. Customers should be aware of these disclosures, which often go unnoticed on trade confirmation slips.
Execution and Dark Pools
Dark pools serve institutional investors executing large orders by not disclosing order quantity, offering inherent liquidity and potential price advantages. Execution within dark pools at midpoint prices between bid and ask rates can yield favorable outcomes, although these private exchanges attract skepticism due to lack of transparency and access for retail investors.
Example of Execution
Suppose Olga places an order to sell 500 shares of ABC stock for $25. Her broker explores the best execution prices and finds a better internal price of $25.50 compared to the market price of $25.25. By executing internally, Olga nets an extra $125 from the sale.
Related Terms: fill, market maker, best execution, limit order, quoted price, price improvement.
References
- Securities and Exchange Commission. “Trade Execution”.
