Source : Amazon
Algorithms provide users with execution strategies that provide access to the market anonymously, to search dark venues, and actually all venues that the user has grant access to, for liquidity (filling at the best price for the best execution) and to apply an execution strategy that fits the trading objective of the order placed.
Equity markets are often fragmented, which means that liquidity in a security can be spread across execution venues, both trading venues and counterparties, and all liquidity may not be immediately visible.
An execution venue can be a trading venue, or it can also be counterparty (MTFs) . A trading venue is an order book or market platform where buyers and sellers interact multi-laterally, posting orders or soliciting quotes via a request for quote (“RFQ”) process or similar trading protocol. Multi-Lateral Trading Facility, MTFs, regulated markets and Organised Trading Facilities, OTFs, are trading venues.
A displayed exchange can be defined as a trading venue that discloses the information of the order book, which is not done by all venues such as dark pools. This information is valuable as it provides to the investors the expected transaction prices, and the expected wait time for a limit order to transact based on the fact that the position of their order in the queue would be known and from that they could compute when it will be executed.
Crossing Networks, alternative trading systems, are multilateral trading venues that facilitate the interaction of orders from counterparties and portfolio management firms. They are a method of accessing liquidity from other sources that may not be readily available in an active market and also provide the ablity to their clients to trade effectively large orders of securities considered as illiquid. In recent years, crossing networks popularity has increased with the increase of difficulty that buy side encountered in executing block trades. They provide access to anonymous, natural liquidity in both small and large blocks. Crossing Networks, being anonymous, are attractive to all portfolio management firms looking to execute large blocks.
Electronic Communications Networks, ECNs
ECNs are electronic trading systems that automatically match and sell orders at specified prices. They connect smart order-routing systems with this kind of market transparency and enables them to perform order routing, exploiting the increased connectivity of electronic trading systems based on the FIX protocol. With its minimum of intermediation and real time price discovery, ECNs enable buyers and sellers to transact relatively inexpensively. They offer more efficient order execution than established market centers’ trading systems. They provide liquidity for investors with more complete price information by allowing them to see the ECN’s limit order book. Only size and price of order can be displaced, which offer stealth and anonymity for market participants, investors and traders. Order can be executed immediately when an internal match is found. And when there is no internal matches, clients are offered the option to leave the limit order on the network, or have it routed to another venue. Some ECNs only utilise limit orders, which means orders will need to be cancelled in order to leave the ECN, even though the trade may be executed on another venue. Other ECNs take market orders and if an internal match is not available, route it to an exchange in search of the optimal price. They offer services that can access different products or multiple markets all around the world .
ECNs can typically provide the following information:
Buy or sell order
Style classifications of the institutions
The only difference between ECNs and exchanges is the listing of stocks that exchanges have the ability to. Also, ECNs are regulated by the SEC and a national securities association.
According to the literature, the highest number of dark pools is in the U.S (about 50), followed by Europe (roughly 20) and Asia, 10. These places differ in their pricing and also rules such as minimum order sizes, possible matching prices, matching rules (price-size priority, time-price priority). Therefore each venue differs in its liquidity and microstructure profile.
A dark pool can be defined as a crossing network, a matching system where order information such as bids and offers, depth of book, number of orders, buy/sell imbalances, where the order will sit in the queue, are not displayed. Different orders, small or large, buy or sell can be entered into the dark pool and executed only when there is a match. The opacity of dark pool, which is also an advantage in privacy and avoidance of leakage of information sense, makes it difficult for sophisticated users to determine if their order will be placed at a specified price. Dark pools are maintenained by third party vendors and brokers and allow customers to cross at the midpoint of the bid-ask spread. The internal dark pools of brokers are used for matching internal and client orders away from the displayed exchanges. Third party dark pools (to name few Bids Trading, Liquidnet, and Level ATS) provide customers with the opportunity to trade large block positions anonymously, which reduces market impact and information leakage.
List of exchanges and venues
The following is a list of largest stock exchange operators in 2021, listed by market cap of listed companies, published by Statista Research Department, Feb 1, 2022.
Types of orders
Different types of orders can be found in the market - market, limit, stop loss ... For algorithmic trading, the most important ones are marketable limit, limit and market.
Market Order: the algorithm is instructed to buy or sell at the best available market price. This order is most likely to be executed as there are no restrictions on its price and it will not be placed into an order book.
Limit Order: the algorithm is instructed to buy or sell at the specified limit price or better, which implies that its execution is not guaranteed, but will "provide" liquidity. Usually, a limit order will be entered into the order book of a venue or an exchange and its eligibility to execution will be subject to the queue.
Marketable Limit Order: the algorithm is instructed to buy or sell at a specified price or better. The order will be cancelled in case no existing orders can match those instructions.
Rebates: customers posting liquidity a rebate may be received, and for the takers of liquidity, a rebate may be provided, depending on the venue or exchange.
Depending upon the exchange or venue, customers may receive a rebate for posting liquidity to the exchange and others may provide a rebate for taking liquidity from the exchange.
Execution Options - How the order is executed ?
In the common case, the investor provides the broker with the order or basket to trade in the market on their behalf, and expecting best execution. Brokers receive a commission for their role in the execution, however all market risk and price uncertainty are incurred by the clients. In agency execution, the profit to be perceived by the broker will be reduced by any applicable fees incurred during trading.
Principal bid is when the client provides the broker with the order (single stock order) or basket (basket of stock), and immediate executions at specified prices (it can be closing price, or the midpoint of the bid-ask spread at some agreed upon point in time) are provided by the broker. When it comes to single stock, the principal bid premium is been incorporated any market events and company specific risk. For a basket principal bid, different brokers are usually solicited for bids, with information such as trade list value, average order size, volatility, risk and tracking error.
Investors, not brokers, generate research based on forecasts of securities movements and their existing allocations, all within the quantitative portfolio management framework.
The customer places an order via electronic networks, greatly reducing errors and misunderstandings and it arrives instantaneously on the desktop of the broker .
Optimal execution algorithm (minimum execution costs and risk) is then selected by the broker or customer.
Selected algorithm electronically divides in small orders the main order and routes them to different trading venues and exchanges.
Those fragmented orders are then matched by the venues, and they acknowledge the execution.
The order acknowledgment is then sent it back to the client, and broker receives his commission.
Some clients go even further and prefer to do away with broker service altogether, building their own execution algorithms, keeping a higher share of the profits. Clients taking the largely broker-independent route are said to engage in “direct access” to the markets, and their execution process consists of the following steps:
Being granted a privilege to access the exchange directly (and being charged for it) for a negotiated per-trade or per-volume fee. Using the identification of the broker, the order routing systems of the investor can then send messages directly to the exchange.
Investor computer systems or analysts generate a portfolio allocation decision (that can be high-or low-frequency) that involves a number of trading orders.
To efficiently place orders directly with different trading venues, the client uses his own order splitting and routing algorithms.
One or several exchanges and trading venues match the orders, and acknowledge execution directly to client.
Settlement information are then sent to the broker.
In Electronic Execution Algorithms, the algorithm used depends on the characteristics of the order and the prevailing market conditions. Algorithms are programmed to execute various strategies, such as, sourcing the best immediately available price; working an order over time or at a particular volume participation rate; managing an order to a particular execution benchmark; or make decisions about the best way to route the order to the exchange.