On defining an order and order type
Market structure critics and pundits blame recent market uncertainly/volatility on the presence of hundreds, or even thousands of different order types that over-complicate and bias the trading process. In order to add some structure to this important debate, we wanted to take a step back and try to define what constitutes an order type, and then analyze how many different kinds of orders a trader can send to an exchange. If we are going to properly assess how many order types actually exist, we have to define exactly what it is that we’re trying to count.
In our opinion, the limit order is the building block of the market structure. It is a basic set of instructions, such as side, size, and price (limit) instruction that communicates a desire to obtain (liquidate) a position in a financial instrument. A derivative of the limit order is the market order, for which the limit is infinity. (See Purging the Market Order – A Dangerous and Outdated Order Type in the Modern Market Structure.)
All order types build upon the limit order. In our view, an order type is an algorithm that gives an exchange, or venue, the discretion to automatically make real-time adjustments to an order’s price (limit) or quantity specifications, as well as the market conditions that should activate order processing. Guidance, constraints or limitations that are applied to a limit order are simply additional, and conditional, order handling instructions.
In the execution space, exchanges compete with each other in three areas: technology (speed and consistency of matching experience, order processing and data dissemination), order types (that define the experience in the exchange) and price. Order types can be an innovative way to enhance execution quality and control. Using our definition of order type, we can start to segment exchange execution offerings and begin the process of counting how many truly exist (and ultimately, the impact the variety of order types have on the efficiency of the capital markets).
Order types can control four variables: side, price, size, and time. We are not aware of any order types that change the side of an order. Order types have tended to control the other three components. Examples include:
– Price (control): Sliding, Pegging, Discretion
– Size (control): All-or-None (AON), Fill-or-Kill (FOK)
– Conditional/events: Stop, Minimum Fill, and in the options market, and underlying stock price qualifiers.
In markets where internalization and block sized orders by regulation have to be executed at an exchange, additional (event) order type would include (Broker) Crosses.
We need to make a special mention about Smart Order Routing (SOR). SOR is clearly an order type because the exchange exercises algorithmic real-time discretion on the child orders (where and how much to send). We view it as a conditional order in the sense that if the exchange doesn’t have the liquidity then it routes out for additional liquidity capture.
Lastly, in the options markets, there are also order types that define complex or multi-leg (security) orders on “complex order books.”
Modifiers are order-handling instructions associated with an order type. Types of modifiers and examples include:
– Display: size, market maker identification
– Location (control): book only, directed routing, Smart Order Routing
– Time in force: Immediate-or-Cancel (IOC), Fill-and-Kill (FAK), Day, Good-to-Cancel or Good-to-Date (GTC/GTD)
– Risk prevention: inter-firm trade prevention, market maker match trade prevention
– Reg NMS compliance: Intermarket-Sweep-Order (ISO)
Before defining this concept for ourselves, we trolled the Internet and academic journals for a definition of “order type.” We were surprised to find a dearth of definitions. Before addressing the question of market structure complexity, we need to define and classify the order type. Only then can we start to accurately categorize and count the types of orders that exist in the market.
Gary Stone has been with Bloomberg since 2001. As Chief Strategy Officer, he is responsible for the discovery of innovative and unique products and forming strategic relationships for Tradebook. He began as a Senior Analyst before being named Director of Trading Research & Strategy in 2004, adding Tradebook development to his responsibilities in 2007.