Order matching system: Difference between revisions

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{{Short description|Electronic system in the stock market}}

[[File:Deutsche-boerse-parkett-ffm008.jpg|thumb|right|Order matching at the heart of trading systems in [[Deutsche Börse]].]]

An '''order matching system''' or simply '''matching system''' is an electronic system that matches [[order (exchange)|buy and sell orders]] for a [[stock market]], [[commodity market]] or other [[financial exchange]]s. The order matching system is the core of all electronic [[Exchange (organized market)|exchanges]] and are used to execute orders from participants in the exchange.

Orders are usually entered by members of an exchange and executed by a central system that belongs to the exchange. The algorithm that is used to match orders varies from system to system and often involves rules around [[best execution]].<ref>{{cite web |url=httphttps://www.cmegroup.com/confluence/display/EPICSANDBOX/Supported+Matching+Algorithms |title=Supported Matching Algorithms |publisher=[[CME Group]] |accessdateaccess-date=November 1, 20152021-05-13}}</ref>

The order matching system and [[Implied Order System|implied order system]] or Implication engine is often part of a larger [[electronic trading]] system which will usually include a [[settlement system]] and a [[central securities depository]] that are accessed by [[electronic trading platform]]s. These services may or may not be provided by the organisation that provides the order matching system.

The matching algorithms decide the efficiency and the robustness of the order matching system. There are two states for a market,: continuous trading where orders are matchesmatched immediately or auction where matching is done at fixed intervals. A typicalcommon example when a matching systemssystem is worksused in auction state is at the market open when a number of orders have built up.

==History==

Electronic order matching was introduced in the early 1980s in the United States to supplement [[open outcry]] trading. (forFor example the then Mid West Stock Exchange (now the [[Chicago Stock Exchange]]) launched the "MAX system, becoming one of the first stock exchanges to provide fully automated order execution" in 1982).<ref>{{cite web |url=http://www.chx.com/chx/history/ |title=History:Chicago Stock Exchange Historical Timeline|accessdateaccess-date=November 1, 2015}}</ref><ref>''Commodity Exchange Act Cea: Issues Related to the Regulation of Electronic Trading'' by Thomas J. McCool, Cecile O. Trop 2000 {{ISBN|0-7567-0329-8}} page 18</ref>

==Algorithms==

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The trading mechanism on electronic exchanges is an important component that has a great impact on the efficiency and [[Market liquidity|liquidity]] of financial markets. The choice of matching algorithm is an important part of the trading mechanism. The most common matching algorithms are the ''Pro-Rata'' and ''Price/Time'' algorithms.

Comparison of Price/Time and Pro-Rata Following are few basic remarks about the two basic algorithms and their comparison. <ref>{{Citecite webCiteSeerX |urllast1=https://pdfs.semanticscholar.org/6d92/0528fc5a3a25cb7a627b93ae3e7d5789bde8.pdfJanecek |first1=Karel |last2=Kabrhel |first2=Martin |title=Matching Algorithms of International Exchanges |websiteyear=pdfs.semanticscholar.org2007 |dateciteseerx=December 10.1,.1.192.6947 2007}}</ref>

|author=Karel Janeˇcek and Martin Kabrhel |access-date=2018-12-14}}</ref>

===Price/Time algorithm (or First-in-First-out)===

* Motivates to narrow the spread, since by narrowing the spread the limit order is the first in the order queue.

* Discourages other orders to join the queue since a limit order that joins the queue is the last.

* Might be computationally more demanding than Pro-Rata. The reason is that market participants might want to place more small orders in different positions in the order queue, and also tend to “flood”"flood" the market, i.e., place limit order in the depth of the market in order to stay in the queue.

===Pro-Rata algorithm===

* Motivates other orders to join the queue with large limit orders. As a consequence, the cumulative quoted volume at the best price is relatively large.

* Does not motivate to narrow the spread in the natural way. This weakness is partially offset by introducing the time priority element for the first order that makes a new price.

==Efficiency==