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{{unreliable sources|date=April 2013}}
'''Smart order routing''' ('''SOR''') is an automated process of handling [[Order (exchange)|orders]], aimed at taking the [[best execution |best available opportunity]] throughout a range of different [[trading venue]]s.<ref>{{cite news |newspaper=[[Wall Street Journal]] |url=https://www.wsj.com/articles/SB119785381762232795 |quote=had led banks and brokers ... to offer smart order routing |title=Brokers doubt forecastsof trading fragmentation |first=Luke |last=Jeffs |date=December 17, 2007}}</ref><ref>{{cite book |title=Market Liquidity: Theory, Evidence, and Policy|quote=They often use smart order-routing technologies to ... |first1=Thierry |last1=Foucault |first2=Marco |last2=Pagano |first3=Ailsa |last3=Röell |year=2013}}</ref>
The increasing number of various trading venues and [[Multilateral trading facility|MTFs]]
== History
===1980s===
The forebears of today's smart order routers appeared in the late 1980s: "In an attempt to lock in the client order flow and free traders up from smaller trades, in order to handle the larger trades, many of the larger broker dealers began to offer a new service called
'''{{visible anchor|Direct Order Turnaround}} or DOT'''.<ref name=DOT.NYT1988>{{cite news |newspaper=[[The New York Times]]
|url=https://www.nytimes.com/1988/01/15/business/stock-exchange-sets-test-to-curb-program-trading.html
|title=Stock Exchange sets test to curb Program Trading
|first=Anise C. |last=Wallace |date=January 15, 1988}}</ref> ''DOT'' boxes were the first electronic machines to provide the institutional buy-side with what we now call "direct sponsored access", they, however, were not very smart yet (they could be directed to only one destination, the New York Stock Exchange)".<ref name=":1">{{cite journal
|last=O’Conor |first=Michael
|title=Smart or Out‐Smarted? |journal=Jordan & Jordan |date=2009-06-03
|url=https://www.jandj.com/sites/default/files/library/Smart_Order_Routing_article_final_03-06-2009.pdf
|access-date=31 October 2016}}</ref>
By 1988, '''SuperDOT''' included "roughly 700 communications lines that carry buy and sell orders."<ref>{{cite magazine
It was in the USA, in the late 1990s, that the first instances of Smart Order Routers appeared: "Once [[alternative trading system]]s (ATSes) started to pop up in U.S. cash equities markets … with the introduction of the U.S. [[Securities and Exchange Commission]]’s (SEC’s) Regulation ATS and changes to its order handling rules, smart order routing (SOR) has been a fact of life for global agency broker Investment Technology Group (ITG)."<ref>{{Cite news|url=http://www.smart-trade.net/wp-content/uploads/2012/12/DWT1005_SmartOrderRouting_Report_web.pdf|title=Navigating the Future of Smart Order Routing|last=|first=|date=2009-10-05|work=Dealing with Technology Special Report|editor-last=Daly|editor-first=Rob|access-date=|via=}}</ref>▼
|magazine=[[Network World]]
|date=October 17, 1988 |page=7 |title=}}</ref>
===1990s===
As a reaction to the introduction of [[Markets in Financial Instruments Directive 2004|MiFID]] (Europe) and [[Regulation NMS|Reg NMS]] (USA), Smart Order Routers proliferated in Europe in 2007-2008, their sole purpose consisting in capturing [[Lit pool|liquidity on lit venues]], or doing an aggressive or a passive split, depending on the market data. Later the SOR systems were enhanced to cope with [[High-frequency trading|High Frequency Trading]], to decrease latency and implement smarter algorithms, as well as work with [[dark pool]]s liquidity.<ref>{{Cite news|url=http://www2.itiviti.com/The_SOR2_Evolution|title=The Evolution of Smart Order Routers: For the European equity markets|last=Wennerberg|first=Christer|date=|work=|access-date=|via=}}</ref>▼
▲It was in the
|url=http://www.smart-trade.net/wp-content/uploads/2012/12/DWT1005_SmartOrderRouting_Report_web.pdf
|title=Navigating the Future of Smart Order Routing
|date=2009-10-05 |work=Dealing with Technology Special Report |editor-last=Daly |editor-first=Rob}}</ref>
===2000s===
Here are some US statistics from 2006-2007: "Smart order routing capabilities for options are anonymous and easy to use, and optimizes execution quality with each transaction". "In a study conducted earlier this year in conjunction with Financial Insights, BAS found that about 5% of all equity orders were executed using trading algorithms, with this number expected to increase to 20% by 2007”.<ref>{{Cite news|url=http://www.prnewswire.com/news-releases/banc-of-america-securities-announces-smart-order-routing-for-equity-options-55081342.html|title=Banc of America Securities Announces Smart Order Routing for Equity Options: New Product Supports Best Execution in Derivatives Markets|last=|first=|date=2006-01-24|work=PRNewswire|access-date=|via=}}</ref>▼
▲As a reaction to the introduction of [[Markets in Financial Instruments Directive 2004|MiFID]] (Europe) and [[Regulation NMS|Reg NMS]] (USA), Smart Order Routers proliferated in Europe in
|url=http://www2.itiviti.com/The_SOR2_Evolution
|title=The Evolution of Smart Order Routers: For the European equity markets
|last=Wennerberg |first=Christer}}</ref>
▲Here are some US statistics from 2006-2007: "Smart order routing capabilities for options are anonymous and easy to use, and optimizes execution quality with each transaction". "In a study conducted earlier this year in conjunction with Financial Insights, BAS found that about 5% of all equity orders were executed using trading algorithms, with this number expected to increase to 20% by
Smart order routing may be formulated in terms of an optimization problem which achieves a tradeoff between speed and cost of execution.<ref name="contkukanov">{{cite journal|last1=Cont|first1=Rama|last2=Kukanov|first2=Arseniy|title=Optimal order placement in limit order markets|journal=Quantitative Finance|volume=17|pages=21–39|date=2017-01-03|doi=10.1080/14697688.2016.1190030|citeseerx=10.1.1.245.1411}}</ref>▼
|url=http://www.prnewswire.com/news-releases/banc-of-america-securities-announces-smart-order-routing-for-equity-options-55081342.html
|title=Banc of America Securities Announces Smart Order Routing for Equity Options: New Product Supports Best Execution in Derivatives Markets
|date=2006-01-24 |work=PRNewswire}}</ref>
▲Smart order routing may be formulated in terms of an optimization problem which achieves a tradeoff between speed and cost of execution.<ref name="contkukanov">{{cite journal
== Benefits and disadvantages of Smart Order Routing ==▼
|last1=Cont |first1=Rama |last2=Kukanov |first2=Arseniy
SOR provides the following benefits:<ref name=":0">{{Cite journal|last=Itkin|first=Iosif|title=Liquidity Fragmentation & SOR|url=http://www.slideshare.net/IosifItkin/liquidity-fragmentation-sor|journal=|volume=|date=2011-09-27}}</ref>▼
|title=Optimal order placement in limit order markets
|journal=Quantitative Finance |volume=17 |pages=21–39 |date=2017-01-03
|doi=10.1080/14697688.2016.1190030 |citeseerx=10.1.1.245.1411|s2cid=14652208 }}</ref>
▲SOR provides the following benefits:<ref name=":0">{{Cite
* Simultaneous access to several venues;
* Automatic search for the best Price;
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* Transparency of information, concerning your transactions, for the third party;
==
The idea of Smart Order Routing is to scan the markets and find the best place to execute a
Thus, SOR can involve a few stages:
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* Settings/preferences of a certain client;
* The state of available markets/market data;
Venue parameters, such as average latency, commission, and rank can be used to prioritize certain venues. Custom algorithms, like synthetic orders (peg, iceberg, spraying, [[TWAP]]), can be used to manage orders automatically, for instance, if a specific client has certain routing preferences among several brokers, or certain rules for handling of incoming, or creation of outgoing orders. It is also crucial to track the actual venue situation, like the trading phase, as well as the available opportunities. Thus, any Smart Order Router requires real-time market data from different venues. The market data can be obtained either by connecting directly to the
3. Routing the orders to one or several venues according to the decision made at step 2 using:
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==Algorithmic trading and SOR==
The classic definition of Smart Order Routing is choosing the best prices and order distribution to capture liquidity.
In some cases, algorithmic trading is rather dedicated to automatic usage of synthetic behavior. "Algorithmic trading manages the
"... slicing a big order into a multiplicity of smaller orders and of timing these orders to minimise market impact via electronic means. Based on mathematical models and considering historical and real-time market data, algorithms determine ex ante, or continuously, the optimum size of the (next) slice and its time of submission to the market. A variety of principles is used for these algorithms, it is aimed at reaching or beating an implicit or explicit benchmark: e.g. a volume weighted average price (VWAP) algorithm targets at slicing and timing orders in a way that the resulting VWAP of its own transactions is close to or better than the VWAP of all transactions of the respective security throughout the trading day or during a specified period of time".<ref name=":2" />
However, smart order routing and algorithmic trading are connected more closely than it seems. Since even Smart Order Routing can be considered the simplest example of algorithm, it is reasonable to say that algorithmic trading is a logical continuation and an extension of Smart Order Routing.
This is a common example of a simple Smart Order Routing strategy
Having the initial Order Book, the SOR strategy will create child orders, that is orders which aim at completing the initial SOR parent order. These orders can either be aggressive or passive depending on the current context and the SOR algorithm. In this example [[Immediate or cancel|IOC]] (immediate or cancel) orders are used:
{| class="wikitable" style="text-align:center"
! colspan="2" |Preferred venue
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1) An SOR Buy Day order for 1000@21.5 comes;
2) Aggressive child order to grab opportunity on preferable venue created: Buy IOC 100@21.5;
3) Aggressive child order to grab opportunity on Venue 1 created: Buy IOC 200@21.5;
4) The remaining part placed passive to the Preferred venue:
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|}
As there are latencies involved in constructing and reading from the consolidated order book, child orders may be rejected if the target order was filled before it got there. Therefore, modern smart order routers have callback mechanisms that re-route orders if they are rejected or partially executed.
If more liquidity is needed to execute an order, smart order routers will post day limit orders, relying on probabilistic and/or machine learning models to find the best venues. If the targeting logic supports it, child orders may also be sent to dark venues, although the client will typically have an option to disable this.
More generally, smart order routing algorithms focus on optimizing a tradeoff between execution cost and execution time.<ref name="contkukanov" />
Some institutions offer cross-border routing for inter-listed stocks. In this scenario, the SOR targeting logic will use real-time FX rates to determine whether to route to venues in different countries that trade in different currencies. The most common cross-border routers typically route to both Canadian and American venues; however, there are some routers that also factor in European venues while they are open during trading hours.
* [[Best execution]]
* [[Central limit order book]]
* [[Dark pool]]
* [[
==References==
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