Smart order routing: Difference between revisions

Revision as of 15:23, 2 August 2020

Latest revision as of 16:45, 27 May 2025

(9 intermediate revisions by 8 users not shown)

Line 1:

{{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>

'''Smart order routing''' (SOR)<ref>{{cite newspaper |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

|author=Luke 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 ...

|author1=Thierry Foucault |author2=Marco Pagano |author3=Ailsa Röell

|year=2013}}</ref> is an automated process of handling orders, aimed at taking the best available opportunity throughout a range of different [[trading venue]]s.

The increasing number of various trading venues and [[Multilateral trading facility|MTFs]] leadshas led to a surge in liquidity fragmentation, when the same [[stock]] is traded on several different venues, so the price and the amount of stock can vary between them. SOR serves to tackle liquidity fragmentation, or even benefit from it. Smart Order Routing is performed by Smart Order Routers - systems designed to analyze the state of venues and to place orders the best available way, relying on the defined rules, configurations and algorithms.

== History of Smart Order Routing==

===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 newspapernews |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

|authorfirst=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"direct sponsored access”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

|accessdateaccess-date=31 October 2016}}</ref>

By 1988, '''SuperDOT''' included "roughly 700 communications lines that carry buy and sell orders."<ref>{{cite magazine

|magazine=[[Network World]]

|date=October 17, 1988 |page=7 |title=}}</ref>

===1990s===

Line 41 ⟶ 33:

|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 2007”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

Line 50 ⟶ 42:

|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>

== Benefits and disadvantages of Smart Order Routing ==

SOR provides the following benefits:<ref name=":0">{{Cite web|last=Itkin|first=Iosif|title=Liquidity Fragmentation & SOR|url=http://www.slideshare.net/IosifItkin/liquidity-fragmentation-sor|journal=|volume=|date=2011-09-27}}</ref>

* Simultaneous access to several venues;

* Automatic search for the best Price;

Line 64 ⟶ 56:

* Transparency of information, concerning your transactions, for the third party;

== A brief conceptConcept ==

The idea of Smart Order Routing is to scan the markets and find the best place to execute a customer's order, based on price and liquidity.<ref>{{Cite journal|title=Stocks for Jocks|url=http://www.investorbrain.com/index.php/logicalblocks/2005/04/|journal=Barron's|date=2005-04-25|volume=}}</ref>

Thus, SOR can involve a few stages:

Line 95 ⟶ 87:

==Algorithmic trading and SOR==

The classic definition of Smart Order Routing is choosing the best prices and order distribution to capture liquidity. “Forwarding"Forwarding orders to the “best”"best" out of a set of alternative venues while taking into account the different attributes of each venue. What is “best”"best" can be evaluated considering different dimensions – either specified by the customer or by the regulatory regime – e.g. price, liquidity, costs, speed and likelihood of execution or any combination of these dimensions".<ref name=":2">{{Cite journal|lastlast1=Gomber|firstfirst1=Peter|last2=Gsell|first2=Markus|title=Catching up with technology – The impact of regulatory changes on ECNs/MTFs and the trading venue landscape in Europe|url=http://www.dbresearch.de/PROD/DBR_INTERNET_DE-PROD/PROD0000000000203508/Catching+up+with+technology+-+The+impact+of+regulatory+changes+___.pdf|journal=Competition and Regulation in Network Industries|volume=|issue=The Future of Alternative Trading Systems and ECNs in Global Financial Markets}}</ref>

In some cases, algorithmic trading is rather dedicated to automatic usage of synthetic behavior. "Algorithmic trading manages the “parent”"parent" order while a smart order router directs the “child”"child" orders to the desired destinations."<ref name=":1" />

"... 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:

Having the initial Order Book:

{| class="wikitable" style="text-align:center"

! colspan="2" |Preferred venue

Line 126 ⟶ 118:

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:

Line 245 ⟶ 237:

|}

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 targettingtargeting 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" />

== Cross-Border Routing ==

Some institutions offer cross-border routing for inter-listed stocks. In this scenario, the SOR targettingtargeting 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.

== Development and testing ==

=== Providers ===

* [[BATS Global Markets|BATS]]

* [[Fidessa]]

* [[Quod Financial]]

* [[MillenniumIT]]

* [[Software AG]]

=== TestingSee also ===

* [[Best execution]]

There are currently few companies, officially defined as providers of testing and quality assurance of the SOR systems:

* [[Central limit order book]]

* Allied Testing<ref>{{Cite web|url=https://www.alliedtesting.com/system/files/Advanced%20SOR%20Testing%20-%20Allied%20Testing%20Whitepaper_1.pdf|title=Advanced SOR Testing: Addressing the challenges in testing advanced execution platforms|last=Itkin|first=Iosif|last2=Zverev|first2=Alexey|date=|website=|publisher=|access-date=|last3=Buyanova|first3=Olga|last4=Klyachko|first4=Dasha}}</ref>

* [[Dark pool]]

* Exactpro

* [[LuxoftOrder book]]

==References==