Trade Execution

Trading has undergone a significant transformation, becoming more feasible and accessible than ever before. In contrast to a few decades ago, when trading was often met with uncertainty and numerous questions, today’s stock market sees around 158 million active traders daily. This remarkable achievement stems from the increased consistency and confidence in everyday trading, a development that has taken considerable time to establish.

Nonetheless, ensuring effective trade execution is a critical aspect that traders must prioritize. This component involves various elements that are essential to understand before moving forward. In this article, we will explore key factors that help you grasp the intricacies of trade execution.

What is Spot Trade execution?

A spot trade refers to the buying or selling of a foreign currency, financial instrument, or commodity for immediate delivery on a specified date. This transaction typically involves the actual receipt of the currency, commodity, or instrument. The price variation between a spot contract and a future or forward contract is influenced by factors such as interest rates and the duration until maturity. In the context of foreign exchange, the exchange rate applied is termed the spot exchange rate.

Foreign exchange spot contracts are among the most widely traded financial instruments. These contracts are generally set for delivery within two business days, whereas most other financial instruments typically settle on the next business day.

Understanding Trade execution

Trade execution occurs when a buy or sell order is accomplished successfully. To execute a trade, an investor must first submit a buy or sell order through their brokerage account, which is then forwarded to a broker. The broker will then decide which market to send the order to on behalf of the investor. Only once the order is fulfilled in the market can it be considered executed.

The timing and method of trade execution can impact the price that investors ultimately pay for a stock. Timing is crucial, as trades are not executed immediately. Because orders must pass through a broker before reaching the market, stock prices may fluctuate by the time the order is fulfilled.

Different Methods of Trade execution

Trade Execution can be done using different methods and timing; both traits play a crucial role. Below are the essential methods through which one can indulge in trade execution.

Over-the-counter (OTC) Market Maker

Brokers have the option to send their orders to a market maker instead of the market itself. Market makers are companies that trade stocks. To entice brokers to send orders their way, market makers may offer payment, known as “payment for order flow.”

Over-the-counter (OTC) Market Maker

Investors can buy and sell stocks through over-the-counter trading. A market maker in the over-the-counter market might compensate a broker to route their orders to them.

Electronic Communications Network (ECN)

Investors can submit their buy and sell requests to an Electronic Communication Network (ECN), where a computerised system pairs them together. This is commonly done when there is a limit order, where the investor specifies a particular price at which they want to buy or sell a stock.

Internalisation

At times, the broker’s company might already have stocks in its possession. If this is the case, it will handle the trade internally by using its stock inventory to fill the order. If there is a variance in the bid-ask spread, the broker could potentially profit from this transaction.

Example of Trade execution

Here is a concise example for you to infer the trade execution better

Let’s say an investor decides to purchase 1000 shares of a stock by placing a market order. The current price of the stock is $500. The investor’s order may be directed to a market maker who can provide a better price than $500. If the order is sent to a market maker offering a price of $490, then the investor will end up buying the shares at the reduced price.

Frequently Asked Questions

How Trade Execution Works?

When a broker receives an order, there are several options for executing it. They can choose to send the order to the New York Stock Exchange (NYSE), a market maker, their electronic communications network, or use their own securities inventory to make the trade.

What Does It Mean for Individual Investors?

A retail investor, also known as an individual investor, is someone who uses their own money to make investments, often using an online broker, bank, or mutual fund

What happens after trade execution?

Once a trade is completed, it goes into the settlement period.

What is the best execution in trading?

Ensuring the best possible execution is a key responsibility for brokers, as they are required to act with diligence when carrying out trades in order to secure the most favourable terms for their clients.

What is a trade execution system?

In securities trading, various systems are employed to connect buyers and sellers. These systems, known as execution mechanisms, categorise markets based on the method they use.