In the quickly-moving environment of stock trading, market orders are executed with little consideration. These represent factors such as how fast transactions are processed and the set up of rival market makers. This article dives a bit deeper into the nuances of order execution in volatile markets. Here’s what it has to say about how orders are processed, the effects of real-time quotes, and the dangers that traders face.
Market orders are executed on a first come first served basis. This requires that all orders sent to market makers or specialists are filled in the order that they were received. In a dynamic and fast-paced market, today’s real-time quotes are tomorrow’s news. By the time your order gets to the market maker, it’s not a true representation of what’s happening in the market. Traders, in turn, often find themselves facing highly surprising results.
When traders place big orders, say one for 10,000 shares, they usually find their orders filled in multiple chunks. This is not a unique situation in the market. One example where this comes into play is when an order for 10,000 shares is filled instead in two separate trades of 5,000 shares. You can open it up and fill it with 2,500 shares at one price. Next, sell the other 7,500 shares at a higher price. Such fragmentation can result in multiple different prices on different parts of the same order, as markets move quickly and can change significantly in minutes or seconds.
The rapid pace at which pricing and trading occurs in volatile markets can lead to dramatic gaps between quotes offered. A market could shift dramatically from the time a “real-time” quote is received to when the actual order is submitted. The impact under these circumstances can be deadly. Traders may be exposed to catastrophic losses if not prepared for sudden price fluctuations.
“Real-time quotes may be far behind what is currently happening in the market.” – Fast Markets service response
To protect themselves from the dangers that come with abrupt price fluctuations, traders frequently use different order types. For example, a stop limit order lets a trader sell stock once it reaches a pre-determined price, like $67. If at any point the stock reaches that price or below, the order is triggered to convert. It will then turn into a limit order, which will fill only at $67 or less. This mechanism is intended to shield traders from adverse price movements in periods of volatility.
Likewise, a stop order to buy at $50 triggers when the stock price hits or goes above that level. At that time it is simply a market order that fills at whatever the current market price is. On the other hand, a sell stop at $67 functions on the same premise. If it does fall to $67 or below, then you’ll have a market order that gets triggered. This order could fill at or around that price.
As you know, the NASDAQ flourishes on a competitive duopoly of market makers. Over 500 firms actively operate as market makers in this immensely robust system. While that diversity generates a rich and vibrant trading ecosystem, it throws a curveball at traders trying to master the rapidly-shifting landscape.
Moreover, certain stocks require initial and maintenance thresholds as high as 70%. This requirement means that most traders need to have a large amount of cash on hand to trade many stocks, limiting their ability to execute trading strategies.
“A limit order establishes a buy price at the maximum you’re willing to pay.” – Limit Orders Can Limit Risk
By learning what these mechanisms are, traders can more effectively access volatile markets. Understand why limit orders are always preferable to market orders. In the process, you’ll not only limit yourself from the potential of surprising executions but allow yourself to use more sophisticated trades. Having defined buy and sell prices allows traders to set their risk to reward ratio and risk management clearly.