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Tarheel Consultancy Services

Corporate Training and Consulting

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Part-02

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Introduction

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Introduction to Orders

What is an Order? A trade instruction given to a broker an e!change

When a trader "ishes to bu# se$$ a securit# he she indicates

What he she "ishes to acco%&$ish 'he ter%s and conditions

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) *ong +hort &osition ) ,a%e o- the securit# places an order


trader

) ,o. o- shares ) Price ) /o" $ong order shou$d re%ain va$id


Order information

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Order In-or%ation

*ong +hort &osition

*ong &osition bu# order needs to be &$aced +hort &osition se$$ order needs to be &$aced

places an order trader

) ) ) ) )

*ong +hort &osition ,a%e o- the securit# ,o. o- shares Price /o" $ong order shou$d re%ain va$id Order information

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Order In-or%ation

'he securit# to be bought so$d %ust be c$ear$# identi-ied

E.g. Assume the investor wishes to go long in IBM stock Place a buy order for IBM shares

places an order trader

) ) ) ) )

*ong +hort &osition ,a%e o- the securit# ,o. o- shares Price /o" $ong order shou$d re%ain va$id Order information

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Order In-or%ation

,o. o- shares to be bought so$d

'his is ca$$ed the Order +i3e E.g. Assume the investor places a buy order for !! shares of IBM Order si"e is !!
) ) ) ) ) *ong +hort &osition ,a%e o- the securit# ,o. o- shares Price /o" $ong order shou$d re%ain va$id Order information
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places an order trader

Order In-or%ation

,o. o- shares to be bought so$d

'his is ca$$ed the Order +i3e E.g. Assume the investor places a buy order for !! shares of IBM Order si"e is !!
) ) ) ) ) *ong +hort &osition ,a%e o- the securit# ,o. o- shares Price /o" $ong order shou$d re%ain va$id Order information
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places an order trader

Order In-or%ation
'rader "ants to bu# se$$

6arket Order

Is trader "i$$ing to acce&t best Price in the %rkt?


5es

,o

+&eci-# the %a! %in &rice trader is &re&ared to acce&t


*i%it Order or *i%it Price

/o" $ong shou$d order re%ain va$id?


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Order In-or%ation

Pre&ared to acce&t the best ter%s avai$ab$e in the %arket 6arket Orders

Wish to &$ace a cei$ing or a -$oor *i%it Orders Price cei$ing 7$oor *i%it Price

E.g. #he investor places a $imit buy order $imit price% &'(

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Order In-or%ation

'he trader needs to s&eci-# ho" $ong he she "ou$d $ike the order to re%ain va$id

E.g. A trader may specify that

the order should be either e)ecuted on submission or canceled *e+she may be prepared to specify a period of time for which he+she is prepared to wait E.g. ,ay Order means that if a suitable match is not found by the end of the day on which the order is entered- it should be canceled
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Order In-or%ation

8!changes do not &er%it orders to sta# a$ive -orever


+&eci-# a %a!i%u% va$idit# &eriod Orders "hich -ai$ to get e!ecuted "ithin this &eriod are auto%atica$$# cance$ed

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Order In-or%ation;

Is it acce&tab$e to &artia$$# -i$$ the order? 8.g. 'ake the case o- a bu# order -or 200 shares. What i- a counter&art# is -ound -or on$# 100 shares?

'he order can be &artia$$# e!ecuted I- investor does not "ish this to ha&&en &$ace an A$$ or ,one 9AO,: order.

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I%&ortance o- an <Order=

Orders are the bui$ding b$ocks o- trading strategies A &ro&er order issued at the right ti%e can>

6ake the di--erence bet"een a &ro-itab$e trade and a cost$# trade It can at ti%es even %ake a di--erence bet"een a trade and no trade

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Wh# Orders?

Orders are essentia$

%ost investors do not &ersona$$# arrange their trades to ensure that others e!ecute their trades as &er their intent? the# %ust s&eci-# a$$ re$evant in-or%ation

8nvisage a$$ &ossib$e contingencies Prescribe suitab$e courses o- action


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@evocation o- order

I- investor "ishes to %odi-# the ter%s otrade

/e she has to cance$ his her e!isting order and resub%it a -resh order A# the ti%e a -resh order is issued? %arket conditions %a# have changed adverse$# An e!isting order %a# get e!ecuted be-ore the trader is ab$e to have it cance$ed
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Prob$e%s "ith %odi-ication

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@evocation 9Bont;:

Borrect s&eci-ication o- order is critica$

+&eed is the essence in order &$ace%ent? e!ecution? and cance$$ation Bo%&uter based trading s#ste%s are su&erior to %anua$ s#ste%s

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'er%ino$og#

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'er%ino$og#
Aid When trader "ants to indicate that he "ishes to bu# a securit#? he "i$$ %ake a bid

O--er When he "ishes to conve# that he is seeking to se$$ he "i$$ %ake an o--er

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'er%ino$og#
When a dea$er "ishes to trade on his o"n account he "i$$ Cuote <a bid= or <an o--er= I- dea$er is trading on beha$- o- a c$ient he "i$$ conve# the bu# se$$ order &$aced b# the c$ient to a broker an auto%ated trading s#ste%
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'er%ino$og#

Order +i3e Aids and o--ers inc$ude in-or%ation the &rice? and a$so about the Cuantit# sought to be transacted. 'his is kno"n as the order si3e.

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'er%ino$og#
Aidding &rice 'he &rice s&eci-ied in a bu# order is ca$$ed <the bid= or <bidding &rice= Asking &rice 'he &rice s&eci-ied in a se$$ order is ca$$ed <the o--er=? <o--ering=? <ask=? or <asking &rice= Aest bid 'he highest bid &rice in the %arket is ca$$ed the <best bid= Aest o--er 'he $o"est o--er &rice in the %arket is ca$$ed the <best o--er=
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'er%ino$og#
'he best bid and o--er are a$so kno"n as the <6arket Aid= and <6arket O--er= Aest Aid and O--er 9AAO: A <6arket Duotation= o-ten ca$$ed a <Aest Aid and O--er= re&orts the best bid and o--er in the %arket at a &oint in ti%e ,ationa$ Aest Aid and O--er 9,AAO: 'he best bid and o--er avai$ab$e an#"here in the E.+. at a &oint in ti%e is kno"n as the <,ationa$ Aest Aid and O--er=
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'er%ino$og#
Aid-Ask +&read 'he di--erence bet"een the best ask and the best bid is the <bid-ask s&read= Inside +&read Aid-Ask s&read is a$so kno"n as the <inside s&read= since it is observed "ithin the %arket 'ouch In 8ng$and the bid-ask s&read is o-ten re-erred to as the touch 'rade Price Once an order is acce&ted? the &rice at "hich the trade is e!ecuted is kno"n as
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'er%ino$og#
Working Order An order %a# not be re$eased -or trading as soon as it is sub%itted. A broker %a# need to check "hether a &articu$ar account is authori3ed to trade. Once an order is acce&ted? but be-ore it is e!ecuted? it is kno"n as a <Working Order=
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Order Friven 6arkets

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Order Friven 6arkets

6arkets %a# be c$assi-ied based on the e!ecution s#ste%

8!ecution s#ste% a set o- &rocedures -or %atching bu#ers and se$$ers

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Order Friven 6arkets

A %arket in "hich bu#ers and se$$ers can trade "ith each other "ithout the inter%ediation o- a dea$er

'hese %arkets have s&eci-ied trading ru$es "hich sti&u$ate as to ho" trades shou$d be e!ecuted

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I$$ustration G Order Friven 6arkets


s&eci-ied trading ru$es

Au#er

trade direct$# "ith each other

+e$$er

s&eci-ied trading ru$es


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'rading @u$es
Order Driven Markets Trading Rules

Order Precedence Rules


ho" bu# and se$$ orders shou$d be arranged and %atched

Trade Pricing Rules


deter%ine the &rice at "hich a trade is to be e!ecuted
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8!a%&$e G Order Friven 6arkets

Auction 6arkets

'rading ru$es de-ine the &rocess b# "hich

bu#ers seek the $o"est avai$ab$e &rices se$$ers seek the highest avai$ab$e &rices 'his is ca$$ed the <Price Fiscover# Process=

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'raders - Order Friven 6arkets

Pub$ic traders are not the on$# traders. Fea$ers can a$so trade.

'here are in -act %arkets "here the# &rovide %ost o- the $iCuidit#.

In a &ure order driven %arket ho"ever? a dea$er is on &ar "ith an# other &ub$ic trader.
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Auctions

6an# order driven %arkets conduct continuous t"o-sided auctions

Auction 6arkets

bu#ers and se$$ers can continuous$# atte%&t to arrange their trades at &rices that var# through ti%e
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O&en outcr# s#ste%s

8$ectronic ru$e based s#ste%s

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O&en Outcr# +#ste%s


A$so ca$$ed Ora$ Auction 'raders negotiate -ace to -ace on the -$oor o- an e!change 'he trading ru$es deter%ine as to "ho can negotiate and "hen

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8$ectronic Aased +#ste%

'he trading ru$es are coded into the order-&rocessing so-t"are

'here are sti$$ so%e outdated s#ste%s "here inco%ing orders are %atched %anua$$# b# c$erks

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Order Friven 6arkets

'hese %arkets e%&$o# c$ear$# s&eci-ied trading ru$es


'raders cannot choose "ith "ho% the# "i$$ trade A trader %a# end u& trading "ith so%eone "ith "ho% he does not have a credit re$ationshi& 'o &revent sett$e%ent -ai$ure? such e!changes e%&$o# e$aborate &rocedures to ensure that a$$ traders are credit"orth# and trust"orth#

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6arket Orders

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6arket Orders

In the case o- a %arket order there is no s&eci-ied &rice $i%it

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6arket Au# Orders

A %arket bu# order

"i$$ be e!ecuted at the best avai$ab$e &rice -ro% the stand&oint o- the trader

this "i$$ be the lowest o- the $i%it &rices s&eci-ied b# a$$ traders "ho have &$aced une!ecuted $i%it se$$ orders &rior to the &$ace%ent o- the %arket order
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6arket +e$$ Orders

A %arket se$$ orders

"i$$ get e!ecuted at the best avai$ab$e &rice -ro% the stand&oint o- the trader

this "i$$ be the highest o- the $i%it &rices s&eci-ied b# the traders "ho have &$aced une!ecuted $i%it bu# orders &rior to the inco%ing %arket se$$ order
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Priorit# @u$es

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Priorit# @u$es

In order to ensure that %arket orders get e!ecuted at the best avai$ab$e &rices? the une!ecuted but va$id $i%it orders at an# &oint in ti%e %ust be sorted according to Priorit# @u$es
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Priorit# @u$es

Price Priorit# @u$e

'i%e Priorit# @u$e

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Price Priorit# @u$e


Buy side A <$i%it bu# order= "ith a higher $i%it &rice ranks higher than a$$ other <$i%it bu# orders= "ith $o"er $i%it &rices Sell side A <$i%it se$$ order= "ith a $o"er $i%it &rice ranks higher than a$$ other <$i%it se$$ orders= "ith higher $i%it &rices

An inco%ing <%arket bu# An inco%ing <%arket se$$ order= is guaranteed order= is guaranteed to get e!ecuted at the to get e!ecuted at the $o"est avai$ab$e &rice on highest avai$ab$e &rice the se$$ side o- the on the bu# side o- the %arket %arket
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'i%e Priorit# @u$e

8.g. /o" shou$d 2 or %ore <$i%it bu# orders= or <$i%it se$$ orders= "ith the sa%e $i%it &rice be &rioriti3ed?

7irst-in--irst-out the one "hich co%es in -irst is auto%atica$$# accorded &riorit#

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*i%it Order Aooks

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*i%it Order Aooks

*i%it Order Aook 9*OA: contains detai$s o- those $i%it orders "hich are current$# va$id? #et have not been e!ecuted so -ar due to unavai$abi$it# o- a suitab$e %atch

In the ear$ier da#s this record "as &h#sica$$# %aintained in the -or% o- a book o- orders 'hese da#s ever#thing is in e$ectronic -or%
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I$$ustration

/o" orders are arranged on the basis o- the &riorit# ru$es /o" %atching bet"een orders on the o&&osite sides o- the %arket takes &$ace

Assume that today is trading

.anuary and that

shares of a company have /ust been listed for Assume that in the first 0! minutes the following orders are placed Copyright Tarheel Consultancy Services
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Bhrono$ogica$ +eCuence oOrders


Time 10>01 10>03 10>01 10>10 10>1( 10>12 10>20 10>2( 10>30 Trader Arvind Aeena Bharu FhiraH 8Ha3 7rancis Iauri /arish *eena Order Side Order Size Limit Price Au# Au# +e$$ +e$$ Au# Au# +e$$ +e$$ Au#
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100 200 200 (00 200 400 (00 200 (00

100.00 100.20 100.10 100.2( 100.00 6arket 100.00 44.40 44.1(


44

I$$ustration 9Bont;:

At 10>01

Arvind=s order "i$$ enter the s#ste%. It is the ver# -irst order so it cannot be %atched "ith an order on the other side.

+ince it is a bu# order it "i$$ go to the to& othe bu# side o- the *OA.
(0

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'ab$e-2 +na&shot o- the *OA at 10>01


Buyers 1ellers

Trader

Order Size 100

Limit Price 100.00

Limit Price

Order Size

Trader

Arvind

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(1

I$$ustration 9Bont;:

At 10>03

Aeena=s order "i$$ enter the s#ste%. It too cannot be %atched because there are no se$$ orders in the book at that &oint in ti%e. /er order "i$$ Cueue u& on the bu# side. Aeena=s $i%it &rice o- 100.20 J Arvind=s $i%it &rice o- 100.00. /ence Aeena "i$$ get &riorit#.

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(2

'ab$e-3 +na&shot o- the *OA at 10>03


Buyers 1ellers

Trader

Order Size 200

Limit Price 100.20

Limit Price

Order Size

Trader

Aeena

Arvind

100

100.00

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(3

I$$ustration 9Bont;:

At 10>01

Bharu=s se$$ order "i$$ enter the s#ste%. /er $i%it &rice o- 100.10 indicates that she is &re&ared to se$$ at this &rice or %ore 'he s#ste% "i$$ tr# and %atch it "ith the best bu# order in the *OA 'he s#ste% -inds a %atch "ith Aeena=s $i%it &rice order o- 100.20
(4

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I$$ustration 9Bont;:

+u%%ar#

A trade is -easib$e. Bharu has sought to se$$ 200 shares and Aeena has sought to bu# 200 shares In the &rocess o- e!ecution? both the orders "i$$ be co%&$ete$# -i$$ed. At "hat &rice "i$$ the trade be e!ecuted?
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One Cuestion re%ains

((

I$$ustration 9Bont;:

On the ,ationa$ +tock 8!change 9,+8: an inco%ing or Active order "i$$ get e!ecuted at the &rice o- the e!isting or Passive order "ith "hich it is %atched

+o in this case the trade "i$$ get e!ecuted at 100.20


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(0

'ab$e-4 +na&shot o- the *OA a-ter the trade

1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Arvind

100

100.00

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(1

I$$ustration 9Bont;:

At 10>10

FhiraH=s se$$ order "i$$ enter the s#ste% "ith a $i%it &rice o- 100.2( 'he s#ste% "i$$ tr# and %atch it "ith the best order on the bu# side "hich has a $i%it &rice o- 100.00 A trade is in-easib$e +o FhiraH=s order "i$$ take its &$ace at the to& o- the se$$ side o- the *OA.
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(2

'ab$e-( +na&shot o- the *OA at 10>10

Buyers

1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Arvind

100

100.00 100.2( (00

FhiraH

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(4

I$$ustration 9Bont;:

At 10>1(

8Ha3=s bu# order -or 200 shares "ith a $i%it &rice o100.00 co%es in It cannot be %atched "ith the best se$$ order In ter%s o- the $i%it &rice it "i$$ have eCua$ &riorit# "ith Arvind=s order /o"ever since it ca%e in $ater it "i$$ be accorded $o"er &riorit# based on the ti%e &riorit# ru$e. /ence it "i$$ be &$aced be$o" Arvind=s order.

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00

'ab$e-0 +na&shot o- the *OA at 10>1(


Buyers 1ellers

Trader Order Size Arvind 100

Limit Price

Limit Price

Order Trader Size (00 FhiraH

100.00 100.2(

8Ha3

200

100.00

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01

I$$ustration 9Bont;:

At 10>12

7rancis= %arket bu# order -or 400 shares "i$$ co%e in. 'his order is assured o- e!ecution i- there ha&&ens to be J1 order on the o&&osite side "ith a cu%u$ative order si3e J or K the si3e othe inco%ing order In this case there is a se$$ order -or (00 shares. /ence the inco%ing order "i$$ be -u$$# -i$$ed. 'he trade &rice "i$$ be the &rice o- the &assive order "hich 100.2(.
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02

'ab$e-1 +na&shot o- the *OA a-ter the trade

Buyers

1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Arvind

100

100.00

100.2(

100

FhiraH

8Ha3

200

100.00

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03

I$$ustration 9Bont;:

At 10>20

Iauri=s se$$ order -or (00 shares "ith a $i%it &rice o- 100.00 "i$$ enter. 'he s#ste% "i$$ tr# and %atch it "ith Arvind=s order. A trade "i$$ resu$t -or 100 shares. /o"ever 400 shares "i$$ re%ain to be -i$$ed on Iauri=s order
04

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I$$ustration 9Bont;:

'he s#ste% "i$$ tr# and %atch the re%ainder othe order "ith 8Ha3=s order A trade "i$$ resu$t -or 200 shares. /o"ever Iauri=s order "i$$ sti$$ not be -u$$# -i$$ed. 7or the ba$ance 200 shares there is no &ossibi$it# o- a %atch. +o the un-i$$ed &ortion "i$$ sta# in the *OA. It "i$$ go to the to& o- the se$$ side since Iauri=s $i%it &rice o- 100.00 is $ess than the &rice o100.2( s&eci-ied b# FhiraH.

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'ab$e-2 +na&shot o- the *OA a-ter the trade

Buyers

1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

100.00

200

Iauri

100.2(

100

FhiraH

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00

I$$ustration 9Bont;:

At 10>2(

/arish=s se$$ order "ith a $i%it &rice o- 44.40 "i$$ enter

Aased on the &rice &riorit# ru$e it "i$$ go to the to& o- the se$$ side o- the *OA

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'ab$e-4 +na&shot o- the *OA at 10>2(


Buyers 1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

44.40 100.00 100.2(

200 200 100

/arish Iauri FhiraH

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02

I$$ustration 9Bont;:

At 10>30

*eena=s bu# order "ith a $i%it &rice o- 44.1( "i$$ enter 'he s#ste% "i$$ tr# and %atch it "ith the best se$$ order "hich has a $i%it &rice o- 44.40 Obvious$# a trade is in-easib$e 'he inco%ing order "i$$ there-ore go to the to& o- the bu# side o- the *OA

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'ab$e-10 +na&shot o- the *OA at 10>30

Buyers

1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

*eena

(00

44.1(

44.40 100.00 100.2(

200 200 100

/arish Iauri FhiraH


10

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Duestion

What "ou$d ha&&en i- a <%arket order= "ere to enter the s#ste% and there "ere to be no <$i%it orders= on the o&&osite side?

8ver# e!change "i$$ s&eci-# a so$ution -or this eventua$it# E.g. On the 21E the incoming order will become a limit order with a limit price e3ual to the last recorded trade price

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'ab$e-11 'he *OA at a Particu$ar Instant


Buyers 1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

44.40 100.00 100.2(

200 200 100

/arish Iauri FhiraH


12

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I$$ustration

Assu%e that the $ast recorded trade took &$ace at a &rice o- 44.20 Assu%e that a <%arket se$$ order= -or (00 shares &$aced b# @aghu enters the s#ste%

Obvious$# a suitab$e %atch cannot be -ound. 'he inco%ing order "i$$ there-ore be converted to a <$i%it se$$ order= "ith a <$i%it &rice= o- 44.20

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'ab$e-12 Post +ub%ission +na&shot o- the *OA


Au#ers
Trader Order Size Limit Price

+e$$ers
Limit Price Order Size Trader

44.20 44.40 100.00 100.2(


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(00 200 200 100

@aghu /arish Iauri FhiraH


14

Duestion

What i- a <%arket order= "ere to enter the s#ste% at the start o- a trading da# and there "ere to be no <$i%it orders= on the other side?

'he inco%ing order in such cases "i$$ be converted to a <$i%it order= "ith a <$i%it &rice= eCua$ to the &revious da#=s c$osing &rice.

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6arket Orders vs. *i%it Orders

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6arket Orders vs. *i%it Orders


Limit Order Iives the investor %ore contro$ over the trade 'raders can contro$ the e!ecution &rice using $i%it orders ,o guarantee that a suitab$e %atch -or such orders can be -ound "ithin a reasonab$e &eriod o- ti%e Market Order Investor has $ess contro$ over the trade 'raders cannot contro$ the e!ecution &rice Iuarantee that trade "i$$ be e!ecuted i%%ediate$#

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I$$ustration - 'ab$e-13

Assu%e that the $ast trade &rice "as 000.20 and the order book at a &oint in ti%e $ooks as -o$$o"s

Buyers

1ellers

Trader Arvind

Order Size 100

Limit Price 100.00

Limit Price 100.2( 100.30 100.30 100.40 100.(0 100.(0

Order Size (00 300 1?100 1?(00 1?000 1?000

Trader FhiraH +o$o%on +uniti +uni$ Lu%ar +"a%#


12

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I$$ustration 9cont;:

Assu%e that 8Ha3 &$aces a bu# order -or 200 contracts "ith a $i%it &rice o100.00

It cannot be %atched "ith an e!isting order +o it "i$$ take its &$ace in the Cueue behind Arvind=s order

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'ab$e-14 +na&shot o- the *OA a-ter 8Ha3=s Order

Buyers

1ellers

Trader Arvind 8Ha3

Order Size 100 200

Limit Price 100.00 100.00

Limit Price 100.2( 100.30 100.30 100.40 100.(0 100.(0

Order Size (00 300 1?100 1?(00 1?000 1?000

Trader
FhiraH +o$o%on +uniti +uni$ Lu%ar +"a%#
20

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I$$ustration 9cont;:

Assu%e that +i%eran &$aces a %arket bu# order -or 1?(00 shares It "i$$ obvious$# get e!ecuted i%%ediate$#.

(00 shares "i$$ be bought at 100.2( 1000 shares "i$$ be bought at 100.30

+o the $ast re&orted trade &rice "i$$ be 100.30

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'ab$e-1( +na&shot o- the *OA a-ter the trade


Buyers 1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Arvind 8Ha3

100 200

100.00 100.00

100.30 100.40 100.(0 100.(0

1?000 1?(00 1?000 1?000

+uniti +uni$ Lu%ar +"a%#


22

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I$$ustration 9cont;:

Assu%e that another %arket order is &$aced -or 1(00 shares b# @ahu$

It too "i$$ get e!ecuted

1000 shares "i$$ get traded at 100.30 And 100 shares at 100.40

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'ab$e-10 +na&shot o- the *OA a-ter the trade


Buyers 1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Arvind 8Ha3

100 200

100.00 100.00

100.40 100.(0 100.(0

1?000 1?000 1?000

+uni$ Lu%ar +"a%#


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I$$ustration 9cont;:

+eeing the %arket &rice Hu%& -ro% 100.20 to 100.40 in a short s&an? other traders "ishing to &$ace bu# orders %a# be induced to &$ace $i%it orders "ith &rices higher than that o- the best order on the bu# side.

Assu%e PooHa &$aces a bu# order -or (00 shares at 100.10 Assu%e AHa# "ho &$aces a bu# order -or 1?(00 shares at 100.1(
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2(

'ab$e-11 'he *OA at the 8nd

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

AHa# PooHa Arvind 8Ha3

1?(00 (00 100 200

100.1( 100.10 100.00 100.00

100.40 100.(0 100.(0

1?000 1?000 1?000

+uni$ Lu%ar +"a%#

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I$$ustration 9cont;:

As can be seen 8Ha3=s order has been &ushed back in the Cueue.

'here is no "a# o- te$$ing "hen it "i$$ get e!ecuted 'here is no guarantee that it "i$$ get e!ecuted at a$$

/ad 8Ha3 &$aced a %arket order instead at the outset it "ou$d have been i%%ediate$# e!ecuted at 100.2(
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6arket Orders

6arket orders are guaranteed to be e!ecuted i- there are su--icient $i%it orders on the other side

Aut the trader has no contro$ over the e!ecution &rice 'he trade &rice "i$$ de&end on the $i%it &rice o- the %atching $i%it order

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6arketab$e *i%it Orders

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6arketab$e *i%it Orders

Aggressive$# Priced

*i%it bu# orders "ith high &rices *i%it se$$ orders "ith $o" &rices

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6arketab$e *i%it Orders


A <*i%it Order=
marketable

i- it can be e!ecuted on sub%ission

Au# Order

marketable

i- higher the $i%it &rice i- $o"er the $i%it &rice


41

+e$$ Order

marketable
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6arketab$e *i%it Orders in &ractice

) $ess than the best avai$ab$e &rice in *i%it Au# Order


in practice

the %arket ) eCua$ to &rice obest se$$ order in *OA

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6arketab$e *i%it Orders in &ractice

) greater than the best avai$ab$e &rice in *i%it +e$$ Order


in practice

the %arket ) eCua$ to &rice obest bu# order in *OA

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I$$ustration - 'ab$e-12 +na&shot o- an *OA


Buyers 1ellers

Trader

Order Size

Limit Price

Limit Price

Order Size

Trader

Ani$ Ashra6ohan

(00 1000 1(00

100.00 44.40 44.1(

100.2( 100.40 100.(0

1300 1200 1(00

Prasad Ah%ed Lu%ar

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I$$ustration;9Bont;:

i- $i%it &rice *i%it Au# Order


executed immediately

greater than 100.2( or %ore


#he limit price for a marketable buy order must be greater than or e3ual to the best available offer

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I$$ustration;9Bont;:

*i%it +e$$ Order

executed immediately

i- $i%it &rice is 100.2( or $ess

#he limit price for a marketable sell order must be less than or e3ual to the best bid
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6arketab$e;9Bont;:
A %arketab$e $i%it order see%s si%i$ar to a %arket order

/ence "h# "ou$d an#one "ish to &$ace a <%arketab$e $i%it order= instead o- a <%arket order=?

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@ationa$e
Market orders Marketa le limit orders A desire -or Cuick A desire -or Cuick e!ecution e!ecution on the &art o- on the &art o- the trader the trader 'rader has no contro$ 'rader can s&eci-# a -$oor or over the e!ecution &ricea cei$ing 'he -reedo% to s&eci-# a -$oor is signi-icant icircu%stances "ere to &rec$ude a %arketab$e $i%it order -ro% getting e!ecuted 42 as &$anned Copyright Tarheel Consultancy Services

@ationa$e
Marketa le limit orders Market orders A desire -or Cuick e!ecution A desire -or Cuick on the &art o- the trader e!ecution on the &art othe trader 'rader can s&eci-# a -$oor or 'rader has no contro$ a cei$ing over the e!ecution &rice 'he -reedo% to s&eci-# a -$oor is signi-icant icircu%stances "ere to &rec$ude a %arketab$e $i%it order -ro% getting e!ecuted as &$anned Copyright Tarheel Consultancy Services

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'ab$e-12 +na&shot o- an *OA

Trader

Buyers
Order Size

Limit Price

Limit Price

1ellers
Order Size

Trader

Ani$ Ashra6ohan

(00 1000 1(00

100.00 44.40 44.1(

100.2( 100.40 100.(0

1300 1200 1(00

Prasad Ah%ed Lu%ar

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100

@ationa$e
Marketa le limit orders

Market orders

@avi issues a $i%it bu# order

Assu%e that a $arge

"ith a $i%it &rice o- 100.30 -or %arket bu# order -or 300 shares.

3000 shares enters Hust be-oreM @avi=s order.

/is e!&ectation is that it "i$$

get %atched "ith the best o--er It &ushes the trade &rice "hich is at 100.2( u& to 100.(0

4#raders throughout the world are monitoring the situation. A split second5s delay in order entry can lead to another order ac3uiring time priority
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@ationa$e
Marketa le limit orders +ince @avi has s&eci-ied a $i%it o100.30 his order "i$$ not be e!ecuted. Instead it "i$$ go to the to& o- the *OA on the bu# side.

Market orders

/ad he &$aced a %arket order it "ou$d have got e!ecuted at 100.(0? an outco%e that %a# not be satis-actor#

6arketab$e $i%it orders give the trader contro$ over the e!ecution &rice but there is e!ecution uncertaint#
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102

*i%it Orders as O&tions

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*i%it Orders as O&tions


+tanding *i%it Order It is an o--er o- $iCuidit# to other traders. It gives the% an option to trade at the $i%it &rice. *i%it +e$$ Order It is a call option that gives other traders the right to bu# *i%it Au# Order It is a put option that gives other traders the right to se$$
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O&tions;
*i%it Order 6hat it is 'he s&eci-ied $i%it &rices are the e!ercise &rices o- the corres&onding o&tions *i%it Order 6hat it is not A$though a $i%it order re&resents an o&tion? it is not an o&tions contract in the conventiona$ sense An o&tions contract is an o&tion to trade that is so$d b# a "riter to a bu#er in return -or a &rice or &re%iu%

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O&tions;
*i%it Orders 6hat it is *i%it orders ho"ever are o&tions given a"a# -or -ree. 'raders "ho &$ace such orders do not receive a &re%iu% *i%it Orders 6hat it is not A trader "ho &$aces a $i%it order does not get an o&tion &re%iu% even though the order re&resents an o&tion.

'here is no e!c$usive o"ner o+o "h# shou$d the trader the o&tion on the other side. o--er an o&tion -or -ree? An# trader can e!ercise the It is because the trader ho&es o&tion b# &$acing a %arket to trade at a better &rice order or a %arketab$e $i%it order
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Bo%&ensation -or traders &$acing $i%it orders


A bu#er "ho has sub%itted /ad he sub%itted a a <standing $i%it order= e!&ects to bu# at the bid &rice re&resented b# his order Bonsider the -o$$o"ing *OA <%arket order= instead he "ou$d have to bu# at the ask &rice

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'ab$e-14 +na&shot o- the Petronet *OA

Trader

Buyers
Order Size

Limit Price

Limit Price

1ellers
Order Size

Trader

Nivek Nikas Ninod NiHa# Nina#

(00 1000 1(00 1000 1(00

20.2( 20.20 20.1( 20.10 20.0(

20.4( 21.0( 21.1( 21.20 21.1(

1300 1200 1(00 2000 1000

Esha E%a Er%i$a Ervi Ettara


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Bo%&ensation;
Marketa le limit orders

Market orders

'he trader "ho has

/ad he &$aced a %arket

&$aced the best bid e!&ects to trade at 20.2(

order he "ou$d have ended u& bu#ing at 20.4(

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Prob$e%s "ith *i%it Orders


Marketa le limit orders A trader &$acing a $i%it order "i$$ not a$"a#s get "hat he is seeking. +o%eti%es the %arket cou$d %ove a"a# -ro% hi% and his order never gets traded I- trader sti$$ "ants to trade he 'rader %a# get a better "i$$ have to chase the %arket &rice than a $i%it order and the &rice he gets %a# be "orse &rice Aidders "i$$ have to increase their bids +e$$ers "i$$ have to $o"er their 110 Copyright Tarheel Consultancy Services o--ers Market orders

I$$ustration;
A trader has &$aced the best bid -or Petronet at 20.2( A %arket order -or 3000 shares co%es in O gets e!ecuted A ne" $i%it bu# order co%es in at 20.40 O 21.00

'he trader observes this? cance$s his $i%it order and> P$aces a -resh $i%it order at 21.00 P$aces a %arket order "hich then gets e!ecuted at 21.1(

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@isks
'raders %a# -ace risks "ith <$i%it orders=

8!ecution uncertaint#
76hen prices move away from their orders limit order traders will fail to trade8

'rader %a# trade and $ater regret it


76hen the price moves towards and through the limit price8
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8!ecution Encertaint#

When &rices %ove a"a# -ro% their orders $i%it order traders "i$$ -ai$ to trade

8.g. in the case o- Petronet>

I- %arket bu# orders kee& entering? the best o--er "i$$ %ove u& -ro% 20.2( 7ro% the &oint o- vie" o- a trader "ho has &$aced a bu# order at 20.0( the odds o- e!ecution "i$$ be reduced

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@egret

When the &rice %oves to"ards and through traders $i%it &rice

'he order "i$$ get e!ecuted I- the %arket continues to %ove shar&$# against the trader? it cou$d %ean signi-icant $osses

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I$$ustration;
In the case o- Petronet? assu%e that a %arket se$$ order -or 4000 shares co%es in It "i$$ cause a bu# order -or 1000 shares at 20.10 to get e!ecuted I- &rice "ere to kee& dec$ining the bu#er %a# have to o--$oad the shares at a $o"er &rice

'he trader observes this? cance$s his $i%it order and> P$aces a -resh $i%it order at 21.00 P$aces a %arket order "hich then gets e!ecuted at 21.1(

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@isks 9Bont;:

'his is ca$$ed e!-&ost regret 'his kind o- regret is an occu&ationa$ ha3ard -or a$$ traders and not Hust those "ho &$ace $i%it orders.

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110

+to&-*oss Order

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+to&-*oss Orders

Order &$aced b# a trader "ho has a &osition in the %arket and "ou$d $ike to cut his $osses and Cuit i%%ediate$# i- the conditions "ere to turn adverse.

+uch a &erson %a# have no desire to c$ose out his &osition at the ti%e o- &$acing his order.

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I$$ustration;
'ake the case o- an investor "ho is $ong in a stock and e!&ects the &rice to rise 'here is a sudden
unantici&ated dec$ine in the %arket 'rader %a# $ike to ensure that the $oss does not e!ceed an acce&tab$e $eve$

Assu%e that trader=s thresho$d $oss corres&onds to a &rice o- PM. >

/e can &$ace a stop order "ith a trigger &rice o- PM


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+to&-*oss Orders 9Bont;:

'he sto& instruction "i$$ &revent the order -ro% getting activated unti$ and un$ess the trigger is hit or breached.

Once the trigger is hit or breached the order "i$$ get triggered o-- and "i$$ beco%e a %arket order.

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'ab$e-20> *OA &rior to the &$ace%ent o- a sto&-se$$ order


Buyers
Trader Aarti Anita
!akanksha

1eller
Limit Price 100.00 44.2( 44.1( 44.(( 44.2( 42.00 Limit Price 100.20 100.30 100.3( 100.40 100.(0 102.00 Order Size (00 1000 (00 100 300 1000 Trader Arvind Anurag A%itabh ArHun AHa# Avinash
121

Order Size 1200 1000 (00 200 (00 1000

Ana%ika Anushua AnHa$i

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I$$ustration;
Assu%e that NiHa# is current$# $ong in 200 shares /e has no intention ose$$ing

I- the %arket "ere to trade at 44.00 or be$o"

/e "ou$d $ike to e!it the %arket i%%ediate$#

/e can there-ore &$ace a sto& se$$ order "ith a trigger &rice o- 44.00

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I$$ustration;
Assu%e that a %arket se$$ order -or 4000 shares co%es in It "i$$ ensure that Aarti=s? Anita=s? Aakanksha=s? Ana%ika=s? and Anushua=s orders are -u$$# -i$$ed

'he $ast trade &rice "i$$ be 44.2(

'his is $ess than NiHa#=s trigger

NiHa#=s order "i$$ get activated and "i$$ get e!ecuted at 42.00 #rigger price in the case 9stop sell order5 will always be less than the best price that is available at the time of placing the order :
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which in ;i/ay5s case is <!!.!!

123

+to& Orders 9Bont;:

+to& Orders can a$so be used b# those "ho "ish to bu# in the event o- adverse %arket conditions

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I$$ustration;

Assu%e that @aHiv has a short &osition in 200 shares

/e e!&ects the %arket to -a$$

/o"ever i- the &rice "ere to rise and hit or cross 100.(0;

;then he "ou$d $ike to o--set his short &osition and e!it the %arket

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I$$ustration;
Assu%e that @aHiv &$aces a sto& bu# order "ith a trigger o- 100.(0

Assu%e that a %arket order -or 3000 shares enters

Arvind=s? Anurag=s? A%itabh=s? ArHun=s? and AHa#=s orders "i$$ be co%&$ete$# -i$$ed 'he $ast trade &rice "i$$ be 100.(0 "hich corres&onds to @aHiv=s trigger

'he sto& bu# order "i$$ get activated and "i$$ get e!ecuted at 102.00
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I$$ustration;

In the case o- sto& bu# orders the trigger &rice "i$$ a$"a#s be greater than the best &rice avai$ab$e in the %arket "hich is 100.20

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+to&-*i%it Orders

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122

+to&-*i%it Orders

An instruction to ho$d the order in abe#ance unti$ a s&eci-ied trigger is hit or breached I- the order is triggered o-- it "i$$ beco%e a $i%it order '"o thresho$d &rices have to s&eci-ied
1. 2.

Activation $eve$ -or the $i%it order *i%it &rice -or the $i%it order

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I$$ustration;NiHa#=s case

NiHa# had s&eci-ied a trigger o- 44.00

/is order got e!ecuted at 42.00

/e had no contro$ over the e!ecution &rice

Aecause the order beca%e a %arket order on activation

NiHa# cou$d have &rotected hi%se$- against such an eventua$it#

/e cou$d have &$aced a <sto& $i%it order= "ith a trigger &rice o- 44.00 and a $i%it &rice o- sa# 44.2( In this case i- the sto& order is activated it "i$$ beco%e a $i%it order at 44.2( +o NiHa# is assured o- a &rice o- 44.2(
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I$$ustration;@aHiv=s case

@aHiv had s&eci-ied a trigger o- 100.(0 When @aHiv &$aced a sto& bu# order it eventua$$# got e!ecuted at 102.00

'o &rotect hi%se$- he cou$d have s&eci-ied a <sto&$i%it order= "ith a trigger o- 100.(0 and a $i%it &rice o- sa# 101

In this case he "i$$ have to &a# a %a!i%u% &rice o- 101

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131

6arket-I--'ouched Order

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132

6arket-i--'ouched 96I': Orders

'his order "i$$ get activated i- the &rice touched or breaches a &re-s&eci-ied trigger Once activated it "i$$ beco%e a %arket order +o> What is the di--erence bet"een such an order and a sto& order?

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133

Fi--. bt"n 6I' Order and +to& Order


Stop loss sell order M"T sell order

'he trigger &rice "i$$ be 'he trigger &rice "i$$ be $ess than the best %ore than the best avai$ab$e &rice avai$ab$e &rice Wi$$ be activated i- the %arket -a$$s and breaches the trigger Wi$$ be activated i- the %arket rises and breaches the trigger

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134

Fi--. bt"n 6I' Order and +to& Order


Stop loss uy order M"T uy order

'he trigger &rice "i$$ be greater than the best &rice that is current$# avai$ab$e Wi$$ get activated i- the %arket rises and breaches the trigger

'he trigger &rice "i$$ be $ess than the best &rice that is current$# avai$ab$e Wi$$ get activated i- the %arket -a$$s and breaches the trigger
13(

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Fi--. bt"n 6I' Order and +to& Order


Limit order M"T order A $i%it order can on$# On activation an 6I' order trade at the $i%it &rice or "i$$ beco%e a %arket better order and "i$$ get e!ecuted at the best avai$ab$e &rice 6I' orders are guaranteed to be e!ecuted on activation but are subHect to e!ecution &rice uncertaint# 130

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'ab$e-21> +na&shot o- an *OA &rior to the &$ace%ent o- an 6I' bu# order


Buyers
Order Size 200 000 400 (00

Trader NiHa# Nirender Nina# Nasudev

Limit Price 100.00 44.20 44.1( 44.00

Limit Price 100.2( 100.3( 100.40 100.(0

1ellers
Order Size 200 200 100 200

Trader @avi @a%esh @uchir @ishi

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I$$ustration;
Assu%e that a trader na%ed @ohit &$aces an 6I' bu# order -or (00 shares at a trigger &rice o- 100.1( A$so assu%e that a %arket se$$ order -or (00 shares enters the s#ste% i%%ediate$# therea-ter

'he $ast trade &rice a-ter the %arket order is -i$$ed "i$$ be 44.20

@ohit=s order "i$$ be triggered o-- and "i$$ get e!ecuted at 100.2( *ad =ohit placed a limit buy order with a limit price of <!!.<( he would have been assured of a trade price of
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>!!.<( or less

132

6arket I%&act

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134

6arket I%&act

*arge %arket orders are %ore di--icu$t to -i$$ than s%a$$ ones *arge %arket orders resu$t in $arge &rice %oves
Large uy order Large sell order Prices %a# %ove do"n substantia$$#

Prices %a# %ove u& substantia$$#

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6arket I%&act 9Bont;:

'he %ove%ent in &rice due to a $arge order is ca$$ed the 6arket I%&act or the Price I%&act o- the order

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'ab$e-20

Trader Aarti Anita Aakanksha Anamika Anushua Anjali

Buyers
Order Size 1200 1000 500 800 500 1000

Limit Price 100.00 99.85 99.75 99.55 99.25 98.00

Limit Price 100.20 100.30 100.35 100.40 100.50 102.00

1ellers
Order Size 500 1000 500 700 300 1000

Trader Arvind Anurag Amitabh Arjun Ajay Avinash


142

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I$$ustration 9Bont;:

A $arge %arket bu# order -or 4000 shares "ou$d get e!ecuted at &rices ranging -ro% 100.20 to 102.00. A $arge %arket se$$ order -or (000 shares "ou$d get e!ecuted at &rices ranging -ro% 100.00 to 42.00

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143

*ot +i3e

'he usua$ unit o- trading is re-erred to as a @ound *ot ,or%a$$# traders trade in %u$ti&$es o- a round $ot

An#thing $ess than a round $ot is an odd $ot.

'he de-inition o- a round $ot de&ends on the instru%ent being traded and the %arket on "hich it trades
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144

8!a%&$es - *ot +i3e

A%erican +tock 8!change ,o standard $ot si3e O a trade can be -or an# nu%ber o- shares 6ost stock e!changes in the E.+. +&eci-# a round $ot as constituting 100 shares Pa&an @ound $ot is eCuiva$ent to 1000 shares

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'i%e Bonditions

'raders s&eci-# ti%e &eriod va$idit# instructions 'he# a$so s&eci-# e!&iration instructions to indicate "hen and ho" their orders beco%e void In &rinci&$e such instructions can be s&eci-ied -or an# kind o- an order
140

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'i%e Bonditions 9Bont;:

'hese conditions are &articu$ar$# i%&ortant -or <standing $i%it orders= and <sto& orders=

'his is because such orders rare$# trade on sub%ission? and so%e %a# never trade

BonseCuent$# there is a need to s&eci-# "hat is to be done "ith un-i$$ed orders

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141

O&en O Iood Orders


Open Order #ood Order An order that that has An order that is e$igib$e not #et been e!ecuted or -or e!ecution is a good cance$ed is an o&en order order A$$ good orders b# de-inition are o&en orders

ever# o&en order need not be a good order

?onsider an order placed on < .uly to buy a stock on or after 0 .uly


On < .uly the order is an 9open order5 But is not a 9good order5
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142

Order Na$idit#

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144

Order Na$idit#

Fa# Orders

Iood 'i$$ Bance$$ed Orders

I%%ediate Iood 'i$$ Bance$ Fa#s Orders Orders

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1(0

Fa# Orders

Na$id on$# -or the duration o- the da# on "hich it is entered I- not e!ecuted during the course o- the da#? the s#ste% auto%atica$$# cance$s it at the end o- the da#

E.g. As of <''' the 1tock E)change of 1ingapore has been permitting only 9good today5 limit orders Every morning the E)change opens with no outstanding orders carried over from the previous day
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1(1

Iood-'i$$-Bance$ed Orders

+uch orders re%ain in the s#ste% ti$$ the# are e!ecuted cance$ed

I- the# are not e!ecuted on the da# on "hich the# are entered? the# "i$$ be carried over to the ne!t da# and so -orth.

Obvious$# the# cannot re%ain in the s#ste% inde-inite$#

'he e!change noti-ies a %a! ti%e &eriod a-ter "hich such orders are auto%atica$$# cance$ed
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I'B Orders va$idit#

6an# brokers give their c$ients a $ist oun-i$$ed I'B orders at the end o- the %onth +o%e brokers cance$ I'B orders a-ter &res&eci-ied ti%e &eriods In the E.+. I'B orders have a %a! va$idit# o- 0 %onths

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Iood-'i$$-Fa#s Order

'he investor has to s&eci-# the nu%ber o- da#s -or "hich the order can sta# in the s#ste% un$ess e!ecuted 'he nu%ber o- da#s that can be s&eci-ied cannot e!ceed the ti%e $i%it set -or I'B orders

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I'F Orders 9Bont;:

,ot a$$ brokers acce&t such orders

It reCuires the% to kee& track o- e!&ir# dates

I'F Orders

Iood-'his-Week Orders

Iood-'his-6onth Orders
1((

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I%%ediate or Bance$ Orders

+uch orders have to be e!ecuted as soon as the# are re$eased into the s#ste%

8$se the# have to be cance$ed

+o%eti%es on$# a &artia$ %atch %a# be -ound

I- so a &art o- the order "i$$ be e!ecuted and the un%atched &ortion "i$$ be i%%ediate$# cance$ed

'he# are a$so kno"n as 7i$$-or-Li$$ 97OL: orders or Iood-on-sight orders

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Other '#&es o- Orders

Iood-a-ter-orders are activated or beco%e va$id on$# a-ter a &re-s&eci-ied date

6arket-on-o&en orders can be -i$$ed on$# at the beginning o- the trading session

6arket-on-c$ose orders can be -i$$ed on$# at the c$ose o- the trading session

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Duantit# Instructions

A$$-or-nothing A$$-or-none 9AO,: orders %ust be either -i$$ed a$$ at once or re%ain une!ecuted 'here are a$so trades "ith a %ini%u% or none instruction

In such cases %u$ti&$e trades can be used to -i$$ an order 8ach trade %ust be -or a Cuantit# that is JK a s&eci-ied %ini%u% si3e +uch orders are a$so kno"n as 6ini%u% Acce&tab$e Duantit# 96AD: orders

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+&read Orders

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1(4

+&read Orders

It is a co%bination o- t"o orders


1. 2.

'o bu# an instru%ent 'o si%u$taneous$# se$$ another instru%ent

+&read orders %a# be %arket s&read orders or $i%it s&read orders

'he trader "i$$ s&eci-# a $i%it -or the acce&tab$e di--erence bet"een the t"o &rices 'he $i%it "i$$ be s&eci-ied as a &re%iu% on either the bu# side or the se$$ side
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Sell Side Premium I- trader "ants to se$$ an instru%ent that is &riced higher than the instru%ent he seeks to bu# +uch orders can be -i$$ed on$# i- the di--erence bet"een the sa$e and &urchase &rices is JK the &re%iu%

Buy Side Premium I- trader "ants to bu# an instru%ent that is &riced higher than the one he "ishes to se$$ +uch orders can be -i$$ed on$# i- the di--erence bet"een the &urchase and sa$e &rice is QK the &re%iu%
101

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'ick +ensitive Orders

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102

'ick +ensitive Orders

A 'ick is the %ini%u% &rice incre%ent or variation observab$e in the %arket

+%a$$est a%ount b# "hich t"o &rices can di--er

A trader "ho "ants to condition his order on the $ast &rice change can sub%it a tick sensitive order
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103

'ick +ensitive Orders

'ick si3e is set b# e!change regu$ations

@.1. Auntil !!!B 6as <+<> of a dollar A>. ( centsB

@.1. AtodayB the system is decimali"ed !.!< dollars A< centB

#okyo 1tock E)change a function of the price

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'ick +i3e
Price P 2000 5en 2000 Q P 3000 3000 Q P 30000 30000 Q P (0000 (0000 Q P 100000 100000 Q P 1000000 P 1000000 Tick Size 1 5en ( 5en 10 5en (0 5en 100 5en 1000 5en 10000 5en
10(

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'ick +ensitive

'raders c$assi-# &rices b# their re$ation to &revious &rices

u&tick i- &rice is higher than the $ast observed &rice do"ntick i- &rice is $o"er than the $ast observed &rice 3ero tick i- &rice is K the $ast observed &rice 3ero do"ntick i- the $ast di--erent &rice observed "as higher 3ero u&tick i- the $ast di--erent &rice observed "as $o"er
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I$$ustration
Previous to Last Price 12.00 12.00 12.10 11.40 Last Price Current Price 12.10 11.40 12.00 12.00 Term

12.00 12.00 12.00 12.00

E&tick Fo"ntick Rero Fo"ntick Rero E&tick

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'ick +ensitive 9Bont;:


A <bu# do"ntick order= A <se$$ u&tick order= can can be -i$$ed on$# on a do"ntick or a 3ero do"ntick 'he trade &rice %ust be 'he trade &rice %ust be $o"er than the $ast higher than the $ast di--erent &rice observed di--erent &rice observed be -i$$ed on$# on an u&tick or a 3ero u&tick

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'ick +ensitive 9Bont;:

When a broker receives a tick sensitive order>

Aroker "i$$ check to see "hether it can be %atched "ithout vio$ating the tick condition

I- not? the order "i$$ be he$d in abe#ance unti$ a suitab$e o&&ortunit# "ere to arise

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'ick Bondition 9Bont;:

'ick condition ensures that tick sensitive orders do not have a %arket i%&act
A broker cannot -i$$ a se$$ u&tick order b# driving &rices do"n Aroker "i$$ have to "ait ti$$ so%eone is &re&ared to

A broker ho$ding a bu# do"ntick order cannot bid u& &rices to encourage se$$ers Aroker "i$$ have to "ait unti$ so%eone is "i$$ing to

trade at a &rice $o"er than trade at a &rice that is the $ast di--erent &rice higher than the $ast
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di--erent &rice

110

I$$ustration;
An investor "ants to bu# shares o- BI+BO at a &rice that is $o"er than the best avai$ab$e ask &rice "hich is current$# 14.10 I- %kt "ere to %ove against hi% to ensure e!ecution ohis order he "i$$ have to cance$ the e!isting order O resub%it a %kt order $i%it order "ith a higher &rice

One a$ternative is to sub%it a $i%it order at sa# 14.1(

Another a$ternative is to sub%it a

bu#
111

do"ntick order
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I$$ustration;Au# Fo"ntick Order


Assu%e that "hen the order is &$aced? BI+BO is on a 3ero u&tick at 14.14 +ince the order is tick sensitive the trader cannot bu# unti$ the &rice dro&s to 14.13 or $ess I- so? the broker can on$# e!ecute the tick sensitive order at 14.1( or $ess

Assu%e that a %arket bu# order co%es in and the &rice rises to 14.10

I- another %arket se$$ order "ere to co%e in? the broker "ou$d e!ecute the tick sensitive order at 14.1(

A tick sensitive order is a $i%it order "ith a d#na%ica$$# changing $i%it &rice
112

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'ick +ensitive 9Bont;:

'he <bu# do"ntick order= is eCuiva$ent to the -o$$o"ing strateg#

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113

I$$ustration;
+ub%it a $i%it order at Hust be$o" the $ast observed &rice "hich "as 14.14 I- the trade &rice "ere to rise? then raise the $i%it &rice to Hust be$o" the trade &rice I- the trade &rice -a$$s? do not a$ter the $i%it &rice
114

8--ective$# a $i%it order is &$aced at 14.13

In this case the trade &rice "as 14.10. +o the $i%it &rice "as e--ective$# raised to 14.1(

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'ick +ensitive 9Bont;:

'his strateg# is %eant -or traders "ho "ish to kee& their $i%it orders c$ose to the %arket "hen &rices %ove against the% 'he a$ternative to such an order "ou$d be a d#na%ic $i%it order sub%ission strateg# Aut i%&$e%enting such strategies is virtua$$# i%&ossib$e in -ast %oving %arkets

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O&en-Outcr# +#ste%s o'rading

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Ora$ Auctions

'raders %eet -ace-to--ace on the -$oor o- the e!change

+o%e cr# out their bids "hi$e others ca$$ out o--ers Others $isten -or bids and o--ers that %eet their reCuire%ents 6ost traders do both G shout and $isten

6an# -utures o&tions stock e!changes use ora$ auctions to trade

E.g. Market for #:bond futures on the ?BO# attracts (!! floor traders
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111

Ora$ auctions - 'rading


Au#er acce&ts se$$er=s o--er 'he bu#er "i$$ shout <take it= to acce&t the o--er +e$$er acce&ts bu#er=s bid 'he se$$er "i$$ ca$$ out <so$d= to acce&t the bid Au#ers and se$$ers take turns bidding O o--ering unti$ the# agree on a &rice Cuantit# to trade Copyright Tarheel Consultancy Services

112

Ora$ auctions - 'rading


A trader "ho %akes a bid o--er to trade su&&$ier o- $iCuidit#

A trader "ho acce&ts a bid o--er acce&tor o- $iCuidit#

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O&en Outcr# @u$e


O&en outcr# ru$e

'rader %ust &ub$ic$# e!&ress his bid o--er to enab$e others to react

An# trader can acce&t bid ask ca$$ed out even though both traders %a# not be active$# negotiating at that &oint o- ti%e
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'he -irst &erson to acce&t a bid or an o--er genera$$# gets to trade


120

Ora$ Auctions;

Order &recedence ru$es deter%ine


A. A.

"ho can bid o--er "hose bids o--ers other traders can acce&t

<Pri%ar# order &recedence ru$e= Price &riorit# <+econdar# order &recedence ru$e= de&ends on the %arket

7utures %arkets ti%e &re-erence +tock %arkets &ub$ic order &re-erence? -o$$o"ed b# ti%e &re-erence
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121

Price as a Priorit# @u$e

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122

Price Priorit# @u$e

'he ru$e gives &recedence to traders "ho o--er the best &rices

Au#ers can on$# acce&t the $o"est o--ers +e$$ers can on$# acce&t the highest bid

'his ru$e is se$--en-orcing

Aecause an honest trader "i$$ search -or the best &rices


123

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Price Priorit# @u$e;

6ost ora$ auctions "i$$ not a$$o" a trader to

bid be$o" the best bid o--er above the best o--er such bids o--ers on$# add to the noise and create con-usion

A trader can i%&rove the best bid b# bidding higher A trader can i%&rove the best o--er b# o--ering at a $o"er &rice

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124

'i%e as a Priorit# @u$e

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'i%e Priorit#

Iives &recedence to the trader "hose bid o--er i%&roves the current best bid o--er

When a trader has ti%e &re-erence no trader can bid o--er at the best bid o--er that is current$# avai$ab$e
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'i%e Priorit#

A trader "i$$ retain his ti%e &re-erence

unti$ another trader i%&roves his Cuote unti$ another trader acce&ts his Cuote

Once a bid o--er is acce&ted? an#one %a# bid o--er at the ne" &rice

a$$ orders at that &rice have eCua$ standing


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121

I%&. o- Priorit#

In an ora$ auction bids o--ers are va$id on$# -or an instant

In &ractice traders %aintain their &recedence b# re&eating their bids o--ers as o-ten as is necessar# to sho" their interest In a $arge active %arket? a trader %a# continuous$# re&eat his bid o--er
122

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'i%e Priorit#;

8ncourages co%&etition a%ong traders

I- a trader is aggressive the "a# to get ahead oso%eone "ho has ti%e &recedence is b# i%&roving the &rice

I- he i%&roves the &rice he auto%atica$$# gets the right to trade -irst

En$ike <&rice &riorit#=? <ti%e &riorit#= is not se$en-orcing


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124

'i%e Priorit#;

6ost traders do not care "hose bid ask the# are acce&ting as $ong as the# get the best &rice

'rader "ith ti%e &re-erence %ust de-end it "hen so%eone i%&ro&er$# tries to Cuote at the sa%e &rice

A trader "hose &riorit# is being cha$$enged "i$$ #e$$

'hat=s %# bid 'hat=s %# o--er 'hat=s %# %arket

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140

Other Priorit# @u$es

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141

Pub$ic 'raders &riorit# ru$e

+o%e eCuit# e!changes &rohibit %e%bers -ro% trading ahead o- a &ub$ic trader "ho is "i$$ing to trade at the sa%e &rice

Wh# is this ru$e reCuired?

An e!change %e%ber can easi$# acCuire ti%e &re-erence at a ne" &rice be-ore a &ub$ic trader? because he sees &rice changes -irst and can Cuote -aster than a &ub$ic trader can sub%it orders.
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142

Pub$ic 'raders ru$e

'his ru$e &er%its a &ub$ic trader to take &recedence over a %e%ber even "hen the %e%ber has ti%e &re-erence 'he obHective is to give &ub$ic traders greater access to the %arket and "eaken the in-or%ation advantage &ossessed b# the -$oor trader

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'rade Pricing @u$e

'his is used to deter%ine the &rice at "hich a trade is acce&ted In an ora$ auction ever# trade takes &$ace at the &rice &ro&osed b# the trader "hose bid o--er is acce&ted

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144

+i3e as a Priorit# @u$e

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I$$ustration - ,5+8

On ,5+8 &ri%ar# &riorit# &rice &riorit# 'i%e &riorit# is not abso$ute

'he -irst bid or o--er at a &articu$ar &rice "i$$ get e!ecuted -irst

Once a trade is e!ecuted at a &rice? a$$ orders at that &rice are said to be <on &arit#=

8ver# co%&$eted transaction is said to c$ear the -$oor and $ead to the co%%ence%ent o- a -resh auction

'ake the -o$$o"ing case "here three orders are eCua$ on the basis o- &rice
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I$$ustration

Time 10>02 10>10 10>12

Buyers
A$e! Aro"n 6ark

Trader

Size 1000 1000 2000

Price 100.00 100.00 100.00

Time

Trader

Sellers
Size

Price

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141

Ana$#sis
+a$$# &$aces a %arket se$$ order -or 1000 shares at 10>14 A$e!=s bid -or 1000 shares "i$$ be acce&ted because his order has &riorit# on the basis o- ti%e

Once this trade is e!ecuted? Aro"n and 6ark "i$$ be on &arit#


142

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I$$ustration;
Assu%e Panet &$aces a %arket se$$ order -or 1000 shares at 10>1( (00 shares each "i$$ be a$$otted to both Aro"n and 6ark
) Aoth have $arge enough orders to -i$$ the inco%ing order ) ,either o) 'he entire $ot "ou$d have the%since has this been so$d to 6ark &riorit# "i$$ c$ear the -$oor ) 'his des&ite the -act that 6ark=s order "as &$aced $ater

What i- Panet had &$aced an order -or 1(00 shares?

What i- Panet had &$aced an order -or 2(00 shares?


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) 2000 shares "ou$d go to 6ark ) Aa$ance (00 "ou$d go 144 to Aro"n

I$$ustration;
'he -irst trade at a &rice need not a$"a#s c$ear the -$oor
) A$e! "i$$ get 1000 shares because o- ti%e &riorit#. ) 'hat $eaves 1000 shares to be -i$$ed ) Aut since +a$$#=s order has not been -u$$# -i$$ed? the auction "i$$ continue
+ubseCuent$# "hen Panet=s order -or 1000 shares arrives? 6ark "i$$ receive 1000 shares
200

Assu%e that +a$$# &$aces a %arket se$$ order -or 2000 shares

In the above case the re%aining 1000 shares "i$$ be a$$otted to Aro"n "hose order ca%e in ne!t chrono$ogica$$#
Copyright Tarheel Consultancy Services

I$$ustration;
Assu%e +a$$# &$aces a %arket se$$ order -or (00 shares A$e!=s order "i$$ be &artia$$# e!ecuted

Assu%e that Panet &$aces a %arket se$$ order -or 1(00 shares

) (00 "i$$ be so$d to A$e! ) (00 each "i$$ go to Aro"n and 6ark ) ,either has ti%e
&riorit# ) Aoth orders are $arge enough to -i$$ the inco%ing order

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201

I$$ustration;
Assu%e +a$$# &$aces a %arket order -or (00 shares Assu%e Panet then &$aces a %arket se$$ order -or 2000 shares A$e!=s order "i$$ get &artia$$# e!ecuted

) (00 "i$$ go to A$e!.


) 1(00 "i$$ go to 6ark since this "i$$ c$ear the -$oor ) 2000 shares "ou$d have been so$d to 6ark. ) 'he ba$ance (00 "ou$d go to Aro"n

What i- Panet had &$aced an order -or 3000 shares?

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202

I$$ustration
Time Trader

Buyers

Size

Price

Time

Trader

Sellers

Size

Price

10>02 10>10 10>12 10>14 10>1(

A$e! Aro"n 6ark Pacob 6ike

1000 2000 1000 1200 200

100.0 100.0 100.0 100.0 100.0


203

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I$$ustration;
Assu%e that +a$$# &$aces a se$$ order -or 1000 shares A$e!=s order "i$$ be e!ecuted

What i- Panet "ere to no" &$ace a se$$ order -or 1000 shares?

) It "i$$ be s&$it bet"een Aro"n? 6ark and Pacob ) 8ach has s&eci-ied
an order si3e JK the si3e o- the inco%ing order ) 6ike "i$$ not get an#thing

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204

Priorit#

On ,5+8? -or orders at a given &rice? &ub$ic orders have &riorit# over s&ecia$ists= orders

Assu%e that a s&ecia$ist is bidding S100 -or 1000 shares


I- a %arket se$$ order -or 1200 shares "ere to co%e in ) 'he &ub$ic trader "ou$d get 1000 shares ) 'he s&ecia$ist "ou$d get on$# 200
20(

+ubseCuent$# a &ub$ic trader &$aces a bid at S100 -or 1000 shares

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Priorit#

'raders on the -$oor o- the e!change can &artici&ate &ro-rata "ith the $i%it order book? once there has been a trade at a given &rice

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200

I$$ustration;
)Assu%e that a trader arrives on the -$oor "ith a %arket se$$ order -or 100 shares )'he best bid-o--er is (0.00 -(0.12 )Assu%e that the bid at (0 is -or (000 shares
201

'he inco%ing order "i$$ get e!ecuted at (0

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I$$ustration;
) Assu%e that a second %arket se$$ order -or 1200 shares arrives ) Assu%e that the %arket continues to be at (0.00(0.12 ) Assu%e that ( ne" traders no" "ish to bu# at the %arket ) +ince the stock has a$read# traded at (0? these ( traders can trade &ro-rata "ith the order in the book ) 'he order in the book "i$$ get an a$$ocation o200 shares. ) 'he ( ne" traders "i$$ get
200 shares each
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202

Priorit# 9Bont;:

/o" did "e get this -igure o- 200?

9the si3e o- the inco%ing order: the no. otraders T 1

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204

A$ock 'rades

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210

A$ock 'rades

A$ock trade is a re$ative$# $arge trade in ter%s o- si3e +i3e c$assi-ication de&ends on

instru%ent var# -ro% e!change to e!change

E.g. On 2C1E <!-!!! shares is the criterion for defining a block


211

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A$ock 'rades;

6ost$# b$ocks can be hand$ed using nor%a$ trading &rocedures

Ae#ond a &oint s&ecia$ &rocedures are needed

E.g. On 2C1E large trades go to a broker on what is called the upstairs market
212

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A$ock 'rades G E&stairs %arket


Arokers dea$ers negotiate dea$s

,or%a$ ru$es o- e!change do not a&&$#

Aroker can active$# so$icit counter&art#

E&stairs %arket Ban earn &ro-it -ro% un"inding &ositions Ban act as broker O dea$er in sa%e transaction

Ban charge a co%%ission -ro% both sides


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213

A$ock 'rades 9Bont;:

Once a dea$ is struck? it %ust be crossed on the -$oor o- the e!change Prob$e% there %a# be <$i%it order= in the book that can inter-ere "ith the order being crossed

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214

I$$ustration;
Assu%e that the best bido--er is (0.00 - (0.12

A b$ock trade is arranged u&stairs -or 166 shares at 44.40

'echnica$$#? a$$ orders in the book "ith &rices ranging -ro% 44.41 ti$$ (0.00 have &rice &riorit#

Aesides $i%it bu# orders at 44.40 "i$$ have ti%e &riorit#

'he broker e!ecuting the b$ock trade has to in &rinci&$e -i$$ these orders -irst
21(

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I$$ustration 9Bont;:

I- there is substantia$ de%and at 44.40 the b$ock trader %a# not have an adeCuate Cuantit# $e-t to trade "ith the counter&art# that he has identi-ied

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210

I$$ustration 9Bont;:

'he broker "ho is arranging the b$ock trade "ou$d $ike to avoid trading "ith the book

Aecause "hen he trades "ith the book he gets a co%%ission -ro% on$# one side I- the trade is -ina$ised "ith the identi-ied counter&art#? he "i$$ receive co%%issions -ro% both sides 'o tack$e such a situation E.+. e!changes have ado&ted a si3e &recedence ru$e
211

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A$ock 'rades 9Bont;:

7or orders J 2(?000 shares

'he %atched b$ock orders are a$$o"ed to outsi3e the book at the trade &rice 'he %atched order "i$$ Hu%& ahead o- the other orders in the book "hich are at the sa%e &rice? ins&ite o- a higher ti%e &riorit# A$$ orders standing in the book at better &rices "i$$ be incor&orated into the b$ock trade U b$ock &rice 'hese orders "i$$ dis&$ace so%e o- the %atched orders that the b$ock trader &resents to the -$oor
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212

Assu%e that the best bido--er is (0.00 - (0.12

A b$ock trade is arranged u&stairs -or 166 shares at 44.40

) When this order co%es to the -$oor it "i$$ auto%atica$$# get &recedence over a$$ <standing $i%it orders= U 44.40 ) Orders bet"een 44.41 O (0.00 "i$$ be incor&orated into the 'echnica$$#? a$$ orders in b$ock U 44.40 the book "ith &rices ranging -ro% 44.41 ti$$ (0.00 have &rice &riorit#

Aesides $i%it bu# orders at 44.40 "i$$ have ti%e &riorit#

'he broker e!ecuting the b$ock trade has to in &rinci&$e -i$$ these orders -irst 214 Copyright Tarheel Consultancy Services

+ubstitution Orders

+o%eti%es a trader %a# "ant to invest a s&eci-ic a%ount or rea$i3e a s&eci-ic a%ount b# "a# o- divest%ent /o"ever he %a# not care as to "hich securities are bought or so$d 'he broker in such cases can use his discretion? based on his &erce&tion othe %arket
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220

+ett$e%ent Instructions

,or%a$ regu$ar sett$e%ent 9in E.+.: trades are sett$ed on a 'T3 basis

'he e!change o- securities -or cash takes &$ace 3 business da#s a-ter the da# o- the trade

A trader %a# at ti%es "ish to sett$e on a non-standard basis


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221

+&ecia$ +ett$e%ent
A trader %a# desire cash sett$e%ent

+uch trades are sett$ed on the da# o- the trade itse$-

+uch orders are %ore di--icu$t to e!ecute and usua$$# cannot be -i$$ed on de%and

+o%e brokers charge higher -ees -or such orders

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Ba$$ 6arkets

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Ba$$ 6arkets

Ba$$ %arket is a$so kno"n as Aatch 6arket

Orders are accu%u$ated unti$ the %arket is ca$$ed -or trading

A$$ accu%u$ated orders are then si%u$taneous$# e!ecuted 'he ti%e interva$ bet"een successive ca$$s %a# be -i!ed or variab$e
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Ba$$ 6arkets;

Ba$$ing securities

A$$ the securities are ca$$ed si%u$taneous$#? or 'he# are ca$$ed one at a ti%e in rotation

6arkets that ca$$ in a rotation %a# co%&$ete one or %ore rotation in a trading session

'his is the e!c$usive %arket %echanis% in certain cases

E.g. most governments sell their bonds+notes+bills in such a framework #he ,eutsche Borse and the Eurone)t Paris Bourse use the call mechanism to trade their least active securities
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Bontinuous vs. Ba$$

'he t"o trading %ethods need not be %utua$$# e!c$usive

'he ,5+8? 'ok#o +tock 8!change 9'+8:? and the Austra$ian +tock 8!change? begin each da# "ith a ca$$ %arket. +ubseCuent$# the# o&erate as continuous %arkets -or the rest othe da#.
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I$$ustration

We "i$$ i$$ustrate
A. A. B.

the en-orce%ent o- order &recedence ru$es the %atching o- orders using an e!a%&$e use o- the trade &ricing ru$e

We "i$$ assu%e that orders that are received unti$ 10>30 a.%.? are bunched together? O that the %arket is c$eared at that ti%e

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Order Precendence

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Order Precedence

Au# O +e$$ orders are ranked in descending order o- &riorit# 'he <order &recedence ru$es= are hierarchica$

6arkets -irst rank orders using their <&ri%ar# order &recedence ru$e= I- 2 or %ore orders have the sa%e &riorit# based on this ru$e? then <secondar# &recedence= ru$es are a&&$ied 'he secondar# &recedence ru$es are a&&$ied in seCuence unti$ a$$ the orders have been ranked

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Pri%ar# @u$e
) Au# orders U highest &rices ) +e$$ orders U the

Price Priority

$o"est &rices ) 6arket orders a$"a#s rank the highest since there is no s&eci-ied
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+econdar# Precedence @u$e


) 'i%e o- sub%ission ) 7$oor ti%e &re-erence Secondary Rule
) +trict ti%e &re-erence ) Pure &rice ti%e &re-erence

) +i3e o- order ) A$$ s#ste%s have


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'i%e Pre-erence

7$oor ti%e &re-erence the -irst order that arrives at a given &rice is given &recedence over a$$ the other orders at that &rice

'his s#ste% is identica$ to the ru$e used in ora$ auctions @e%aining orders "i$$ be at &arit# "ith each other

+trict ti%e &re-erence ru$e a$$ orders at the sa%e &rice are ranked according to the ti%e o- sub%ission Pure &rice-ti%e &recedence s#ste%s s#ste%s that rank on the basis o- &rice &riorit# and strict ti%e &re-erence
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+i3e Precedence

'hese ru$es var# -ro% %arket to %arket *arger orders get &recedence over s%a$$er orders

In other %arkets it is Hust the o&&osite

When t"o or %ore orders are at &arit# and cannot a$$ be -i$$ed? so%e %arkets a$$ocate the avai$ab$e si3e on a &ro rata basis

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I$$ustration o- Order Arriva$


Time 10:01 10:0 10:0" 10:10 10:1$ 10:1& 10:!0 10:!$ Trader Alex Bob Carol #avid %mma 'rank )eorge *arry Order Size Buy Buy Sell Sell Buy Buy Sell Sell
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Size 100 !00 !00 $00 !00 (00 $00 !00

Price 100.00 100.!0 100.10 100.!$ 100.00 market 100.00 ++.+0


234

@anking o- Orders "ith Price Priorit#


Buyers Trader 'rank Bob Alex %mma Size (00 !00 100 !00 Price ,arket 100.!0 100.00 100.00 Trader *arry )eorge Carol #avid Sellers Size !00 $00 !00 $00 Price ++.+0 100.00 100.10 100.!$

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Ana$#sis
1. 2. 3.

Au#er=s side> 7rank=s order is a %arket order gets to& &riorit# Aob=s order gets &rice &riorit# co%es ne!t A$e! O 8%%a have the sa%e &rice $i%it but A$e! gets ti%e &riorit# +e$$er=s side> /arr#? Ieorge? Baro$? and Favid? are in order based on &rice &riorit#
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230

6atching

'he %arket "i$$ -irst %atch the highest ranking bu# order "ith the highest ranking se$$ order
/ighest ranking bu# order
%atch

/ighest ranking se$$ order

A 'rade I- the <bu#er= is "i$$ing to &a# at $east as %uch as the <se$$er= de%ands Aest bu# order K %arket order
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I$$ustration

7rank=s order -or 400 shares J /arr#=s se$$ order -or 200 shares

/arr#=s order "i$$ be co%&$ete$# -i$$ed

Aa$ance 200 shares de%anded b# 7rank "i$$ get %atched "ith Ieorge

7rank=s order "i$$ be co%&$ete$# -i$$ed


%atch

7rank=s order o- 400 shares

/arr#=s se$$ order -or 200 shares O Ieorge=s se$$ order -or 200 shares

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I$$ustration
) ) Aob is "i$$ing to &a# a %a! o- 100.20 Aob is de%anding 200 shares )
%atch

Ieorge is de%anding a %in o- 100.00 Ieorge is o--ering 300 shares

) )

Ieorge sti$$ has 100 %ore shares to o--er Ieorge is de%anding a %in o- 100.00

)
%atch

A$e! is de%anding 100 shares A$e! is de%anding a %a! o- 100.00

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I$$ustration

@e%aining orders "i$$ sta# une!ecuted At "hat &rices shou$d the res&ective trades get e!ecuted?

Wou$d de&end on the trade &ricing ru$es used b# the s#ste%

We "i$$ i$$ustrate the <uni-or% &ricing ru$e= that is used b# %an# e!changes
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+ing$e Price Auctions

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+ing$e Price Auctions


+uch auctions are a -eature o- %an# ca$$ %arkets 6ost continuous order6ost e$ectronic -utures driven stock %arkets o&en %arkets o&en trading in trading "ith this the %orning "ith a sing$e &rice ca$$ auction 'he Ari3ona +tock 8!change uses this %echanis% -or trading eCuities ,ationa$ treasuries use such auctions to se$$ 'reasur# instru%ents
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Eni-or% Pricing

A$$ trades take &$ace at the sa%e %arket c$earing &rice 'he &rice is deter%ined b# the $ast %atch that $eads to a -easib$e trade 6arket c$earing &rice

As &er $ast %atch &rice o- bu# order K &rice o- se$$ order


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Eni-or% Pricing;

'he <%arket c$earing &rice= "i$$ be satis-actor# -ro% the &ers&ective o- a$$ &revious$# %atched orders

'his is because a$$ &revious$# %atched order "i$$ have greater than or eCua$ &rice &riorit#

Buyers

Sellers

Au#ers corres&onding to +e$$ers are "i$$ing to acce&t such orders "i$$ be "i$$ing to the <%arket c$earing &rice= &a# at $east as %uch as the or $ess <%arket c$earing &rice= An# other &rice "i$$ be either An# other &rice "i$$ be too too high to satis-# the bu# $o" to satis-# the se$$ order order corres&onding to the corres&onding to the $ast $ast %atch %atch
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I$$ustration

6arket c$earing &rice is 100.00

Price o- $ast e!ecutab$e bu# order Price o- $ast e!ecutab$e se$$ order

In &ractice the orders corres&onding to the $ast -easib$e trade %a# s&eci-# di--erent &rices

Aid &rice o- the bu# order Q Ask &rice o- the se$$ order

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I$$ustration

Assu%e that A$e!=s bid -or 100 shares U 100.0( not 100.00 In this case the %arket can c$ear U 100.0( s&eci-ied b# A$e!? or U 100 s&eci-ied b# Ieorge? or U in bet"een

'he s#ste% "i$$ s&eci-# ru$es -or such eventua$ities

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Brossing ,et"orks

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Brossing net"orks
,o auctioning

,o &rice discover#

'rades take &$ace at &rices deter%ined e$se"here Prices at "hich these %kts are c$eared are obtained -ro% other %kts trading in si%i$ar instru%ents
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Brossing net"orks
+uch net"orks are said to use a derivative &ricing ru$e

Prices on such %arkets are co%&$ete$# inde&endent o- the orders sub%itted b# the traders

'he on$# -unction o- such %arkets is to deter%ine "hether an order can be e!ecuted at the crossing &rice
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8!a%&$es

'he %ost i%&ortant net"orks trade E.+. eCuit# securities


I#D5s PO1I# Instinet5s Dlobal Instinet ?rossing 2C1E5s after hours trading session I

'hese %arkets are ca$$ %arkets

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2(0

Brossing;Ba$$ 6arkets
'raders have to sub%it their orders &rior to the ca$$

A-ter the ca$$? order &recedence ru$es are used to %atch bu# and se$$ orders A$$ %atches that can trade at the crossing &rice beco%e trades
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Brossing;e!a%&$es

I$oba$ Instinet Brossing O ,5+8=s a-ter hours trading session I both cross a-ter hours?

Aoth use the 4>00 &.%. c$osing stock &rice on the ,5+8 'raders use these s#ste%s because it is a <2nd chance= to trade at c$osing &rices

PO+I' crosses stocks 2 ti%es a da# during regu$ar trading hours

Brossing &rices are chosen b# se$ecting a ti%e at rando% "ithin seven %inutes -o$$o"ing the ca$$ Brossing &rice K avg o- bid &rice O ask &rice o- &ri%ar# %arket
2(2

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Brossing;

'here is invariab$# e!cess de%and or su&&$# at the crossing &rice

I- bu#ers "ant %ore than I- se$$ers "ant to se$$ "hat se$$ers "ish to o--er? a$$ se$$ orders "i$$ -i$$ co%&$ete$# %ore than "hat bu#ers "ish to bu#? a$$ bu# orders "i$$ -i$$ co%&$ete$#

'he -u$$# -i$$ed side is a$$ocated to the oversubscribed side in accordance "ith <order 2(3
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Brossing;

In &ractice on$# a s%a$$ -raction o- the tota$ orders sub%itted get c$eared 'raders $ike such %arkets the# a$$o" bu#ers O se$$ers to discover each other "ithout having a &rice i%&act Bo%%issions are $o"> 1V - 2 V &er share Brossing net"orks are co%&$ete$# con-identia$ O anon#%ous

'he# don=t dis&$a# orders 'he# don=t disc$ose order i%ba$ances a-ter the cross
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2(4

Duote Friven 6arkets

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Duote-Friven 6arkets

In a &ure-Cuote driven %arket? a Fea$er %ust &artici&ate in ever# trade 'hus an#one "ho "ishes to trade? %ust trade "ith a Fea$er A trader can either direct$# negotiate "ith a Fea$er or his re&resentative Aroker %a# do so on his beha$Copyright Tarheel Consultancy Services

2(0

I$$ustration

broker

trader

dea$er

,ealers may trade among themselvesbut public traders cannot


2(1

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Duote-Friven e!a%&$e

@avi "ants to bu# 100 shares o- IBIBI Aank @aHa "ants to se$$ 100 shares o- IBIBI Aank 8ven though the# %a# agree on the &rice? the# cannot trade "ith each other in a &ure Cuote-driven %arket @avi "i$$ have to -ind a dea$er "ho is "i$$ing to se$$ shares -ro% his inventor# @aHa "i$$ have to -ind a dea$er "ho is "i$$ing to bu# shares in order to add to his inventor# O- course it %a# so ha&&en that the sa%e dea$er %a# take both the sides
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2(2

Duote-Friven;

Fea$ers su&&$# t"o-"a# Cuotes? one to bu#? and the other to se$$ A$so kno"n as dea$er %arkets because $iCuidit# is su&&$ied b# the dea$ers ,ot a$$ Cuote-driven %arkets are entire$# Cuote-driven

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2(4

Duote-Friven;

In certain %arkets? traders can trade "ith each other "ithout the intervention o- a dea$er

A$though the bu$k o- the trades occur "ith the dea$er taking one side o- the transaction 8.g. ,asdaC is $arge$# Cuote-drivenW but dea$ers o-ten arrange trades a%ong &ub$ic traders on o&&osite sides
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Duote-Friven;

In %ost Cuote driven %arkets dea$ers and c$ients choose each other "hen the# "ish to trade

Busto%ers choose dea$ers "ho o--er good &rices and good service. Fea$ers &re-er c$ients "ho are &erceived as trust"orth# and credit"orth#.

6an# dea$ers s&ecia$i3e in servicing s&eci-ic c$iente$es such as s%a$$ retai$ investors or $arge institutiona$ investors.
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@o$e o- Arokers

'raders "ho do not have credit re$ationshi&s "ith dea$ers route their orders through Arokers "ho &rovide a guarantee to sett$e on their beha$-. In so%e dea$er %arkets there are <inter-dea$er brokers= "ho he$& dea$ers to arrange trades a%ong the%se$ves Arokers= services are use-u$ because %an# dea$ers "ou$d not $ike to disc$ose their identit# "hen the# trade

Arokers -aci$itate anon#%ous trading

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Duote-Friven %arkets e!a%&$es

A$%ost a$$ bond and currenc# %arkets are Cuotedriven. 6ost such %arkets are in-or%a$ net"orks odea$ers co%%unicating "ith each other O "ith c$ients b# te$e&hone Other structured dea$er %arkets are characteri3ed b# &ro&rietar# e$ectronic data s#ste%s that -aci$itate co%%unication a%ong dea$ers

+uch %arkets %a# be organi3ed b# a dea$er net"ork -or%a$ e!change broker b# an e$ectronic data vendor
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Duote Friven 6arkets


T$P%
,asdaC +tock 6arket *ondon +tock 8!change e+&eed 9 a govern%ent bond trading s#ste%: @euters 3000 9 a -oreign e!change trading s#ste%:

%&!MPL%
Fea$er Association 8!change Aroker 8$ectronic Fata Nendor

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Arokered 6arkets

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Arokered 6arkets

In such %arkets? brokers active$# search to %atch bu#ers O se$$ers

In %ost cases the search -or a counter&art# "i$$ begin as soon as an order is received -ro% a c$ient In so%e cases the broker hi%se$- %a# initiate the search

+uch %arkets arise "here the assets being traded are uniCue and not he$d in inventor# b# dea$ers
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Arokered %arkets e!a%&$es

*arge b$ocks o- stocks O bonds are traded in such -ashion G b$ock trading is nothing but a brokered dea$

@ea$ estate transactions too invo$ve brokers


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/#brid 6arkets

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/#brid 6arkets

'he# e!hibit characteristics o- %ore than one kind o- structure

8.g. the ,5+8 is &ri%ari$# order driven

/o"ever it reCuires the s&ecia$ists to o--er $iCuidit# i- no one e$se is "i$$ing. 'hus it does have e$e%ents o- a Cuote driven s#ste%
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/#brid 6arkets - ,A+FAD


,A+FAD %arket is a h#brid It is essentia$$# Cuote driven but dea$ers are reCuired to dis&$a# O e!ecute &ub$ic $i%it orders

A$ock trades on both the ,5+8 O ,asdaC are e!a%&$es o- brokered trading

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