[ D ATA ]
DO YOU KNOW HOW
YOUR ORDERS ARE
ROUTED?
Do you know how your order is routed? Should you care? Lately, more and more
emphasis is being placed on how orders are routed. Typically concerns are raised
around whether brokers are routing in their own best interest or in their clients’ best
interest. Other considerations relate to whether certain trading venues are ‘toxic’
and lead to deterioration of performance.
L
et’s begin with a bit of back-
ground. In order to realise
an investment opportunity,
traders must first acquire a position.
They can do this by buying or selling
shares of stock in the ‘market’. While
this sounds quite simple and maybe
obvious, the term ‘market’ hides a lot
of complexity. The reason is that the
‘market’ consists of many places to
trade. While many years ago, there
was typically only a single place to
trade (often called an exchange),
we now have many places to trade,
some with names like MTFs, ATSs
or ECNs. This means that we need to
make choices about which of these
venues to interact with when we go
to purchase shares of stock. We also
need to consider the ways in which
we interact with the collection of
trading venues we refer to as
96 // TheTRADE // Spring 2020
the ‘market’.
While there are many possible ques-
tions to address, three key questions
we would like to answer regarding
our order are: When did we execute?
Where did we execute? and how did
we execute?
The portfolio manager generally
knows why they want to execute, but
the other three questions all relate
to how the order was managed by a
broker. The brokers use technologies
such as algos that determine timing,
and routers that determine where
to direct the order and the way to
execute.
One of the key things being
managed in this approach is market
impact. When we go to the market,
we don’t want to move the market
too much as that can only hurt our
performance. At the same time, the
role of the market is to provide price
discovery – the process of finding
equilibrium prices that balance supply
and demand. Therefore, we want to
develop tools that can allow us to de-
termine the answers to the questions
of where, when and how we should
trade so we can understand why we
got the outcome we did.
Ultimately, what we want to be able
to do is to see the big picture of how
our order interacted with the market.
It therefore seems natural to visualise
this interaction in a picture. We can
develop such a picture by plotting
the way we interacted along three
dimensions.
The first dimension we care about
is time – we want to answer the
question ‘when did we trade?’ We
want to be able to show how much
volume we traded as a function of