Once you have a trading account set up, buying or selling shares, options, and futures seems pretty straightforward. Press a button, and the instrument appears in your account, provided that your order was “filled.” Inevitably, you have some orders that immediately fill, some that don’t, and some that take a while. What is filling an order? How does that happen? Who’s involved and who profits? Most importantly, how can YOU profit? As an investor or trader, understanding the process of how an order gets filled, albeit complex, is essential to maximizing profit.
Prior to the invention of the telephone, investors who wished to acquire shares of a company had to either visit the company directly and obtain shares, or to trade them, be located near Wall Street. Usually, these people were either under the employment of a very wealthy individual who wished to put his or her money to work, or they were trading as a profession. They would enter the New York Stock Exchange and physically signal to other traders what they were willing to buy or sell at. Traders could immediately buy at the seller’s “ask” or sell at the buyer’s lower “bid” price. The outdated methods which they used to keep track of orders are still present in the current financial lexicon: “order book” for example. When telephones were invented, investors could phone their brokers to execute these trades for them. Brokers make the difference between the bid and the ask, or the “spread”: The broker buys from the seller at the bid price, and sells to the buyer at the ask price. This is why brokers make more money in markets where the tick size is not decimalized.
Nowadays, with computers and the internet, traders can place orders using their trading platform, such as Etrade Pro or Thinkorswim, with a commission so miniscule that anyone can afford to invest in stocks (around $5 for stock orders). These orders are routed to the brokerage firm, which can choose to fulfill the order immediately using the brokerage’s own reserve of shares, if they happen to hold stock in that company, for fast execution. If the broker chooses not to do that, the order is sent to the exchange. If it is a market order, it is executed immediately at the bid or ask price at the exchange with the best price. If it is a limit order, it is entered into an order book on multiple exchanges and is executed once the price falls below for a buy order or rises above for a sell order. There are other types of orders that are essentially variations of the previous two, like stop-loss orders. When the market makers find that they can fulfill your order while making a profit for themselves, you obtain the shares.
The process of filling an order is itself a market in a way, fulfilling the desires of all the parties involved. Next time you place an order, realize that you are making many other parties a few cents.
– Michael Trehan