What Is Order Execution?

Investors and traders assume that orders are immediately executed once they click the "enter" button on an online trading account. However, they may be surprised at how an order is filled and the associated time delays.

The Broker's Options

A common misconception among investors is that an online account connects the investor directly to the securities markets. When an investor places a trade online or over the phone, the order goes to a broker. The size and availability of the order determine which path is the best way for it to be executed:

• Order to the floor: For stocks trading on exchanges such as the New York Stock Exchange (NYSE), the broker can direct the order to the floor of the exchange or a regional exchange. Regional exchanges may pay a fee for the privilege to execute a broker's order, known as payment for order flow.
• Third market maker: For stocks on an exchange, the brokerage can direct the order to a third market maker. A third market maker is likely to receive the order if they entice the broker with an incentive to direct the order to them or if the broker is not a member firm of the exchange.
• Internalization: Internalization occurs when the broker decides to fill the order from the inventory of stocks the brokerage firm owns and quickly executes the transaction. The broker's firm makes additional money on the spread.
• Electronic Communications Network: ECNs automatically match buy and sell orders. These systems are used for limit orders because the ECN can match prices quickly.
• OTC Market: For over-the-counter (OTC) markets such as those under the OTC Markets Group, a broker can direct a trade to the market maker in charge of the stock. This is usually timely, and brokers make additional money by sending orders to certain market makers.

Types of Orders

Many orders sent to a broker are market orders, which include the instruction to buy or sell a security immediately at the current price. Some types of orders have conditions attached that limit or alter how and when they can be executed. A conditional order can include, for instance, a limit order, which specifies a fixed price above or below which a purchase or sale cannot take place.

Other conditions include the time frame within which an order may be executed, such as immediate-or-cancel (IOC) for orders that must be filled in the following seconds or good-til-cancel (GTC), which stays available to be filled as a standing order until it is explicitly canceled and can last several weeks.

The Bottom Line

The best possible execution is no substitute for a sound investment plan. Fast markets involve substantial risks and can cause the performance of orders at prices significantly different than expected. With a long-term horizon, however, these differences are merely a bump on the road to successful investing.