Small Order Execution System (SOES): What It Is, How It Works

The small order execution system (SOES) was a computer network that automatically executed trades in Nasdaq market securities and some Nasdaq small-cap securities. Brought out in 1984, the SOES was made mandatory for certain traders after the Black Monday stock market crash in 1987. SOES enabled individual investors to execute trades in fast-moving markets and gave them the same access to orders and execution as larger traders. 

SOES was crucial in automating markets for retail investors and significantly increased day trading. The system was phased out in the early 2000s with even faster, higher-volume trading systems coming online.

Understanding Small Order Execution Systems

SOES was first introduced in December 1984 for use with 25 stocks. It provided automatic order execution for individual traders with orders of 1,000 shares or less, bypassing brokers and receiving automatic execution at the best possible price.

The system was designed so small investors could access the same prices as large institutional investors, automatically executing small orders against market makers at the inside market price. While institutional traders and brokers couldn't use SOES, market makers were required to execute SOES trades at their quoted prices. Once a trader placed an order through SOES, they had to wait five minutes before being able to place another trade on the same stock through the system.

SOES was an important part of the "dot-com" boom of the late 1990s, enabling the heavy onslaught of trading aimed at the Nasdaq's tech stocks. By the early 2000s, the dot-com bubble had burst, and Nasdaq was ready to move on to faster systems that would replace the SOES.

SOES is most remembered for leveling the playing field between professional and retail investors. Before SOES, small investors often faced significant hurdles in getting their orders executed promptly and efficiently, particularly during periods of high volatility. Large investors and institutions could dominate the trading floor, leaving smaller players at a disadvantage.

SOES Bandits

Following the SOES became mandatory after the Black Monday crash, new rules were needed to keep day traders from making a quick buck by taking advantage of old prices quoted by market makers. That turned out not to be enough. Soon, professional traders, known as "SOES bandits," found a way to exploit the system to make quick profits at the expense of market makers. While their average margins per trade were relatively low, they made up for it with high volume. SOES bandits executed a small transaction on a security to manipulate the price and then executed a more significant transaction to take advantage of the price inefficiency. They would put in a position before the market makers could update their quotes, then sell the position at favorable prices through alternate systems.

The Nasdaq prohibited individual bandits from initiating more than one position in the same stock within five minutes. However, SOES bandits told researchers that so many of them were pushing trades into the system (whole firms were dedicated simply to this business) that the exchange and regulators couldn't keep up with them. In time, so many bandits were clogging the system that only about half of their trades could get through to the market makers.

What Replaced SOES

Over time, technological advances and changes in electronic trading practices led to developing more sophisticated trading platforms like the Nasdaq’s SuperMontage system, which launched in 2002.

SuperMontage

SuperMontage replaced (SOES) and another Nasdaq system; SelectNet. Here are some of its main features:

1. Integrated order book: SuperMontage consolidated all Nasdaq-listed stocks into a single system so every market participant could access the entire market.
2. Greater transparency: SuperMontage provided real-time, detailed information on the best bid and offer prices and the aggregate size of all quotes at each price level.
3. More order types: Traders could see more than the top-line prices (the bids and offers). The system supported market orders, limit orders, reserve orders (large orders with only a portion displayed), and discretionary orders (allowing traders to specify a range of execution prices).
4. Anonymity: SuperMontage offered traders the option not to be identified to encourage greater participation and liquidity.
5. Improved execution: The system used an algorithm to match orders based on price, time priority, and other factors, all to meet its mandate of being more fair and efficient than the SOES.
6. Decimalization: SuperMontage supported decimalized trading (prices in cents rather than fractions), which was mandated by the Securities and Exchange Commission (SEC) in 2001.
7. Order routing: If an order couldn't be matched within the SuperMontage system, it would be shifted to other market centers or electronic communication networks (ECNs).
8. Regulatory compliance: The system was designed with newer SEC regulations in mind that were meant to improve transparency and modernization in the exchanges.

SuperMontage faced a lot of resistance from ECNs. These computerized trading systems provide for trading in stocks, bonds, currencies, and derivatives outside the traditional exchanges. ECNs are designed to match buyers and sellers directly, without the need for intermediaries like market makers or specialists. They were concerned that Nasdaq's new system and its speed took away many ECN advantages. First, some tried boycotting the system, not allowing the Nasdaq to access their trades. This inevitably backfired since Nasdaq's liquidity was too much to turn away for long. The Nasdaq relented a bit, too, allowing ECNs to participate in the system and route orders to their own networks if desired.

Nasdaq Market Center

SuperMontage was eventually integrated into the more comprehensive Nasdaq Market Center Execution System (MCES). The new system was more of a concept than a specific technology, eventually integrating several Nasdaq systems into one.

1. Nasdaq Integrated Data Store (NIDS): Launched in 2006, NIDS collects and processes massive amounts of trading data in real-time.
2. Nasdaq OMX INET: In 2007, Nasdaq acquired OMX, a Swedish-Finnish financial services company. INET was known for its speed, reliability, and scalability.
3. Nasdaq OMX XStream: Introduced in 2010, XStream is a trading platform designed to handle high-volume, low-latency trading across different asset classes, including equities, derivatives, commodities, and, later, cryptocurrencies.
4. Nasdaq Financial Framework: Launched in 2016, it's aimed at clearinghouses, brokers, and all kinds of other traders—essentially, a cloud and API service for trading.
5. Nasdaq Trade Surveillance: This system uses algorithms and AI analytics to identify unusual trading patterns to protect the market's integrity.

The Bottom Line

The SOES was an automated system used on Nasdaq exchanges to allocate and execute retail orders by assigning fills to exchange member firms. It allowed small traders and investors access to markets on a more level playing field with larger and more professional market participants. The system debuted in 1984 and was folded into broader Nasdaq electronic trading systems over time. Despite its evolution, the legacy of SOES in providing greater access to smaller investors and making the markets more efficient was a significant step toward the light-speed trading we see today.