Stock Order Execution:
Is Ignorance Really Bliss?
An old adage tells us why laws and sausages are essentially
alike: because we'll be happier if we
don't see either of them being made.
It's tempting to feel the same way about how your stock
orders are executed. "Aah, why should I
worry," you say to yourself. "It'll only annoy me." Maybe. But as with laws
and sausages, the more you know about stock order execution, the better your
decisions will be. Whereas the less you
know . . .
If questioned, many individual investors would say that an
online account means they're somehow hooked directly, almost physically, into
stock exchanges. After all, it happens
so fast: You click, you blink, you get
the best available deal, it's over, right?
Actually, there are several ways a securities order can be placed and
filled, and any number of related delays and occasional surprises.
"Buy long 500,000 XOM at 3/16 under market now!"
If you own a seat on the New York Stock Exchange and are
trading a few hundred thousand shares of Exxon Mobil, don't worry: Your order will be filled in full at the
price you specify in considerably under two seconds.
If, however, you're a NYSE-seatless civilian investor
trading a couple of hundred shares of a an over-the-counter issue, your order
may go instantly and precisely as you place it. Or not.
Whether placed online or by phone, your order always goes to
a broker. The broker considers the type
and size of your order to determine how it will be routed and filled; this can
affect the cost of your transaction and even the price you end up paying for
the stock. For the record, there are a
number of ways to fill an order:
For stocks trading on listed, established,
predictably-traded exchanges like the New York Stock Exchange (NYSE) or the
American Stock Exchange (ASE), the broker will in most cases direct the order
to the floor of the exchange. Since
this order is actually going through human hands, it can take some time for the
floor trader to get your order and fill it.
(See "What About Those Markets," below.)
With over-the-counter markets such as the Nasdaq, your
broker directs your trade to a "market maker," someone in charge of
selling and buying the stock you're trying to buy or sell. Not all market makers charge the same
commission, so some (not all) brokers make more money on your trade by
directing it to certain market makers.
(The OTC market is a dealer market where several market makers can
compete for your order.)
Electronic Communications Network (ECN) automatically
matches buy and sell orders very quickly, so ECNs are often used for limit
orders (see below).
Internalization (or "trading upstairs") takes place
when the broker fills your order from the inventory of stocks the brokerage
firm owns. Very fast execution and
sometimes a better deal; but know that your broker's firm will make money not
only on the commission but on the spread — the difference between the bid (what
the buyer is willing to pay) and the ask (what the seller is willing to
How would you like that, sir?
It's worth knowing about the four common order types, too,
as they determine how and when, or whether, your order will be handled:
A market order lets you buy or sell your stock as
quickly as possible at the best available price at the moment your order hits
the market. Execution is almost certain
since you haven't specified a price. However, a market order can cause you to
say "Yikes!" if you place, say, your "market buy" order at 50 on a fast-moving,
volatile trading day and by the time it fills, the market price has gone to
A limit order, on the other hand, is an order to buy
or sell at a specified price or better.
Buy limit orders are executed at or below limit price; sell limit orders
are executed at or above limit price.
Since you've specified a price, there's no guarantee your limit order
A stop order is an order to buy or sell at the market
price once your stock has traded at or through the trigger (stop) price. If the stock trades at or through that price,
your order will be filled as a market order.
Again, no guarantee of execution.
A stop limit order lets you buy or sell at a
specified price once your stock has traded at or through the trigger
price. No guarantee of execution; your
order, if placed, will be placed as a limit order.
Orders can also be partially filled, and there are other
factors that affect execution. We'll
cover those topics in future articles.
What About Those Markets
You'd be surprised to discover how many sophisticated,
longtime investors don't know the intricacies of the exchanges and
over-the-counter markets, and are too shy to ask:
Listed markets are auction-style markets where issues
are traded in a central "marketplace," with professionals who match investors'
buy and sell orders via an open auction system. Prices are determined by
matching the best asking price with the best selling price.
Listed markets offer the stocks of some 6,000 companies in
the U.S. The best known of these, of
course, is the New York Stock Exchange, whose companies must be registered with
the Securities and Exchange Commission and meet specific qualifications as to
shares outstanding, earnings, market value, tangible assets and share price;
this is why the NYSE's companies tend to be large and well established. The other listed markets are the regional
exchanges (the Pacific and Philadelphia exchanges, for example). The
regionals compete on some of the same stocks as the NYSE, as well as serving
The over-the-counter market, or OTC, is the
principal trading market for securities not traded on one of the
exchanges. Traditionally OTCs have been
dealer markets, which means that shares are bought from and sold to market
makers, who are dealers in individual securities. The OTC market has provided an important mart for stocks of
countless growing companies. There are
three markets for OTC trading: The
Nasdaq, the Pink Sheets, and the OTC bulletin boards.
The Nasdaq, or National Association of Securities
Dealers Automated Quotation system, established in 1971, is a computerized
network that provides bid and ask prices on more than 5,000 securities. Capitalization and volume requirements are
smaller for the Nasdaq than for the listed exchanges. The Nasdaq has two levels:
the Nasdaq National Market, for nearly 5,000 well-capitalized
companies that must meet strict standards for listing and corporate governance;
and the Nasdaq Small-Cap Market, for about 1,000 smaller, emerging
companies, with listing requirements less stringent than for the National
Market. All Nasdaq quotes are entered
into a nationwide automated computer system that links market makers and
customers. Execution speed varies based
on the market where the order is placed, the number of shares available, market
conditions, size of order and volume of trading in that stock.
Thousands of less-actively traded stocks that don't qualify
for Nasdaq listing are carried on Pink Sheets, a company that publishes
stock price "indications" rather than true bids and asks. To trade a Pink Sheets stock, a broker must
obtain a price quotation by phone from at least market makers, which can slow
The NASD's electronic bulletin board, established
in1990, carries quotes for several thousand stocks previously quoted only on
Pink Sheets. While you get quotes more
quickly, your trades are still handled manually. For both bulletin board and
Pink Sheet stocks, prices are not current and are indications only of where a
stock might trade. Generally these
stocks are not actively traded and thus have comparatively large spreads
between bids and asks. Moreover,
bulletin board companies are thinly capitalized, not followed by analysts, and
may not be required to file financial reports with the SEC, all making it
difficult for investors to judge the risks of trading them.