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Trading Mechanisms

Trading mechanisms cite the logistics behind trading assets and securities, irrespective of the category of the market. These markets can be stock exchanges, dealers, or OTC markets. The mechanisms are the operations by which buyers of an asset are approximated with sellers.

There are two major categories of trading mechanisms:

  • Order driven markets
  • Quote driven markets

Trading Mechanisms: Quote Driven

In a quote-driven market, continual prices or “quotes” are given to buyers and sellers. These prices are given by market makers, which implies these categories of systems are nicely suited for dealer or OTC markets. For a buyer, the price given is the price a dealer is ready to sell at. For a seller, the price given is the price a dealer is ready to purchase at. Commonly, the quoted buy price will be lower than the selling price. The spread is the revenue that the market maker, the dealer, earns.

Trading Mechanisms: Order Driven

In an order-driven market, buyers and sellers of assets can place orders for assets they desire to purchase or sell. They can list at market price, which enforces a market order instantaneously at the best accessible price. Alternatively, they can list a fixed/limit price, which implements either a limit or stop order, not to be implemented until specific pricing conditions are fulfilled.

In an order-driven market, counterparties are not necessarily accessible instantly, depending on the listed price. Because this is so, order-driven trading mechanisms are also fitted for exchanges. Orders will execute once a desirable counterparty is created for each buyer or seller. In other words, a buy order will only implement if a seller is found who is ready to sell at the specified limit price. Order-driven trading mechanisms are frequently favored by an order book.

Order Book

An order book is a system or database that regulates an order-driven trading mechanism. The book lists all buyers and sellers, as well as their planned bid or asks rates.

we see sell orders summarized in ascending order and buy orders summarized in descending order, sorted by list price. Orders in an order-driven trading mechanism execute when the lowest sell order and the highest buy order match, or outperform each other. Order books will commonly remain updating as new orders are added in real-time.

Disadvantages of the Order Driven Market

  • As ascertained by the order book above, the order-driven style of trading mechanisms will have lower liquidity than the quote-driven market. In a quote-driven market, a market maker is constantly readily accessible to sell or buy, as long as the trader is ready to meet the slightly higher premiums of the quoted price. In an order-driven market, trades can stagnate if buyers are not willing to meet seller prices or vice versa.
  • Because of this automated matching system, order-driven market trading mechanisms are most suitable for assets that are frequently traded and commonly very liquid. These markets stocks, options, bonds, and some currencies, among others.

Trading Mechanisms: Order Types

  • In order-driven trading mechanisms, there are various order types that a trader can take benefit of. These are briefly described above but are moreover described in one of our different blogs.
  • The presence of the real-time order book enables traders to take benefit of limit and stop pricing that will not fulfill until their conditions are fulfilled. This differs from market pricing, which implements instantly, and may be unlucky for traders.

Trading Mechanisms: Order Timing

Also, order-driven trading mechanisms enable traders to specify the shelf life of a particular order. Orders, for instance, can be kept indefinitely until executed, set to endure only a day, or set to last until a particular duration.

Trading System

The Futures and Options Trading System gives a completely automated trading environment for screen-based, floor-less trading on a nationwide basis and an online monitoring and supervision mechanism. The system assists an order-driven market and gives comprehensive transparency of trading operations.

Orders, as and when they are received, are first time-stamped and then instantly processed for a probable match. If a match is not established, then the orders are stored in various 'books classified in price-time priority in multiple books in the subsequent sequence:

  • Best Price
  • Within Price, by time priority.

The Bottom Line

Understanding the various trading mechanisms is significant know-how for traders. Comprehending the game enables the trader to play it better. Specific markets, for instance, will utilize algorithms in conjunction with order-driven markets, and understanding this will enable a trader to make the most out of their trades. As such, understanding the distinction between the quote and order-driven trading mechanisms is productive information.


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