From the July 01, 2009 issue of Futures Magazine • Subscribe!

Order management in electronic markets

Technological victories and hard work on the part of many individuals have led to the resounding success of electronic trading. According to CME Group, electronically executed trading accounted for 85% of its total volume in the first quarter of 2009.

Electronic trading has brought many benefits, but it also has brought some new challenges in terms of managing different order types. Beyond some changes to the range of available order types, the trader also must consider something that was not an issue during the traditional days of open outcry: How to manage open orders during the hours that extend beyond the traditional regular trading day.

SELECTING THE PROPER ORDER

Understanding of the various types of orders that are available when trading electronically is the first step to selecting the proper order. “A menu of orders” shows the order types available on the CME Globex and ICE electronic platforms for futures and options trading. Many of these are familiar to most traders, though it might be useful to clarify a few.

Market orders are executed at the best available price, meaning that a buy order hits the best (lowest) offer and a sell order hits the best (highest) bid until the order is completely filled. A market limit is the same order except if the order cannot be completely filled, then the order becomes a limit order at that initial best available price for the remaining quantity of the order. The market limit order is used when price is more important than quantity in filling the order.

Stop orders are activated when the order’s trigger price, the stop price, is traded. The order becomes a market order when the stop is triggered and can entail a great deal of slippage in thin markets. Stop limit orders place a limit on the acceptable level of slippage on the stop order. This can protect you from quick moves, but leaves you unprotected if the market continues to move against you.

Both CME Group and ICE have a protection feature on market or stop orders executed on their respective electronic trading platforms that is designed to prevent fills at extreme prices. This might be used by a trader having a large quantity to transact who does not want to fill the order incrementally (see “How to hide your hand”). With protection, the fill price of an order cannot be outside of a dynamic price range set by the exchange for that market. Any unfilled quantity becomes a limit order at the edge of the range. As more bids and offers enter the system, prices may adjust so that the remainder of the order can then be filled.

Among order qualifiers, CME Globex allows a good ‘till date (GTD) order. GTD orders remain active on the order book until they are completely executed, expire at the date specified, are canceled, or the instrument expires. Say that you want to place an open limit order to buy, but don’t want to trade during the release of upcoming employment data several days hence, expecting volatility to be severe. You might, then, place a GTD order to expire the day before the release.

GONE BUT NOT FORGOTTEN

Neither Globex nor the ICE platform supports the market-on-open (MOO) order, market-on-close (MOC) order or market-if-touched (MIT) order. Any trading system that relied on these order types needs to be adjusted accordingly when moving to electronic execution. While exchange match engines may not allow some traditional order types you may have used on the floor, many of the front-end systems that write to the exchange can imitate these order types.

When this author was trading 30-year Treasury bond futures during the regular trading hour session, the MOC order type was relied on quite a bit. It’s not uncommon for bonds to experience a final push in the last 30 minutes of trading and close at or near the high or low for the day. On a day when it was decided a trade needed to be, an MOC order would be placed in the afternoon to capture any such end-of-day price movement. However, with a shift to electronic trading of bonds, this coveted order type and the flexibility it offered was lost. It then was necessary to resort to the more tedious effort of calling in a market order at or around the close.

The loss may, in fact, go a bit deeper than this. In the old days when there was just open outcry trading, the market close was a time when participants gathered, so to speak, to cast a final opinion on the state of the market and to adjust their positions, if necessary, in accordance with their expectations of what may happen overnight.

Consequently, there may have been informational content in the net result of this group consensus and this, in turn, provided the rationale for giving the market closing price special importance in many econometric and trading models.

With extended electronic trading hours, though, the downtime until the next day begins (with the exception of the close prior to the weekend) may be just an hour or less, so participants no longer need to make such a decision. The decreasing relevance of the open and close of a market that trades practically around the clock needs to be considered by those who have developed a trading system that, based on traditional regular trading hours, attaches special importance to these two events.

MANAGING ORDERS OVERNIGHT

The extension in hours of electronic trading raises the question of how to handle open orders during the overnight session. Should open orders be left to work just the same as during the day? This is especially pertinent if volume tends to be thin overnight.

The answer depends upon the trading system. For example, when implementing a technical system that was designed based upon prices over the entire trading day, open orders should continue over the entire day as well. Price behavior in the overnight session is already incorporated into the system’s methodology and performance and the open orders, whether stop or limit, should already be set to accommodate that behavior.

On the other hand, a trading system that was designed based upon prices during the day (traditional regular trading hours) or even a subset of the day, and that is implemented only during these hours should not be extended to include trading around-the-clock without prior testing and possible modification. Open orders, then, should not be automatically carried to the overnight session. They will have to be cancelled and re-entered the following day to coincide with the desired session. While this will continue to expose the trader to risk of a gap in prices, the trading system presumably already incorporates this into its methodology.

Beyond this, a trading system originally designed for regular trading hours may itself suffer with the movement toward around-the-clock trading because of volume migration.

Rick Thachuk is president of WLF Futures, Options & Forex Education Network. Contact him via www.worldlinkfutures.com

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