What Exactly Are Matching Orders?
The procedure by which a securities exchange connects one or more unsolicited buy orders with one or more sell orders to execute trades is known as matching orders. This differs from requests for a quote (RFQ) on securities to proceed with a trade.
If one investor wants to buy a certain amount of stock and another wants to sell the same amount at the same price, their orders will match, and a transaction will occur. Order matching is the process of exchanging buy orders and bids with corresponding sell orders or asking to execute them. This process has become almost entirely automated during the last decade.
How Order Matching Works
The primary function of exchange experts and market makers is to match buyer and seller orders. When compatible purchase and sell orders for the same securities are filed nearby in price and time, matches occur.
A buy order and a sell order are generally compatible if the buy order’s maximum price meets or exceeds the minimum price of the sell order. Following that, different exchanges’ computerized order-matching systems use a variety of strategies to prioritize orders for matching. An exchange’s ability to match orders quickly and accurately is crucial. Investors, particularly active investors, and day traders will look for strategies to reduce trading inefficiencies from any source. A sluggish order-matching mechanism may force buyers and sellers to complete trades at less-than-ideal pricing, reducing investors’ profits. If some order-matching protocols favor buyers while others favor sellers, these methods can be exploited.
High-frequency trading (HFT) was able to improve efficiency in this field. Exchanges strive to prioritize trades in a way that benefits buyers and sellers to maximize order volume—the exchange’s lifeblood.
Popular Order Matching Algorithms
Electronic matching has been implemented in all major marketplaces. To match orders, each securities exchange has its algorithm. They are broadly classified into first-in-first-out (FIFO) and pro-rata.
FIFO
A basic FIFO algorithm, also known as a price-time-priority algorithm, prioritizes the earliest active buy order at the highest price over any subsequent order at that price, which prioritizes any active buy order at a lower price. For example, if a buy order for 200 shares of stock at $90 per share comes before a sell order for 50 shares of the same stock at the same price, the system must first match the complete 200-share order to one or more sell orders before matching any portion of the 50-share order.
Pro-Rata
A basic pro-rata algorithm prioritizes current orders at a specific price in proportion to the relative quantity of each order. For example, if a compatible 200-share buy order enters while both a 200-share buy order and a 50-share buy order are active, the system will match 160 shares to the 200-share buy order and 40 shares to the 50-share buy order.
The system will only partially fill both because the sale order is insufficient to satisfy both buy orders. The pro-rata matching algorithm fills 80 percent of each order in this example.
Conclusion
- When there are equal and opposite calls for security (a buy and a sale at the same price), matching orders find them and make a trade.
- Order matching is how many markets match buyers and sellers at reasonable prices. This makes trade smooth and efficient.
- After ten years, almost no human steps are involved in this process.
