Electronic Trading System Facilities

Features of Electronic Trading Systems

The mushrooming of electronic trading systems has forced buy-side traders, proprietary traders, and brokers to adopt the usage of new electronic trading tools.

We discuss a few of the features of electronic trading in this section.

1. Hidden orders: Hidden orders are trade orders that do not reveal trade intentions. They are only exposed to brokers or exchanges who receive them. These types of orders work better in electronic transactions than at floor-based exchanges because computers do not display orders unless instructed to do so.
2. Flickering quotes: Flickering quotes are exposed to limit orders that electronic traders submit and cancel immediately. Automated trading systems enable dealers to submit, withdraw, and resubmit orders when they do not want them to stand in the market.
3. Electronic arbitrage: Electronic arbitrageurs use automated trading systems when taking and offering liquidities. When they use fast trading systems, they may often cancel and resubmit their orders when market conditions change.
4. Leapfrog: Leapfrog is a game that emerges when the bid-ask spread is big, and the dealer has to jump ahead of the trader. Dealers are willing to trade at better prices than they quote if there is a wide market spread. When a trader quotes a better price, dealers will quote a better price than that; thus, the game occurs repeatedly. This behavior affects buy-side traders since they must quote a better price to maintain order priority.
5. Machine learning: Machine learning is a method of data analysis that automates analytical model building. It is also referred to as data mining. Improved statistical techniques are used to describe data structures. Machine learning methods are important when dealing with large data.

Uses of Electronic Trading Systems

Firms that purchase securities use electronic brokers and their systems to make advanced orders, trading tactics, and algorithms to seek liquidity.

• Advanced orders: Advanced orders are limit orders with limit prices that change with dynamic market conditions. An electronic system with relatively low latency is used to adjust a pegged limit order quickly.
• Trading tactics: A trading tactic is a strategy for running a function that involves the submission of multiple orders. If the order delays, the electronic system will cancel the order and resubmit it repeatedly until the order fills.
• Algorithms: An algorithm is a set of programmed strategies that use a combination of simple, advanced, or multiple orders to achieve its objective. A VWAP algorithm obtains a volume-weighted average fill price that is close to the VWAP of all trades organized in a specified time range. Buy-side traders use VWAP algorithms when spreading the order over time and when obtaining the average market price within an interval.

Question

Exposed limit orders that electronic traders submit and cancel immediately are best known as:

1. Leapfrogs.
2. Flickering quotes.
3. Hidden orders.

Solution

The correct answer is B.

Flickering quotes are exposed to limit orders that electronic traders submit and cancel immediately. Automated trading systems enable dealers to submit, withdraw, and resubmit orders when they do not want them to stand in the market.

A is incorrect. A leapfrog is a game that emerges when the bid-ask spread is big, and the dealer has to jump ahead of the trader.

C is incorrect. Hidden orders are trade orders that do not reveal trade intentions. They are only exposed to brokers or exchanges who receive them. These types of orders work better in electronic transactions than at floor-based exchanges because computers do not display orders unless instructed to do so.

Reading 46: Trading Cost and Electronic Markets

LOS 46 (g) Describe characteristics and uses of electronic trading systems.