What Is Trade Execution?

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DEFINITION
Trade execution is the process of completing an order to buy or sell a security on the market. It starts when you confirm a trade within your online brokerage account or call your broker about initiating a transaction.

Trade execution is the process of filling an order to buy or sell a stock. The process begins when you hit “enter” on your online brokerage account or call your broker to place an order.  Your broker will then decide the best way to complete your request as quickly as possible.

Learn more about trade execution, how it works, and a broker’s options for managing this process.

Definition and Example of Trade Execution

Trade execution is the process of completing an order to buy or sell a security on the market. It starts when you confirm a trade within your online brokerage account or call your broker about initiating a transaction.

Let’s say you enter an order to sell 100 shares of a company’s stock for $50. Your broker should get you the best execution price for your order. They’ll send your order to a market or a market maker who can possibly get you a higher price of $50.50. If your broker executes the order, you would receive $5,050 for the sale, $50 more than if the broker had only used the current quote.

When and how a broker executes your trade may affect the overall transaction cost, including the price you pay for the security.

How Trade Execution Works

You don’t have a direct connection to the stock market when trading securities through online stock brokers. Most firms have automated systems that handle buy and sell orders they receive from customers. And while trade execution is often quick and seamless, it’s not instantaneous.

When you hit the “enter” button or call your broker to place a trade, they’ll decide which market to send it to for execution. Your broker is obliged to seek the best reasonably available execution for you. This means they must classify all orders received from customers and constantly evaluate which competing markets, market makers, or electronic communications network (ECN) offers the most favorable terms of execution.

Fast-moving markets may have erratic price movements, so the price of a security could change by the time your order hits the market. For instance, a large buy order may not fill in one trade, and instead may be broken down into smaller orders that are easier to fill. The result is that trades will have different execution times and potentially different prices. There may even be an opportunity for your broker to execute a trade at a better price than what your order quoted.

Price quotes are usually for a specific number of shares, so you’re not guaranteed to receive the price your broker quoted or the one you saw on your online brokerage account.

The Securities and Exchange Commission (SEC) doesn’t place limits on the time it takes to execute a trade. However, brokerage firms can’t exaggerate or fail to disclose the possibility of a delay in executing a trade beyond their advertised execution speeds.

Types of Trade Execution Methods

Your broker typically has multiple options for executing your trade.

Exchanges and Market Makers

For a security listed on an exchange such as the New York Stock Exchange (NYSE), your broker may send the order directly to the exchange or a different one. In other cases, the broker may direct your order to a market maker—a high-volume individual or firm that’s always ready to purchase or sell securities on an exchange at publicly quoted prices. To attract orders, market makers or regional exchanges may pay a broker to route its orders in their direction, a process known as payment for order flow.

Over-the-Counter (OTC) Markets

Brokers may execute trades over the counter. In this case, your broker may direct orders to an over-the-counter market maker who, in turn, pays them for the order flow.

ECNs

Brokers may execute trades through ECNs that automatically match buy and sell orders at specific prices. This may occur when using limit orders to buy or sell stocks at specific prices.

Internalization

Instead of routing your order to a market or market maker for execution, your broker may choose to execute your trade order in-house if they already have their own inventory of the stock you want to trade. They may make a profit on the difference between the buying price and selling price, also known as the spread.

If you prefer to direct your trade to a specific exchange, market maker, or ECN, you can call your broker and ask them to execute your trade following this preference. However, you may incur a fee for this service.

What It Means for Individual Investors

For an individual investor, the almost-instantaneous execution of your trades through an online brokerage may imply that you’re directly connected to the securities market. However, that’s not exactly the case. When you confirm your order to buy or sell a security, your broker will decide where to send it for execution. In fast-moving markets, the process of trade execution means you may not always receive the price you saw on your trading screen.

Key Takeaways

  • Trade execution is the process of filling an order to buy or sell a security in the market.
  • Your broker is obliged to seek the best execution reasonably available for you, such as by completing your request in the shortest time possible.
  • Brokerage firms can’t exaggerate or fail to disclose the possibility of a delay in executing a trade beyond their advertised execution speeds.
  • You have the option to ask your broker to direct your order to an exchange, market maker, or electronic communications network of your choice.

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Article Sources

  1. Securities and Exchange Commission. “Trade Execution: What Every Investor Should Know.”