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October 3, 2011

Brokers Look to Ban Market Orders

By Peter Chapman

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  • Brokers Look to Ban Market Orders

Should brokers be required to convert their customers' market orders into limit orders? As part of a discussion among brokers over risk management practices that has been ongoing since the 'flash crash' of May 2010, an industry group is considering issuing guidelines that would do just that.

The idea has won favor with some brokers but not all.

FIX Protocol Limited, a pan-industry group that promotes and supports electronic trading through the ubiquitous FIX communications standard, is in the process of finalizing a set of order-handling guidelines. Included in a long list of recommendations over how to mitigate risk is one directing brokers to convert all incoming market orders into limit orders.

The guidelines are being crafted with the input of about a dozen of the industry's largest brokers. They apply to orders dropped into algorithms or direct market access mechanisms, and not necessarily to those handled by sales traders.

A first draft was issued earlier this year. The second draft is currently under review. The idea of banning market orders has not been fully vetted by the working group responsible for the guidelines, and could still get revised or dropped altogether from the final document.

"We strongly support this proposal," said Dan Mathisson, head of electronic trading at Credit Suisse, which has been involved in drafting the guidelines. "It would lead to a safer and more robust market."

Many brokers, especially those handling institutional orders, already restrict their usage of market orders and often convert them into priced limits. The concern is that an open-ended market order could fill at an unfavorable price.

Dan Mathisson, Credit Suisse

Credit Suisse's Advanced Execution Services desk, for instance, of which Mathisson is the head, takes all incoming market orders and puts a limit on them that is 2 percent away from the last sale.

If AES receives a market buy order, for example, when the last sale was $50, AES would send a buy limit into the marketplace at $51. That way the customer would pay no more than $51 for the stock even if the price spiked.

Other brokers may convert their market orders into limits that are a penny or two away from the national best bid or offer.

Practices also may vary depending on the firm, the size of the order and market conditions, sources say. If the order is for 100 shares of a very liquid stock, then a market order may be appropriate. If the order is for one million shares, then a limit would likely be advisable.

"You don't want to move the stock," noted one trading executive. "Depending on the size of the order, it may be more prudent to use a limit price-perhaps 5 percent. You know you will get filled, but you won't take the stock up or down."