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January 1, 2013

Out of Order

By Tom Steinert-Threlkeld

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The most straightforward problem is simply keeping up. "It's hard for me to understand the need for 2,000 order types," said John M. Donahue, senior vice president and head of equity at Fidelity Capital Markets, a unit of the mutual fund giant.

Indeed, the head of one of the industry's largest electronic brokerages, who declined to be quoted on the record because of the size of his business, says it is extremely difficult to get a handle on how each order type works, even if you try to keep up with all the filings made on the subject by the exchanges.

But the exchanges say they are simply responding to customer demand: There has to be a base of interest in each mechanism for placing a buy or sell order, or it wouldn't be introduced.

"This allows people to trade in different ways in different time frames with different objectives," said BATS chief operating officer Chris Isaacson.

The proliferation comes as market participants already struggle to keep up with a modern reality where orders are sent not just across 13 national exchanges but also into scores of "dark pools" that operate out of public view, and another hundred more internal pools of orders managed by brokers.

And the competition to keep orders on exchanges, instead of being handled by alternative trading systems and internally by brokers, is intense. Overall trading volume on the nation's 10 largest exchanges dropped 28 percent in the first 10 months of 2012 and is running at about 2007 levels. That means approval from the Securities and Exchange Commission will be sought for almost any order type that likely will appeal to a broad segment of trading firms, brokers or investors.


Customization and Competition

The creation of customized orders is to keep the major players in the industry-those generating the most trading volume-coming to play in an exchange's given arena.

One example of a new highly specialized order type is the NBBO Offset Pegged Order, from Direct Edge.

Chris Issacson, BATS

That allows a market maker, in particular, to automatically redefine the price of an order by its distance from the national best bid or offer.

Creating this sort of new order type helps Direct Edge differentiate itself. But it typically also occurs in response to a need or desire expressed by an exchange's membership. Those memberships now include high-speed market makers such as GETCO, Tradebot and Knight Capital, as well as brokers representing institutional investors and handling orders for retail investors.