What Exactly Happens When You Place An Order Through A Broker-Dealer?

In a world of algorithmic trading and high-frequency traders who can make hundreds of trades per second, it’s easy to take for granted just how easy placing an order has become.

In reality, every decision to buy or sell a security sets in motion an efficient chain of events involving multiple parties working together instantaneously to get the best possible price based on supply, demand, the specifications of the order, and a host of other factors.

Let’s walk through the order process.

The Investor: Prior To Trading

There are four things that need to be figured out prior to placing an order for a publicly traded security: why you want to buy or sell, how much you want to buy or sell, when you want to buy or sell, and where you want to buy or sell.

The why involves doing some fundamental or technical research on the security in question. This is how you decide whether it’s likely to rise or fall in the coming days, weeks, months, or years.

For how much, most investors will either buy a set amount every time (for example, 100 shares) or let the price of the security dictate how much they can afford.

The when involves the type of order you want to use. There are a dozen or so possible orders to place on the open market, but the two most common are market and limit orders.

Of the two, market order is the most straightforward, consisting only of an investor’s request to buy or sell a particular number of shares in a certain stock as soon as possible, with no regard for the price. Market orders are the “buy it now” or “sell it now” option and almost guarantees the investor will buy or sell the full amount of shares they ordered at a price close to where the security is currently trading.

On the other hand, a limit order is a more measured approach to bidding or offering, wherein the investor defines the number of shares they would like to purchase or sell and the maximum or minimum price they’re willing to pay or be paid. The implications of this limitation will reappear in the next part. At this point, the investor does not know whether they are going to buy or sell the full amount of shares they ordered at the price they want. While it’s possible, they could also get a partial fill of their order or simply not have their order filled at all.

The where has to do with the broker-dealer you place your trade through. You generally need to have a brokerage account with a FINRA member broker-dealer to buy and sell securities in the U.S. public markets.

The Broker-Dealer: Processing The Trade

Once the order is placed, its fulfillment is in the hands of the investor’s chosen broker-dealer. Generally, the broker-dealer will first attempt to work within its own asset holdings to fill the order. This means that the broker-dealer provides shares supplied from a client that is selling them or from their internal supply. Similarly, the broker-dealer can buy shares on behalf of a client that is buying or for their internal supply.

How and whether the broker-dealer will be able to provide those shares now comes back to the type of order that was placed. For now, let’s assume the broker-dealer can fill the orders without looking to outside sellers or buyers.

In the case of a market order, the broker-dealer can simply mix and match any sell or buy orders that are available at the time and make the exchange. Due to what is called the best execution rule, broker-dealers are required to supply investors with the best-quoted price or better on their orders.

This also holds true for limit orders. But since the upper or lower limit of the transaction’s price is dictated by the investor, it’s often less likely that a broker-dealer will fill limit orders internally, although they might also have to look elsewhere for matching market orders as well.

Third Party Buyers Or Sellers

If there are no available shares for a given price level within the broker-dealer’s network—or if there are no shares being bought or sold at all—the broker-dealer can communicate with other buyers/sellers or other broker-dealers through high-speed messaging and trading networks where they can match the order with a counterparty and execute the trade. Other broker-dealer then can either accept or decline the trade.

Orders for non-exchange-listed securities function differently than orders for exchange-listed securities, which use a central matching system. In the OTC market, broker-dealers can negotiate the trade by sending trade messages, and counter-offering with a different price and size. This-back and-forth can be done by phone, or on OTC trading platforms like OTC’s Link ATS.

If the broker-dealer cannot find available shares that meet the investor’s limit order price, it then has to update the quoted price on its platform to reflect this recent scarcity.

The Broker-Dealer: Executing And Reporting The Trade

Once the broker-dealer has compiled the requested shares, they can then confirm the transaction with the investor and execute the exchange of cash for equity (or vice versa). Broker-dealers generally take on the heavy lifting of making the exchange, clearing and settling the trade, though traders should remain vigilant until they are certain a trade has been fully executed.

However, the trade is not fully completed until the broker has reported the trade to FINRA. This is the ultimate validation of a stock market transaction and generally takes anywhere from a few minutes to a full day to finalize.

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