Smart Order Routing: The Newest Technology In Trading
12 Jan 2016 in Finance
Smart Order Routing (SOR) is a process used in trading applications. With the advent of technology and its use in the stock exchange market, SOR is turning out to be a key technology for brokers. The system is implemented to enhance the efficiency of the trade flow systems. Today, SOR systems are being preferred and deployed by both asset management firms as well as boutique brokers for a better optimization of their executions.
Buy-Side and Sell-Side SOR
Now, SOR is a technology that comes to the aid of traders on both the buy and the sell -side. When used by the sell-side firms and broker dealers, SOR is used for managing client order flow. Equities are routed best though the system generally improves the overall execution quality and costs in any asset classes. SOR systems work well in choosing between execution options. This particular feature ensures that sellers get the best possible execution for the customer with minimum fees. Execution is improved by means of market impact and slippage. On the other hand, large-sized firms with multiple venues for execution can go with the best venue based on market conditions, parameters of the trade and business relationships.
SOR systems help those on the buy-side too like asset managers and hedge funds. The system allows minimizing execution costs and managing relationships with brokerages. High volume trade flow can be managed better. Also, many may not be aware but SOR is not entirely dedicated to equities trading. The system can be utilized strategically to manage multiple execution venues for derivatives, FX and fixed income trading.
Factors Influencing SOR Decision
Just like any other system with advanced technology, SOR too aims at helping firms make the best decision for the clients. In doing so, it does not only take the parameters of the trade into account but also real-time market conditions, historical reference data, execution options and venue performances.
Analyzing the Market Data
A reliable SOR system keeps monitoring the real-time market conditions. The behavior of the market participants is analyzed in details to adjust the volume curves, estimate the volatility and calculate the risk metrics. This timely data ensures that no time is wasted on the wrong type of market. Availability of accurate market data further helps in measuring the execution quality. The best kind of SOR feed back their own executions and estimates the accuracy of the predicted price impact and transaction costs.
Detection of Liquidity
Apart from the basic market data analysis, data derived from different venues is also used to detect available liquidity. SOR combines information from other asset classes or even unstructured news data to get an idea of the market depth. The methodology enables pre-determination of the effectiveness of the execution methods.
The process of the SOR can be augmented by business rules, which specify the destination of a given order and classify orders for special treatment. For instance, business rules might often control the orders that receive a manual intervention. Consequently, an order of more than 5% of the average daily volume is routed directly to a professional trader. On the contrary, orders in liquid stocks are handled algorithmically.
SOR is the newest technology trend in trading and it is sure to establish itself as indispensable in the years to come.