Guide to Execution in Trading

Execution in finance refers to the completion of a buy or sell order of a financial asset in securities markets. Executions are carried out by brokers on behalf of traders. Once you put in a request for a trade, the broker works to complete your order as quickly as possible and at the best price available at that moment. Execution does not occur until the trade is confirmed to be completed.

How are Orders Executed?

Brokers can execute trades in a number of ways. The original method was to send requests directly to the exchange floor, although this is time-consuming and inefficient compared to electronic brokers operated with computer systems. Thankfully there are quicker ways to place and execute orders than a human trader operating as a floor broker.

Order to Market Makers

On large exchanges like the NYSE, market makers uphold ample liquidity for buy and sell orders. A broker may have orders routed to the market makers for execution.

Market makers are brokerages who hold large amounts of an asset to the point they can readily fill buy and sell orders across the exchange, ensuring trades can be executed immediately.

Order in House

If a broker holds enough of an asset, like shares of stock, themselves, they can buy and sell with traders directly from their own inventory. In house execution occurs if a trader places a market order directly with a market maker.

Order by an Electronic Communications Network

An electronic communications network (ECN) makes use of computer systems to electronically match buy and sell orders across the entire exchange. This is the dominant form of trade execution and often and often provides a better price than human brokers.

In house orders and transfers to market makers both use ECNs when executing trades to find the best prices. But how many brokers their system presents trades to in order to find the best possible execution depends on where they are submitting trades.

All of these methods of execution are regulated by the Securities and Exchange Commission, which ensures brokers of the best execution prices possible in the over the counter (OTC) market.

Types of Orders Executed

Orders are executed three different ways. Most orders are executed immediately, as the trader wants to enter or exit the market at the current price or time. In this instance, execution will occur immediately barring no liquidity issues.

There are two other cases where traders may request a delay in execution. The first is for limit orders, which traders set to execute once the market reaches a specific price. A limit order can have different expiry dates depending on its type. Good till Canceled (GTC) orders will remain open indefinitely until they are executed, or the trader manually cancels them. A day limit order, on the other hand, will remain open through the trading day but will be canceled by the broker if the specified price is never reached, making execution impossible.

Traders can also request to manually execute trades, meaning their buy or sell order will not be executed until they accept or reject the offer. This is less common in highly-liquid, fast moving markets where any hesitation can change the price at which a trade is executed.

Execution risk

Execution risk describes when a buy or sell order is executed at price different than expected at the time of placing the order. This price differential is known as slippage, and it's caused by illiquid markets or slow execution speeds.

Buy or Sell Order Execution Example

Say you want to buy a stock currently trading at $50 per share. You can place a limit order for 100 shares at $49.50. This means your order will only be executed if the market price drops to $49.50 or less. In the event that the price falls to $49.50, your trade is executed and $4,950 is pulled from your account to make the purchase.

When you're ready to sell, you might place another limit order, this time to sell your 100 shares at $51 per share anticipating a price improvement. If the price rises to $51, your trade is executed and you receive $5,100.

In both the buy and sell orders, your trade is only executed once the specified price is reached and money is debited or credited to your account in exchange for shares. In this example, you would have made a profit of $150 using limit orders.

Keep in mind online brokers will charge execution costs that eat away at your profit. Executing small order sizes at marginal price improvements can turn into a loss with these costs.