Dark Pools and Flash Trading: New trends in Equity Trading?
©2015
Textbook
83 Pages
Summary
This book examines the characteristics of equity trading and especially two relatively new phenomena which are dark pools and flash trading. Over the last years these two terms became more and more important in equity trading and today they are a real alternative to traditional exchanges, like the New York Stock Exchange or Deutsche Börse. But these new evolutions do not only have advantages. Indeed there are concerns that beside the benefits, like fast execution times, sophisticated techniques and less market impact, these mechanisms can also burrow risks. These risks are difficult to estimate, with an evolution of these new platforms that was so quick, that one might have the impression that even regulators do not full yet understand what might happen in the case of a next financial crisis. <br><br>However with a market share of 15%-20% of all trading activity in global equities and a jump of almost fivefold in the period of time from January to October 2009, these new mechanisms cannot be ignored anymore. Therefore this book explains in detail the functionality of dark pools and other current trading strategies. All important factors like different market structures, market liquidity aspects, as well as regulatory framework and technology facets will be reviewed. Further an outlook should be given to the reader on how the evolution of dark pools & co. might continue in the coming years. <br><br>With dark pools and flash trading, trading is now dominated by rapid-fire computer systems that might create a more technically driven market, rather than one based on fundamental forces. It remains to see whether this evolution will continue.
Excerpt
Table Of Contents
VIII
List of Abbreviations
ATS
Alternative Trading Systems
BATS
Better Alternative Trading System
CESR
Committee of European Securities Regulators
EBBO
European Best Bid and Offer
ECN
Electronic
Communications
Network
FD
Fair
Disclosure
IOI
Indicator of Interest
MiFID
Markets in Financial Instruments Directive
MTF
Multilateral
Trading
Facility
NASDAQ
National Association of Securities Dealers Automated Quotations
NBBO
National Best Bid and Offer
NMS
National Market System
NYSE
New York Stock Exchange
OHR
Order Handling Rules
OTC
Over-the-counter
SEC
United
States
Securities
and
Exchange
Commission
SOR
Smart Order Routers
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1. Introduction
The history of equity trading began hundreds of years ago, when the first companies
needed money for their projects and asked private investors instead of banks for equity.
Later, in 1969, when the first electronic stock trading was introduced in the U.S., namely
Instinet or Institutional Networks, trading became electronic. Shortly thereafter, in 1971,
the first fully automated exchange, the so called NASDAQ (National Association of
Securities Dealers Automated Quotations), was created. The NYSE, which was founded
as a physical, order-driven, auction-based market, entered the electronic sphere in the
early 1970s. In 1977 the first electronic trading montage screen, showing quotes on
NYSE stocks, went live through Instinet's efforts. Another pioneering platform was
Investment Technology Group's (ITG) POSIT (Portfolio System for Institutional Trading),
which was introduced in the late 1970s. POSIT was already crossing block trades
electronically away from the exchanges on a scheduled basis (Domowitz et al, 2008: 1).
From 1980 on brokers started to use their own electronic proprietary trading systems to
cross trades for clients. Further pioneering move was the introduction of the first after-
hours crossing platform in 1986 by Instinet. In Europe it was the Paris Bourse (today
part of NYSE Euronext), which developed a leading edge electronic trading platform for
the French stock market as early as 1989. Although electronic trading developed during
the late 1980s and early 1990s, it was only in the late 1990s and beginning of the 21
st
century that technology, communications and networking reached a state that ATSs
became useable (ibid).
Although the concept of hiding is not a new concept, as it has been around for several
years, in the form of hidden orders, the dark pool phenomenon and crossing network
structure came into focus only in 2002, when the INET, a product of a merger between
the Island ECN and Instinet, announced that it would stop displaying order book limit
prices to avoid connecting to the relatively slow Intermarket Trading System (ITS). With
this action INET effectively "went dark", as limit orders were no longer visible to market
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participants. A formal dark pool platform, Instinet CBX, followed in 2003 (Domowitz et al,
2008: 1).
While in 2003, 7 crossing networks has been established as providers of nondisplayed
liquidity, only 5 years later their number had surpassed 40. Although estimations about
the current dark volumes are not easy, as these volumes appear mixed with all OTC
trades, it can be assumed that approximately 15 % of all traded volume in the U.S. and
about 10 % of all European trades are executed in the dark. With this fast growth, in only
one decade, electronic trading and especially dark trading became a very important
market mechanism. This becomes even more apparent when looking at the projections
which suggest that at least half of European and U.S. markets will trade in the dark
within the next 5 years (Grant, 16.12.2009).
This book is supposed to give the reader a better understanding of equity trading in
general, with a focus on new trading phenomenon's, namely dark pools and flash
trading. It provides a definition of equity trading in general and dark pools in special in
chapter 2 where these terms as well as other trading related terms are explained and an
overview of the trading framework is given. Moreover the most important types of orders
and order parameters are explained to the reader.
In order to better understand the concept of the new mechanisms, chapter 3 gives an
overview of the different types of market structures and explains the importance of
market liquidity. The chapter is concluded with a differentiation between liquidity
suppliers and liquidity demanders.
In chapter 4 the pricing in the dark pool sector is explained. The importance of price
discovery and price derivation is highlighted.
Chapter 5 deals with the important topic of regulation and control. Due to the multiplicity
of different national regulations, the book focuses only on the European regulatory
framework, which is MiFID.
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Finally in chapter 6 the structure of dark pools is explained. All different sources of dark
liquidity are highlighted and a market overview of the dark sector is given. The chapter is
concluded with a regard on the dark sector evolution. Chapter 7 continues with the dark
pool sector and focuses on the different trading strategies in this sector. In addition the
technological aspects of dark trading are explained in non-technical terms.
Chapter 8 will summarize all important information about equity trading in general and
dark pools and flash trading in special. Further some possible future trends for the
industry development are drawn.
2. Equity Trading and its new phenomenons Definitions and
Characteristics
In the following chapter a basis about equity trading and dark pools should be given to
the reader. The most important terms will be explained and an overview of the trading
phases and the different types of orders and order parameters will be given.
2.1 What is Equity Trading?
In general equity trading can be described as the buying and selling of securities, which
can take place on a regulated market, for instance at one of the major stock exchanges
like the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE), or off-
exchange, bilaterally, on the so-called Over-The-Counter (OTC) markets.
Equity trading can be performed by the owner of the shares directly or by an agent
authorized to buy and sell on behalf of the share's owner. Proprietary trading or principal
trading is buying and selling for the trader's own profit or loss. In this case, the principal
is the owner of the shares. While agency trading is buying and selling by an agent,
usually a stock broker, on behalf of a client. Agents are paid a commission to the broker
for performing the trade and for supplying the investors with research on shares.
Stock exchanges and brokers have so called market makers who help to limit price
variations (volatility) by buying and selling a particular company's shares on their own
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behalf or on behalf of others clients. They are called market makers as they influence
with their trades, usually of huge blocks of shares, the price of a share. They buy certain
shares because they assume that according to researches, news flows or the market
situation, these shares give a very interesting buy opportunity and so they can sell them
to investors. The blocks of shares are only kept for a short period of time, usually of
maximum an hour (wikinvest).
2.2 Dark Pools Definition
Having define equity trading, and before getting on a more detailed discussion on the
subject, a common definition of the term dark pool should be given to the reader. Dark
pools can be defined as a type of alternative trading systems (ATS) that do not display
prices to the public, unlike on exchanges and other platforms with a "public order book",
and which are often owned by big banks like Goldman Sachs and Credit Suisse (SEC
Fact Sheet, 21.10.2009).
Another definition is given by Erik Banks, who defines a dark pool as "a venue or
mechanism containing anonymous, non-displayed trading liquidity that is available for
execution" (Erik Banks, 2010: 3).
He defines further that anonymous, non-displayed trading liquidity means order flow that
is not visible in public order books, like those operated by exchanges, and that this fact
leads to the name "dark" liquidity. Furthermore a venue is any electronic platform and a
mechanism is any structure within an exchange or any participant in the market that
offers non-displayed liquidity. Execution is, according to Erik Banks, the capability to
trade an asset through the submission of an order (ibid).
Thus it can be summarized that a dark pool is an accumulation of orders to buy or sell
stocks (or other assets), but whose existence is not publicly known or advertised.
According to his definition a dark pool resembles a traditional visible market in terms of
structure, function and executing according to market rules, but differs as it indicates not
the market depth.
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2.3 Dark Pools Rationale
Having said this in the following a look should be taken on why dark liquidity exists and
why the number of dark pools and other mechanisms is growing in recent years.
In general new financial products or markets are always introduced in order to bring
market participants advantages, like costs savings, higher returns or faster execution
times. In the case of dark pools the primary drivers are confidentiality, reduced market
impact, cost savings and price improvements. To explain these drivers a simple example
can be used: If, for instance, an investor wants to buy a large number of a certain stock,
he will try to do so by being as quietly and confidentially as possible, as if his intention
becomes public there is a risk that other investors might try to jump ahead of the
investor to buy the same stock. The price of the stock would increase in such a case.
This would create an unfavorable price movement for the investor. Of course, this would
not happen if the investor would try to buy only a small number of the stock, as a small
order would not generate the same interest in the market. Thus only large trades, so
called block trades, which are defined as those in excess of several thousand shares
per trade, are central to dark liquidity (Banks, 2010: 5).
Another driver for trading in the dark is cost saving. In general it can be assumed, that
all electronic trading generates cost savings, as all execution that is done off-exchange
avoids the payment of exchange fees. In addition there is the possibility of price
improvements, as active sell-side and sophisticated buy-side institutions use advanced
technologies and analytics for different strategies, like high frequency trading or
algorithmic trading. These strategies are designed to take advantage of electronic
trading and to increase short-term returns. Venues that are able to take or provide
liquidity away from conventional exchanges are important in this process and can attract
buy- and sell-side investors. It can be considered that any mechanism or venue that
brings together sellers and buyers in a confidential manner, reduces market impact,
generates fees savings and creates the possibility for price improvements, will succeed.
In the case of dark pools all four advantages are given, which helps to explain why their
market share has increased in recent years (ibid).
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Indeed various catalysts have led to the development of new venues in the last years.
First of all technological innovation plays the most important role in the evolution of the
off-exchange sector. Without the development of communications networks and the
processing of speed and power, the creation of efficient and reliable platforms and
sophisticated routers and algorithms, as well as rapid pricing and matching routines
would have not been possible. Although a closer look at the technical aspects will follow
later in the book, a correlation of the development of new venues with the rise of
increasingly sophisticated technologies is obvious.
Further to the technological innovation regulatory changes have been fundamental to
the development of the dark sector. Those changes came in various forms and across
various jurisdictions, but the most important to mention include the Regulation on Order
Handling Rules (Regulation OHR) in the U.S., the Regulation Alternative Trading
Systems (Regulation ATS) in the U.S. and the Markets in Financial Instruments Directive
(MiFID) in Europe. Another catalyst for the growth of the off-exchange market was the
so-called decimalization, so the moving of the minimum quoted price to 0.01 from some
larger amount, which had as consequence that smaller price increments led to lower
spreads, which in consequence led to lower profit opportunities and this in return led to
the reduced willingness to risk capital. Indeed the consequences of decimalization were
quite dramatically as it has caused average trade size executed on exchanges to
decrease by 70 % in the U.S. and by 50 % in Europe. As it became more difficult to
cross block trades without being noticed, more business was routed to the non-visible
markets (ibid: 15).
Further to the catalysts described above one other reason for the increasing importance
of off-exchange trading rest to mention which is capital accumulation and mobility.
Actually capital is a raw material of every economy, and includes the equity and debt
obligations firms raise to fund their operations. Therefore as the global demand for
goods and services has risen in the past, the demand for capital financing has risen as
well. As industrialized and emerging nations continue to build on their economic bases it
is quite likely that the amount of outstanding capital will continue to rise. And as capital
is mainly supplied by institutional investors, like mutual funds, hedge funds, insurance
companies, and other asset managers, this has radically reshaped capital mobilization,
7
allocation and trading. The most important of these investors, namely hedge fund
investors, are especially interested in sophisticated, high-volume trading strategies, like
high frequency trading or program trading, and these are critically important to the
electronic markets and dark trading. Of course, capital needs to be centralized in order
to give interested parties the possibility to trade it in an efficient and effective way.
Therefore both exchanges as well as over-the-counter venues are crucial for capital
trading. But as the supply of capital has increased enormous in the last decades, any
single venue is able to handle the large amount of outstanding capital on its own.
Therefore there is a need for a multiplicity of venues, and this made it possible for new
venues, including dark venues, to develop and expand. Further to the accumulation of
capital also the ability to move capital quickly across markets had helped in the
development of new platforms. Both traders and investors ask for rapid possibilities to
buy and sell, or transfer capital, and as this demand will probably continue, one can
assume that venues, which offer such services, will continue to benefit (ibid).
2.4 The Trading Framework
Investors trade for different purposes and over different time horizons. Therefore their
demand for and supply of liquidity are very different. But although different trading
strategies exist, the process of trading typically follows a logical sequence that
represents an entire cycle. The key elements of any trading framework include three
phases, which will be described in the following. These phases comprise together the
"lifecycle" of a trade. Some of the steps described in the following, like the entry of a
trade are very short, lasting no more than a few seconds or even milliseconds, while
other steps such as the execution can last for milliseconds, seconds, minutes, hours or
even days, depending on the specifics of a transaction. And still others such as clearing
and settlement can take up to several days to conclude.
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2.4.1 Pre-trade phase
The first step in the pre-trade phase is the analysis of potential trading opportunities.
This analysis can occur through fundamental analysis, technical analysis,
benchmarking, or other models. The output of this analysis process is the identification
of a specific security that should be bought or sold. The second step of the pre-trade
phase includes the analysis of the opportunity in relation to the current trading portfolio.
As the addition of a single security can radically change the characteristics of a portfolio,
it is critical to understand the effects before the execution of a trade. The last step in the
pre-trade phase is the identification of specific transaction strategies. The trader must
decide which venues should be triggered, when the trade should be executed, what
prices are acceptable and so forth. Further the trader must also define a strategy for the
case that an order cannot be filled immediately. He must decide whether the order
should be canceled or rerouted in such a case. Another decision regards whether to
display an order or to leave it in the dark. Each one of these points contributes to the
development of a trading strategy (Bhowmik, 2012).
2.4.2 Trade phase
The first step in executing a strategy that has been developed by a trader during the first
three stages of the trading framework is the order entry. Order entry is a positive action
that must be taken by a trader. The trader can chose between various order entry
mechanisms, like verbal/telephonic communication to a broker, or via direct input into
some type of order application, like electronic communication networks (ECN) entry via
interface (e.g. application program interface), broker algorithm via interface, and so forth.
All these mechanisms are valid but whereas voice via broker is less common in today's
marketplace, algorithms are increasingly common. In fact investors send less order flow
to brokers because they can reduce costs and minimize the potential for information
leakage by using flexible technologies for order entry by themselves. The order entry
stage gives the trader the opportunity to define precisely what should be done with
regard to the purchase or sale of securities. Numerous types of orders can be selected
9
with parameters that define price, time, venue and so forth. While certain clients rely on
voice-only orders which are typically taped in order to ensure accurate transcription of
details and which may be followed by a confirming message from the broker, many other
clients prefer to directly input their own orders electronically by supplying relevant details
in the entry fields provided by the application. The more complex the order details, the
greater the flexibility needed within the application. Of course, if a large number of
orders should be entered, as in the case of high frequency trading for instance, the
process must be automated. In such case batches of orders may be generated
automatically by the trader's model and submitted either directly into the market or via a
router to one or several brokers or venues (ibid).
The second step in the trade phase is order routing. Even though an order has been
entered into an order management system or conveyed verbally to a broker it must still
find its way to a marketplace. This step is heavily dependent on technology. The only
practical way for tens of thousands of individual orders to enter into a marketplace at
any one time is by placing them into an electronic line and leading them to a destination.
This line is a network that connects the client terminals with the servers that feed the
engines of a particular exchange. The faster this network connection and the more
robust the server architecture and the closer to the physical proximity of an exchange,
the quicker is the delivery and the execution. The client or the broker gives the
instructions where the order should go. While some of the routing is very standardized
and can be viewed as a simple set of instructions stating that the order should be moved
from the order entry terminal and delivered to a particular destination, also more
complex routers exist. These routers are known as smart order routers (SOR) or routing
algorithms and they ensure that the order is treated in a very specific way if it is not filled
immediately. In such cases the order can be moved sequentially through other random
or defined dark of light venues in search of best execution opportunities (ibid).
The third step in the trade phase is finally the execution. This step is in fact completely
technology-driven and based on pricing and matching routines that run in an automated
way. As the loss of even some milliseconds in the process can be harmful to a trader's
10
position, the most important factor in order execution is time. Therefore advanced
technologies are employed, in order to route orders into venues, and to flow them
through pricing and matching engines, which match and execute, or reroute orders, with
a minimum of latency (ibid).
2.4.3 Post-trade phase
After an order has been executed, details must be reported to all stakeholders. This
comprises the first step of the post-trade phase. Reports are sent to the trader, but also
to regulatory bodies and to the market at large. But of course the levels of detail which
are reported are not the same to all parties and also the time horizons over which
reporting must occur are different. While deal confirmations are send out immediately,
via an order management system or through electronic messaging, the reporting to the
public or to regulators may occur at the end of the trading day or at some later date.
Same as the execution of an order, also the reporting is largely driven by technology
(ibid).
The last step in the trading lifecycle is the dual process of clearing and settlement. Once
the trade has been executed and reported, it must pass through the clearing process,
which is usually managed by an independent clearinghouse or the clearing department
of the venue. Clearing includes the confirmation of all relevant details of the executed
trade, including the counterparties, the price, the quantity and so forth. If any of these
details do not match then the process is diverted to a resolution department where
further investigation must be undertaken. After the clearing process is concluded the
final stage can begin, namely the settlement. This step includes the delivery of cash for
shares and vice versa, between the two parties to the trade through the clearing and
settlement agent. This step is extremely automated and usually involves electronic
debits and credits to the cash and securities accounts of buyers and sellers. Once this
stage is completed the trade lifecycle is concluded (ibid).
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2.5 Orders
In trading instructions are given how and when to buy and sell securities. These
fundamental instructions for the transfer of liquidity are orders, and they are essential in
creating and transferring liquidity. In the following the most common types of orders will
be explained. Within the broad classes of orders certain additional parameters may be
attached, to specify for example the speed of execution, to achieve price improvements,
to limit the risk, or to determine the method of display.
Before describing in the following the major types of orders, some important
terminologies in relation to order types should be defined:
- Bid:
the highest price at which one party is willing to buy a security (representing
the demand side of the transaction) (Deutsche Börse Glossary)
- Offer:
the
price at which one party will sell a security (Banks, 2010: 34)
-
Best bid: the best buy offer. The highest price at which one party is willing to buy
(www.centralact.com)
- Best offer: the best sell offer. The lowest price at which one party is willing to sell
(ibid)
- Inside spread: the difference between the best bid and best offer (Banks, 2010:
34)
2.5.1 Market Orders
Market orders, alias unpriced orders, are the classic form of orders. They are not-limited
buy or sell orders which should be executed as soon as possible, at the next price in the
market.
Within the class of market orders several subtypes exist, including stop orders, trailing
stop orders, market-to-limit orders, market-if-touched orders, market-on-close orders,
market-on-open orders, uptick/downtick orders and sweep-to-fill orders.
12
The most used of these order types are stop orders, trailing stop orders, market-to-limit
orders and sweep-to-fill orders (Deutsche Börse Group, 2009:11).
Stop orders are similar to limit orders: securities are sold or bought if a trigger price is
attained. In the case of insufficient volume a fill cannot be guaranteed even if the stop is
triggered and the order converts into a market order.
Trailing stop orders are similar to stop orders except that a trailing amount is attached
that moves with the market price.
Market-to-limit orders are not limited buy or sell orders which should be executed at an
action price or in the continuous trading at the best limit price in the order book. A
Market-to-limit order is only accepted if there are only limit orders at the opposite site in
the order book. If only a part execution of a market-to-limit order is possible, the rest of
the order will be placed in the order book with the limit of the part execution (ibid).
Sweep-to-fill orders are orders that should be executed as fast as possible at the best
available price, regardless of venue. That means that these orders are submitted to the
first venue with the best price and are filled to the extent possible. Then the remaining
portion sweeps to the next venue with the next best price, and so forth until the order is
completed. Typically with each sweep the price becomes less favorable (Banks, 2010:
36).
2.5.2 Limit Orders
Further to market orders a limit can be added to an order. Limit orders are buy or sell
orders with a price limit. They should be executed at a certain price or better. If the price
limit is not reached, limit orders are not executed and depending on the investors
instruction these orders are than deleted or the investor gives also a time limit, which
indicates how long a limit order is valid. An unfilled limit order is placed in the
exchange's limit order book for future execution. While in the process of being filled, a
limit order is considered to be a working order.
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Subtypes of limit orders are: stop limit orders, trailing stop limit orders, limit-if-touched
orders, limit-on-close orders, limit-on-open orders, discretionary orders and intermarket
sweep orders (Deutsche Börse Group, 2009: 11).
2.5.3 Peg Orders
Peg orders are based on a price that is pegged to a recognized base reference, such as
the NBBO or the EBBO. Within the class of peg orders the following subtypes can be
considered:
- Primary peg orders: are peg orders that peg to the same side of the base
reference
- Market peg orders: are peg orders that peg to the opposite side of the base
reference
- Midpoint peg orders: with midpoint orders the execution of an order takes place at
the precise midpoint course between ask and bid price of the base reference.
Midpoint orders interact only with other midpoint orders and not with the other
orders in the order book.
- Alternative midpoint peg orders: are peg orders that peg to the "less aggressive"
side of the midpoint (Interaktivbrokers.com).
2.5.4 Hybrid and Complex Orders
Further to the order types noted above, many other orders can be created, by combining
different order types with each other. An example is for instance the cross order, which
is an order to buy and an order to sell the same stock at a specific price. Sometimes
broker receive an order from one customer to buy and from another customer an order
to sell the same security; this is then a cross order, which is not fictitious.
The most complicated order types are called algorithms, which contain many different
parameters that define precisely how an order is to be filled (Banks, 2010: 40).
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2.5.5 Order Parameters
Many of the orders from the four main order classes' described above can be further
defined through additional parameters, namely display parameters, quantity parameters
and time in force parameters. In the following an overview over the most common
parameters should be given.
2.5.5.1 Display Parameters
Display parameters need to be added specifically, with a "do not display" instruction. If
such an instruction is not given, an order is assumed to be visible to the public in most
marketplaces. A "do not display" inscription can be applied to all or only part of the order.
If it applies to all of the order, the order is a hidden one, if it applies only to a part of the
order; the order is an iceberg order. It should be noted at this at this point that both
hidden and iceberg orders are critical to dark liquidity formation. Therefore a closer look
at these two order types will be taken in the following.
2.5.5.1.1 Hidden Orders
Hidden orders are non-visible limit orders, which are embedded in a venue's dark book.
Generally, they are excluded from the MiFID pre-trade transparency regulations,
because of their huge volume compared with normal market size. In order to comply
with MiFID requirements for orders which are large in scale the minimum size for a
hidden order is specified in Table 2 in Annex II of the MiFID Implementing Regulation
1287/2006, titled "Orders large in scale compared with normal market size" (CESR,
2010: 18).
15
Hidden orders rest hidden, even if the rest volume of a part execution is smaller than the
requested minimum size. Generally hidden orders are executed in the order book as
limit orders, which mean that the execution follows the price-/time priority. However if
there are hidden and visible orders at the same price, visible orders are executed before
hidden orders (Deutsche Börse Group, 2009: 15).
2.5.5.1.2 Iceberg Orders
Iceberg orders (also known as reserve orders) are orders which make it possible to an
investor to place orders with huge volume into the order book without making the whole
volume visible to the public. Iceberg orders are limit orders with a defined total volume
as well as a defined visible part of the order, the so called peak-volume. Both, the total
volume as well as the peak-volume, have to match a so called round lot, which means
that the volume of an iceberg order has to be a normal unit of trading for a security,
which are generally 100 shares of a stock.
In the continuous trading when the first peak has been fully executed, another peak is
automatically displayed in the order book. The hidden part of the order is then reduced
by the corresponding number of shares. When an iceberg order's displayed part is fully
executed, and the next peak converts from hidden to displayed status in the order book,
the newly displayed peak also receives a new time stamp which determines its time
priority (Banks, 2010: 42).
For instance, if the total volume of an iceberg order is 100,000 shares and the peak
volume is defined as 10,000 shares, the market would see only 10,000 shares on the
ask or bid side of the order book, depending whether the order would be a buy or a sell
order. When the display quantity of 10,000 shares would be executed, the next peak
volume would be automatically visible to the market, and wait for its next opportunity to
get a fill. The trading system automatically displays new peaks after additional
executions, until the final peak is displayed or the order is cancelled. As iceberg orders
are not specially marked in the order book, it is not visible from the outside whether an
order has a rest volume or not. Only after the full execution the total volume is visible.
16
But the immediate automatic display of a new peak after the currently displayed peak is
executed creates a distinct pattern in the order book updates that is observable to any
trader who monitors the order book closely. A trader who detects an iceberg order
cannot determine the iceberg order's size although its peak size may provide a signal.
But as peaks are executed and new ones are displayed, the trader can form more
precise forecasts of the order's total size. So rather than disclose the information about
the order size right away, iceberg orders sequentially reveal more information as peaks
are executed. Iceberg orders are therefore often justified and promoted as an order type
that facilitates the execution of large orders with minimal price impact, a property that
should appeal to large liquidity traders. In the order book iceberg orders, including their
hidden volume, have a higher priority than hidden orders (Deutsche Börse Group, 2009:
15).
Although both hidden and iceberg orders assume lower priority than visible orders that
have the same price level, these order types are, according to recent empirical evidence
about traders' order submission strategies on electronic limit order books, more and
more used. The growing importance of these special types of orders can be seen in the
fact that they make up recently around 44 percent of all Euronext volume (Buti et al,
2008: 3).
2.5.5.2 Quantity Parameters
In addition to display parameters, many of the orders described above may also contain
quantity parameters. These parameters specify the action to be taken if the full order
cannot be executed instantly. The most common quantity parameters are:
- Fill-or-kill (FOK): with this designation the order should be immediately and
entirely executed. If this is not possible the order should be cancelled (Private
Trader Club; Trader Lexikon).
- All-or-none (AON): with this designation the order should be immediately and
entirely executed. If the execution of the entire amount is not possible the order
remains in force pending future execution unless it is specifically cancelled. An
