Finance

Order Driven Market

Order Driven Market

Order driven market consists of a constant flow of buy and sell orders from market participants. There are no designated liquidity providers but are more transparent than the quote-driven market. By comparison, in quote driven market, designated market makers provide bids and offer that other market participant may trade on. Stock exchanges like the New York Stock Exchange and the Nasdaq are seen as hybrid markets—a combination of both order and quote driven markets.

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What is an Order Driven Market?

An order-driven market is a financial market where all buyers and sellers display the prices at which they wish to buy or sell a particular security, as well as the amounts of security desired to be bought and sold. It is the opposite of a quota-driven market. The order-driven market provides two different types of orders: Market orders and Limit orders. Market orders are executed in the market at the best possible price, although there is no certainty of their fulfillment or price. On the other hand, Limit orders establish a maximum buy limit or a minimum sell limit. Two sets of rules determine order-driven market mechanisms order matching rules that match purchase and selling orders, and trade pricing rules that specify the price of the trades concerned.

How does it work?

They work with the progression of purchase and sell orders from market members. The order book is shown to investors who would like to access the information. This is an information base kept up by the trade which records the purchases and sellers and the offer costs. For the data, you have to pay a certain amount to the exchange. An order-driven market is not as liquid as a quote-driven market. This is because trading takes place only at the posted bid prices. Orders can only be executed during market hours. Any request after the market closes will be executed the next day when it opens. Order-driven market rank orders based on price. The highest-ranked order will be matched at the best possible price. The lowest sell order and the highest buy order will be matched.

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Examples:

Order-driven markets are quite common. All markets that conduct open-outcry auctions are order-driven. These include all major future exchanges, most stocks, and options exchanges, such as New York Stock Exchange, American Stock Exchange (merged with NASDAQ in 1998), Chicago Board of Trade, Chicago Board Options Exchange, and Tokyo Stock Exchange, and many trading systems created by brokerages ECNs to organize trading in stocks, bonds, swaps, and currencies.

Advantages:

  • The biggest advantage of an order-driven market is its transparency.
  • It clearly shows the total of the market orders (also known as orders book).
  • This displays all the bids and asks for security in the open marketplace or exchange.

Disadvantages:

  • The downside is that there is no certainty that these orders can eventually be fulfilled, it’s just the prices that traders or investors want to offer.
  • Due to the order-driven style of trading mechanisms order-driven market will have lower liquidity than the quote-driven market.
  • Trade can stagnate if buyers are not willing to meet seller prices, or vice-versa.

Bottom Line:

It is very important for traders to know the different trading mechanisms. It allows them to understand the market in a better way and therefore play better. Certain markets, for example, use algorithms in contrast with order-driven markets, knowing this will allow traders to make the most out of their trades. Therefore, understanding different market mechanisms are very important.

 

Author – Priyanshu Ahuja

About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and the investment domain.

 

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