An order is an instruction to trade that is given by a party who wishes to take a position in an asset. If parties wish to establish a long position, they will issue a buy order, whereas if they desire to go short, they will place a sell order. At the time of placing an order, the security in which the investor wishes to take a position must be clearly identified. This is fairly simple in the case of stocks because most companies usually issue only one type of shares. It must be remembered that some firms may have issued equity shares with differential voting rights, or even nonvoting shares, in which case merely specifying the name of the company will not be adequate. Bonds are more complex. Company XYZ may have issued bonds maturing in 2025 or in 2030. In 2025 there may be an issue maturing in January and possibly one in October. There may be multiple types of bonds maturing in the same month and in the same year, but with different coupons. Thus, XYZ may have bonds maturing in October 2025 with a 5% coupon as well as with a 6% coupon. Hence, if traders wish to buy or sell bonds, they must identify the issuing company and specify the maturity year, the month of maturity, and the coupon rate. Without such a detailed description, the specification may be inadequate. There are certain supranational agencies that may issue bonds with the same month and year of maturity, and the same coupon rate, but with different currencies, say, US dollars and euros. In this case the currency should also be specified by a potential trader.

Derivatives also require more elaborate specification. XYZ company may have futures contracts expiring in January 20XX, February 20XX, and March 20XX. Thus, while placing an order for a futures contract, it is imperative to specify the expiration month, in addition to the identity of the underlying asset. Options are even more complicated from the standpoint of identification. To place an order for options on XYZ, the trader needs to specify the expiration month and the exercise price. That's not all. For each combination of the expiration month and exercise price, there will exist call and put options. Thus, to place a buy or a sell order for an options contract, the trader must spell out the underlying asset, the expiration month, the exercise price, and whether it is a call or a put.

The quantity in which a long or short position is sought to be taken must be clearly spelled out. Most stocks used to trade in what were known as round lots or board lots, where each lot was usually for 100 shares. With the advent of dematerialized securities or scripless trading, however, this requirement has been dispensed with. The quantity that is specified in an order is known as the order size.

The price at which an investor is willing to transact is obviously a key feature of the order specification. There are two possibilities. There are investors who will accept any price that a market may offer at the point in time at which the order is placed. Such investors will place what are known as market orders. There are others, however, who may have a floor or a ceiling in mind. Traders placing buy orders may seek to specify a price ceiling, that is, a maximum price they are prepared to pay. On the other hand, those placing sell orders may wish to specify a price floor, that is, a minimum price below which they would not like to transact. Traders who specify a floor or a ceiling for the price, place what are known as limit orders. Obviously, in the case of market orders, the only parameter that has to be specified is the order size. In the case of limit orders, however, in addition to the quantity, the limit price also has to be specified.

Traders are also required to specify the period of time for which they wish their orders to remain valid. Many exchanges allow only good today limit orders or what are known as day orders. That is, an order is valid only until the close of trading on the day on which it is placed. If it were to fail to be executed on that day, it would automatically stand canceled. Other exchanges may permit orders to be carried forward; even in such cases the exchange will specify a maximum validity period. Some exchanges permit traders to specify a validity period. These are called good till days or GTD orders. Variants include good this week orders, and good this month orders. Not all brokers may accept such orders, at least not for all clients. There could be situations where traders specify an order with an expiration limit and then forget about it. If it were to go through subsequently, they may call and berate the broker for not informing them about the presence of this order. Clearly, the broker is not at fault. Hence, most brokers will allow only regular clients to specify such orders.

Some traders specify that their orders should be executed on placement or else should be canceled immediately. These are known as fill or kill orders. In such cases, the trader will get 100% of the quantity sought, or the order itself will be canceled. Immediate or Cancel orders are similar, but permit partial execution. Thus, if a buy order is placed for 500 shares, and a counterparty is available for only 250 shares, then 250 shares will be bought, and the rest of the order will be canceled. Some traders may allow their order to be filled only if the trade results in the fulfillment of the entire quantity that has been specified; that is, they will not accept a partial match. Such orders are known as all-or-none or all or nothing orders. The difference between a fill or kill and an all or none order is that in the case of the former there is either 100% execution or cancellation, whereas in the case of the latter, if 100% execution is not possible, the entire order will be kept pending. The following examples will illustrate these concepts.

IMPORTANT ACRONYMS

• WAP: Weighted Average Price

  If a trade is executed at multiple prices, the WAP will be computed.

• LTP: Last Traded Price

  This is the last price at which a trade has taken place.

• CMP: Current Market Price

  This is the best bid for sellers and the best ask for buyers.

• FOK: Fill or Kill
• IOC: Immediate or Cancel
• AON: All or None
• GTC: Good Till Canceled
• GTD: Good Till Days
• GTW: Good This Week
• GTM: Good This Month
• LOB: Limit Order Book
• SLB: Stop-Loss Book

MARKET ORDERS AND LIMIT ORDERS

Traders who place market orders are content with the best price that the market has to offer. Obviously, the trading system should be structured in such a way that an order is executed at the best available price from the standpoint of the trader. The best available price for a potential buyer is the lowest of the limit prices of all the limit sell orders that are pending in the market when the market buy order enters. On the other hand, the best available price for a potential seller is the highest of the limit prices of all the limit buy orders that are pending in the market when the market sell order enters. Thus, in order to ensure that buyers are given access to the lowest prices on the sell side, while sellers are given access to the highest prices on the buy side, limit orders that are pending execution are arranged in descending order of price if they are buy orders, and ascending order of price if they are sell orders. This helps ensure that both buyers and sellers will get the best possible price from their perspective.

In practice, limit orders are arranged in the system using two or more priority rules. The primary priority rule is the price priority rule. All limit buy orders that are pending execution are sorted in descending order of price, and all limit sell orders that are awaiting execution are sorted in ascending order of price. Thus, an incoming market buy order is assured of execution at the lowest available price on the sell side, whereas an incoming market sell order is guaranteed to be executed at the highest available price on the buy side.

Price priority is the primary criterion that is universally valid across exchanges. Every exchange will have at least one secondary criterion. The secondary criterion that is universally applied is time priority. That is, if two limit orders have the same price limit, the order that came first in a chronological sequence will be accorded priority. Thus, for a given limit price, the orders are arranged in the sequence in which they are received. That is, an order that came in earlier would be accorded priority over an order that came later. Some exchanges also use order size as a priority rule.

THE LIMIT PRICE

For orders placed in connection with stocks and bonds, the limit price represents the highest price that a buyer is prepared to pay, or the lowest price that a seller is prepared to accept. In the case of a futures contract, the specified price limit refers to the futures price. As mentioned earlier, in the case of options, the limit price is for the option premium per unit of the underlying asset.

THE LIMIT ORDER BOOKS

All unexecuted but valid orders need to be stored in the system until they can be matched with an incoming order. The record of such orders is referred to as the limit order book (LOB). Prior to the advent of electronic trading, the record was physically maintained in the form of a book of orders. In modern systems everything is maintained in an electronic form. The advantage of the modern system is that with the click of a mouse, a trader can switch from the limit order book for one security to that for another security.

ILLUSTRATION OF A LIMIT ORDER BOOK

Consider the following limit order book (LOB) at a given point in time. The book represents the situation for the common stock of XYZ, as at 11:30 a.m. on the morning of 15 July 20XX.

As can be seen, on the buy side the orders have been arranged in descending order of price, whereas on the sell side they have been arranged in ascending order of price. On the buy side both Maureen and Myra have given a limit price of 98.85. Obviously, Maureen's order was placed before Myra's.

The prices specified by traders seeking to buy are known as bids. Conversely, the prices given by those seeking to sell are called offers. The best bid is the highest of the bids in the book. Obviously, it is the best from a seller's perspective. Similarly, the best ask is the lowest of the asks in the book. As can be deduced, it is the best from a buyer's perspective. The difference between the best ask and the best bid is called the bid–ask spread. In our example it is 100.55 – 99.45 = $1.10.

LIMIT ORDERS VERSUS MARKET ORDERS

Traders who place limit orders are able to control the price at which their order will be executed. A potential buyer who has placed a limit buy order with a limit price of 99.25 can be assured that the eventual price paid will not exceed this limit. Similarly, a potential seller who has placed a limit sell order with a limit price of 101.25 will receive at least this price. However, a trader who places a limit order can never be sure how long it will take for the order to get executed. It could take an inordinately long time for the order to get executed, and there could be circumstances in which the order fails to get executed. This is particularly true for limit orders that are not aggressive. The meaning of aggression may be explained as follows. For buy orders the higher the limit price, the greater is the projected aggression, whereas for sell orders the lower the limit price, the greater is the displayed aggression.

Consider the case of Molly, who is eighth from the top in the list of buy orders. Now assume that Robert gives a market buy order for 1,000 shares. The last traded price will be 100.95. Assume that Roger now gives a market buy order for 750 shares. The last traded price will jump to 102.25. Seeing the price jump to this level, other potential buyers may get more aggressive. That is, they may give limit orders with higher limit prices. For instance, what if Mitch gives a buy order for 300 shares with a limit rice of 99.65, while Marvin gives a buy order for 500 shares with a limit price of 100.05? Due to these two orders, Molly will now be tenth from the top in the list of buy orders.

Thus, if a series of market buy orders keep entering, the last traded price will be steadily pushed upwards. In such situations, if more aggressive limit buy orders were to keep entering, there could be a substantial delay in the execution of a limit order that was placed earlier. The same is true for the other side of the book. If a series of market sell orders were to keep entering, the LTP will be pushed downward. Now if more aggressive limit sell orders were to enter with lower limit prices, a preexisting limit sell order could be pushed behind considerably. In the event of the exchange accepting only day orders, an order like Molly's may not be executed during the course of the day and consequently will have to be canceled.

It is not essential for incoming orders to be market orders for a preexisting limit order to lose its relative position in the queue. A series of aggressive limit orders, either buy or sell orders, could cause the same result to be achieved.

MARKETABLE LIMIT ORDERS

Consider Table 12.1. The best bid is 99.45 and the best ask is 100.55. If potential buyers feel that the best ask price of 100.55 is acceptable, they will place a market buy order. If they feel it is too high, they will place a limit buy order with a lower limit price. Similarly, if potential sellers feel that the best bid price of 99.45 is acceptable, they will place a market sell order. If they feel it is too low, they will place a limit sell order with a higher limit price. Thus, usually, limit buy orders are placed with a limit price that is lower than the best ask, whereas limit sell orders are placed with a limit price higher than the best bid.

There could be situations, however, where traders price their limit order very aggressively. How will such aggression manifest itself? A potential buyer may place an order with a limit price higher than the best ask, or a potential seller may place an order with a limit price lower than the best bid. Such orders are referred to as marketable limit orders. Marketable limit orders by definition are those limit orders that are likely to be executed upon submission. In the situation depicted in Table 12.1, a limit buy order with a limit price greater than or equal to 100.55 will be classified as a marketable limit order. Similarly, a limit sell order with a limit price of 99.45 or less will also be classified as a marketable limit order.

Why would anyone wish to place a marketable limit order when they can place a market order? Assume that an investor named William places a limit buy order with a price of 100.60 for 200 shares. His anticipation is that it will be matched with the best sell order and that a trade will result. But what if a market buy order for 1,000 shares enters the system before the limit order is placed? Remember that in today's online trading world, traders throughout the world are watching the action, and an order can always sneak in before we can place our order as planned. In this case, the best ask after the execution of this order will be 100.95. Because William's bid is lower than 100.95, it will stay in the book in the form of a limit buy order with a limit price of 100.60, at the top of the list of buyers. If, however, William had given a market order and the same sequence of events were to have occurred, his order would be matched with the sell order at 100.95, and a trade would result at that price. Thus, if a trader like William were of the opinion that speed matters, but so does price, beyond a point, he may prefer a marketable limit order to a market order.

Thus, with marketable limit orders, in the event that things don't work out as planned, the trader still retains an element of control over the price. But there is a drawback in the case of such orders as compared to market orders. A marketable limit order is, after all, a limit order, and limit orders, marketable or otherwise, are subject to execution uncertainty.

TRADE PRICING RULES

The incoming order is referred to as an active order, whereas the orders that are already present in the system are referred to as passive orders. The trade price is the limit price of the passive order with which the active order is matched.

Consider the LOB depicted in Table 12.1 Assume that William places a market buy order for 800 shares. 500 will get matched with Nancy at a price of 100.55, and 300 with Nina at 100.75. The WAP will be 100.625. Both Nancy and Nina are passive compared to William. What would happen if William were to issue a marketable limit order with a limit price of 100.80? Once again, 500 will get matched with Nancy and 300 with Nina. The WAP will still be 100.625.

An interesting situation arises when a market order enters the system when the opposite side of the LOB is empty. If we were to wait until a limit order appears on the other side, the passive price rule cannot be applied, as the passive order in this case is a market order. Consequently, in such situations, the market order is usually converted to a limit order with a limit price equal to the last traded price. If it is then matched with an order on the opposite side, a trade will result at this assigned limit price.

It is not necessary that a market order go to the top of the limit order book, if it is converted to a limit order. In the previous illustration, what if the last traded price was 99.15? William's order will be converted to a limit order with this limit price. It will be third in the queue, between Mark and Mathew.

STOP-LOSS AND STOP-LIMIT ORDERS

Stop or stop-loss orders are placed by traders who already have a position in the market. At the time of order placement, the traders have no desire to unwind their existing position. However, if market conditions were to suddenly turn adverse, the traders may have a threshold price beyond which they are unwilling to tolerate losses. This desire to cap a trader's loss is why such orders are also termed as stop-loss orders.

Assume that William is short in 400 shares and observes the LOB shown in Table 12.1. The best available price is 100.55. If William is of the opinion that the price is acceptable, he will place a market order. But if he feels it is not high enough to make him buy, and that his threshold price corresponds to 100.95, he could place a stop-loss order with a trigger price of 100.95. For a stop-loss buy order, the trigger will be higher than the best ask. Unlike a market order, or a limit order, the stop-loss order will not directly enter the LOB. It will go to the stop loss book (SLB). It will lie dormant there until it is triggered off and, if triggered, will jump into the LOB as a market order.

Now assume that a market buy order for 1,750 shares enters. The LTP will be 102.25. William's order will get triggered off and will go through at 102.25. As can be seen, the eventual trade price is substantially different from the threshold that is specified. This is because once a stop-loss order is triggered off it becomes a market order, and with such orders, traders cannot control the price.

If William wanted to ensure that the execution price is close to his trigger of 100.95, he has the option of placing a stop-limit order. This, as the name suggests, is a hybrid between a stop-loss order and a limit order. Thus, two prices have to be specified. The first is the trigger price corresponding to the threshold. The second is the required limit price, if the order were to be triggered off. Obviously, the limit for a stop-loss buy order will be higher than the threshold price for such orders. Such an order, if triggered, will enter the LOB as a limit order. As is the case with all limit orders, however, there is execution uncertainty, if they were to be activated.¹

Stop-loss and stop-limit orders can be placed by potential sellers as well. Assume that Winnie is long in 500 shares. She would like to sell if the price were to hit or go below 98.75. Assume that she gives a stop sell order with a trigger of 98.75, and that a market sell order for 3,000 shares enters the system. The LTP will be 98.05. Winnie's order will be activated and will become a market sell order. 50 shares will be sold at 98.05 and 450 at 97.95 and the WAP will be 97.96. Once again, the WAP is substantially different from the trigger price of 98.75. This is because once the order was triggered off it became a market order, and the eventual execution price in such cases is uncertain. If Winnie had wanted, she could have given a stop-limit order with a trigger of 98.75 and a limit of say 98.60. In such a situation, she would be assured of a minimum price of 98.60. However, as in the case of a stop-limit buy order, this kind of an order too will lead to execution uncertainty. Obviously, the limit price for a stop-limit sell order will be less than the trigger price.

TRAILING STOP-LOSS ORDERS

In the case of trailing stop-loss orders, the trigger price does not remain fixed, but moves with the market in one direction. Let us consider sell orders first. The trigger price will be specified as a price that is less than the last traded price. The specification can be as a percentage or in dollars. If the market price increases, the trigger will increase along with it. However, if the market price declines, the trigger will remain constant.

For a buy order the trigger will be specified as a price that is greater than the last traded price. Once again, the difference can be as a percentage or in dollars. If the market price declines, the trigger will decline along with it. However, if the market price were to increase, the trigger will remain constant. Here are some examples.

MARKET TO LIMIT ORDERS

While an order will typically get filled at multiple prices, which could be very different from each other, a trader may wish to ensure that the order is filled at prices that do not vary much. In such a situation the trader has the option of placing a market to limit or MTL order. The execution of such as order may be illustrated with the help of an example.

EQUIVALENCE WITH OPTIONS

Limit orders may be perceived as options. A limit buy order is a put option, for it gives other traders the right to sell to the trader placing the order. Similarly, a limit sell order is a call option, for it gives other traders the right to buy from the trader placing the order. The limit price that is specified in the order is the strike price of the corresponding option.

There are two key differences between conventional options and the options implicit in limit orders. First, unlike normal options, limit orders represent options with a zero premium, because a trader will not be paid for placing a limit order, which is tantamount to selling an option. Second, a conventional option is a contract between the seller and a particular buyer. In the case of limit orders, however, there is no exclusive owner or buyer. Once the order has been placed, anyone is welcome to come and trade by placing a market order or a marketable limit order.

The question therefore arises as to why someone should offer an option without receiving a premium in return. The rationale is as follows. Traders have an option of placing a market order or a limit order. By placing a limit order, they hope to trade at a better price. Consequently, in such a situation, they may offer an option to others, despite the fact that they will not receive a premium for selling such an option.

VALIDITY CONDITIONS

Traders have the option of specifying a validity instruction to indicate how long their order should remain valid in the event of there being a delay in execution. Such instructions may be appended to any kind of order. However, they are used primarily for limit orders and stop orders (with or without a price limit), for such orders have a tendency to experience delays in execution.

GOOD TILL CANCELED (GTC) ORDERS

If a GTC order is not executed on the day it is entered, it will be carried forward to the following day. Thus, on the following day the LOB at the opening of the market will contain such pending orders. This will happen every day until the trade is executed or canceled. Obviously, such orders cannot remain in the system for an indefinite period of time. Therefore, the exchange will specify a maximum validity period. The order will be automatically canceled if it remains unexecuted at the end of this prescribed time limit.

GOOD TILL DAYS ORDERS

In the case of these orders, the trader can specify the validity period. However, the time limit for such orders cannot exceed the validity period for a GTC order. Thus if a GTC order on a particular exchange has a maximum limit of a month, then this would be the maximum limit for a good till days order. There are different variations of such orders, such as good this week (GTW) and good this month (GTM) orders. The former is valid until the close of trading on Friday of the week in which it is placed, whereas the latter is valid until the close of trading of the last trading day of the month in which it is placed.

ORDERS WITH QUANTITY RESTRICTIONS

A fill or kill order (FOK) is one where the entire order must be filled on submission or the order itself must be canceled. Partial execution is not permissible. On the other hand, an immediate or cancel (IOC) order permits partial execution. In this case, the mandate is to fill whatever is possible and cancel the balance. Here is an illustration.

An all or none or all or nothing (AON) order is another type of order with a quantity restriction. Like an FOK order, it is required to be filled in its entirety or not at all. However, unlike the FOK, it need not be canceled if it cannot be filled, and needs to be kept alive until a suitable match can be found. An AON limit order receives lower priority as compared to a normal limit order with the same limit price but without any such restriction. An AON order may be filled at multiple prices as the following example illustrates.

A POINT ON ORDER SPECIFICATION

In an electronic trading platform, it is important to specify the order correctly to achieve the desired result. If traders were to desire to modify an order subsequently, they will have to cancel the original order and rebook a fresh order. There are two related problems in practice. First, by the time the order is canceled and modified, market conditions may have changed substantially. Second, before traders are able to cancel a preexisting order, it may have gone through. Thus, it is imperative to correctly specify the order right at the outset.

OPEN-OUTCRY TRADING SYSTEMS

Open-outcry systems, also referred to as oral auctions, are a type of continuous bilateral auction. They were extremely common in the last century, but have of late been replaced to a large extent by electronic trading systems.

In an oral auction there is a central location at the stock or derivatives exchange where the traders congregate. This location is referred to as a ring in a stock exchange and as a pit in a derivatives exchange. Traders cry out their bids and offers hoping to entice others who may be willing to take a matching position.

While shouting out their requirements, they will concurrently be listening for orders being shouted out by other traders. A trade will result if a buyer were to accept a seller's offer, or if a seller were to accept a buyer's bid. The consummation of a trade is accompanied by a shout of “take it” if the buyer were to accept an offer, or by a shout of “sold” if the seller were to accept a bid.²

Since both buyers and sellers will be shouting out their requirements, it is necessary to distinguish between bids and offers. In most oral auctions the convention is that buyers will call out their limit price first followed by the quantity, whereas sellers will call out their required quantity first followed by their limit price. In certain exchanges, traders have a practice of using a system of hand and finger signals to indicate their limit prices, and the quantities they wish to trade.

The first rule that traders are required to follow on an open-outcry exchange is known as the open-outcry rule. This means that whatever the traders have in mind has to be verbally expressed. Once traders express their intention, any other trader standing in the pit may respond. It is a normal practice for traders to take turns in making bids and counter-offers, and offers and counter-bids, before the two parties are able to agree on a price. When a trader expresses the bid or offer, the first counterparty who accepts it gets to make the trade.

As in the case of electronic systems, there are certain priority rules. The principal rule is price priority. That is, a bidder is required to accept the lowest offer, and a seller is required to accept the highest bid. Such a rule is obviously self-enforcing in practice, because an honest buyer will always be on the lookout for the lowest price, while an honest seller will always strive to obtain the highest price.

The price priority rule requires that there should be clarity about the best bid and best offer that are available at a point in time. Obviously inferior bids and offers – bids with prices lower than the best bid, and offers with prices higher than the best offer – will only serve to create confusion. Consequently, most open-outcry systems will not allow a trader to bid below the best bid that is currently available, or offer above the best offer that is currently available. However, a trader may at any time improve upon the best bid by bidding higher, or improve upon the best offer by quoting a lower offer. A trader who does so will obviously attain priority.

The time preference rule in an oral auction, however, is not self-enforcing. This is because from the standpoint of a potential counterparty, it is immaterial as to whose bid or offer is accepted. The sole criterion is that traders should get the best available price. Hence, in such auctions traders who are currently enjoying time preference may have to vocally defend their status. That is, if another party were to bid or offer at the same price, they would have to shout out “That's my bid” or “That's my offer” to ensure that they continue to enjoy priority. Also, in such auctions, bids and offers are valid only for an instant. Hence, if a counterparty is not available, traders may have to repeatedly shout out their order in order to indicate to potential counterparties that they are very much interested in trading.

The trade pricing rule in such auctions is simple. Once a bid or an offer is accepted by another trader, the trade will take place at the price proposed by the trader whose quote was accepted.

ELECTRONIC MARKETS VERSUS OPEN-OUTCRY MARKETS

A system is considered to be successful if the liquidity is high and transactions costs are low. Transactions costs include not just direct transaction costs such as commissions, but also indirect costs such as lost revenues due to illiquidity.

Liquidity in an open-outcry system is supplied by traders called locals. These sell-side traders are always ready to buy and sell on their own account. The problem in practice is that a local is restricted at any point in time to a single pit. In a typical derivatives market, different assets trade in different pits. Obviously, locals cannot devote attention to multiple pits at the same time by running back and forth between pits. As a consequence, locals are in practice required to service the traders at their usual pit, even though there may be very little trading activity there.

In contrast, in an electronic system, traders do not face such locational constraints and can effortlessly switch to a different screen displaying the LOB for a different asset, simply with the click of a mouse. Hence, for assets characterized by relatively lower trading volumes, electronic trading is clearly the preferred mode of trading. Thus, most derivatives markets in emerging economies, where the trading volumes are lower, have chosen electronic systems as the mode of trading.

Evidence indicates that even advanced economies are increasingly switching to electronic systems. It must be remembered that exchanges in these countries introduced derivative contracts decades ago. In the earlier years, trading volumes were high for most contracts, because such instruments with their novel features provided opportunities that were simply not available earlier. In most of these cases, trading was active even though the underlying assets were not necessarily very sophisticated. After a point in time, however, the financial instruments on which derivatives have subsequently been introduced tend to be highly specialized. Consequently, the number of traders attracted to such contracts is relatively lower. Thus, derivatives on new instruments are characterized by relatively lower trading volumes, which is causing even established exchanges to switch to screen-based trading systems. Exchanges like the CME Group, which is a pioneer in derivatives trading, continue to use both types of trading platforms.

The older exchanges are also faced with the specter of declining trading volumes. This is to a large extent due to competition from newly established exchanges that embraced modern trading systems from the very outset. In the face of such rivalry, there is little option for the older exchanges but to embrace electronic systems. Electronic systems also play a key role in cross-border trading. Trading across borders is an accepted fact of the modern economy, characterized by the tenets of LPG: Liberalization, Privatization, and Globalization.

Electronic trading platforms are characterized by lower operational costs as compared to open-outcry systems. Screen-based trading platforms typically require less labor, skill, and time. Oral auctions are characterized by higher fixed costs due to the need for relatively larger manpower. The overheads such as building and back-office costs also tend to be higher.

The disadvantages not withstanding open-outcry systems continue to have certain merits of their own. As Sarkar and Tozzi have argued, highly active derivative contracts are better traded on traditional trading platforms, because the traders on such exchanges are more accomplished at executing large and complex orders.³ Traders in traditional systems also have the advantage that they are well aware of the trading behavior of competitors and counterparties, because the same parties trade with each other virtually every day. Such knowledge is indispensable for predicting the response of counterparties while implementing a trading strategy. In contrast, traders in electronic trading systems are faceless entities, and the counterparties remain unidentified.

Finally, in an oral auction, order revision is relatively simpler because quotes are valid only for an instant after being expressed. In an electronic system, however, modification of an order that has been placed earlier requires the trader to explicitly cancel the prior order. In such a situation, there is always a possibility that the original order will get executed before the change can be effected.

CALL MARKETS

In a continuous market, orders keep coming in when the market is open. They are ranked in the LOB based on the priority rules, and are executed as and when a match is feasible.

In a call market, orders are accumulated for a period in time. At the end of the stipulated period, all the buy and sell orders which have been received are ranked according to price priority. That is, buy orders are arranged in descending order of price and sell orders are arranged in ascending order of price. The market clearing price is determined, and all the orders that satisfy the criteria for execution are executed at the market clearing price. The modalities may vary from market to market. Here is an example based on a major emerging market stock exchange.