Trade Execution

Trade Execution refers to the stage where an order is considered complete, indicating that the stock order has been fulfilled per investor specifications. In this process, a third-party broker takes care of the sell or buy order and is legally bound to get the best deals possible for the parties involved.

The trade execution process involved in execution is simple. An investor, through a brokerage account, either buys or sells orders and then sends them to brokers. The brokers, on behalf of the investors, determine the suitable market for the order to be executed. Once the order reaches the market and is fulfilled as per instructions from both parties, it is considered executed.

Trade execution is the process that indicates fulfillment of a sale or purchase order for a security. It takes place when an order is filled out, not when the investor places an order. In a typical trade setup, an investor places a trade, which is then sent to a broker. These brokers then determine the best possible way of execution for their clients. As soon as the order is fulfilled, it is said to be complete.

Brokers play an important role in the process, as the executions, when done properly, can increase trust in the brokerage firms, boosting the reliability of the stock market. The executions also impact the sale and purchase prices and, hence, significantly impact the investor's total returns. 

A broker is legally bound to find the best possible execution deal for investors. The US Securities and Exchange Commission (SEC) requires brokers to prepare reports on their stock-by-share execution accuracies. Brokers are responsible for alerting customers who do not have orders routed for the best possible execution. 

Brokers commonly offer commission rebates for their customers if they perform over a certain dollar amount or trade number a month. This helps short-term traders who intend to keep their trade execution costs low. 

There are various trade execution strategies that brokers adopt. Let us check out the methods used for the same:

• Order to floor - A floor broker issues the orders here. The transactions are filled in and processed by humans and, hence, can take time.   
• Order to the market maker - Brokers may direct orders to market makers instead of the market. Market makers are companies that sell or buy shares. There are over-the-counter (OTC) market makers who pay the brokers for directly collaborating with them, and this amount is called payment for order flow.    
• Electronic communications network - Under this arrangement, computers coordinate with each other to buy and sell orders. The trade here is executed electronically.  
• Internalization - Brokers hold stock inventory and execute the order in-house. Here, the transaction is carried out internally by fulfilling orders using company inventory. In this case, the difference between the bid-ask spread becomes the broker's profit. 

Let us look at some of the instances to understand the concept better:

Example #1

Suppose Mary is an investor who wants a fast trade execution and saves her time from making trades. She, therefore, approaches a brokerage firm. The brokerage firm entered an agreement with her to provide a 5% commission on the sale proceeds to execute the trade. Thus, the firm, on behalf of Mary, buys or sells orders and makes money for her by engaging in the most suitable deals.

Example #2

A Japanese online brokerage firm, au Kabucom Securities, is set to collaborate with Morgan Stanley MUFG Securities (MSMS) to improve its trading execution services. According to this October 2024 report, the platform is set to facilitate the expansion of its smart order routing (SOR) service by using execution algorithms for individual customers. The SOR, through simultaneous monitoring of multiple markets, is set to help identify the best markets for placing orders to ensure the most suitable and profitable deals for investors.

The execution of a trade comes with multiple challenges, which might impose certain restrictions to smooth trade facilitation. The following points include the restrictions on the execution of trades:

• Not all trade orders can be fulfilled or executed. This is especially true of large orders, which must be broken into small orders. In such situations, trades are executed at different times at different prices.  
• In some instances, a limit order for sale may not be executed if the prices of the stock are lower than the limit selling price of orders. 
• Limit buy orders may not be executed if the price of stocks is higher than the limit buy price of orders. 

Given below are some of the differences between both concepts: 

• For a trade to be executed, brokers enter into a valid, legally binding agreement with investors and undertake the best trade deals on their behalf. Settlement, on the other hand, is the transfer of stocks and securities for money between buyers and sellers after the brokers execute the trade. The transfer of ownership happens here.  
• Trade execution jobs are real-time activities. An investor places the order, and if the specifications are fulfilled, the order is fulfilled and considered executed. On the other hand, settlement happens in an arrangement of T+2 days. This means that it takes two business days for the settlement to take effect after execution. 
• Trade order executions require brokers' involvement. In a settlement transaction, a broker is not required, and clearing houses are a basic part of the process.