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Traders, especially stock traders, can trade the instruments in many different ways; can pit trade on exchange floor, can trade exchanges online and can trade through alternative trading systems. Matching systems is one of the most common alternative trading systems which work by automatically matching orders. Matching systems match bid and offer prices of buy and sell orders and execute trades for traders.
Matching systems differ from major exchanges in a way that there is no continuous trading (or order execution). They usually have periodic execution sessions; when all orders until then is matched as much as possible. Most systems are owned by big players of the market like banks, market makers, money managers, institutional traders and other big financial firms; traders can access them via a stock broker.
Matching systems create an alternative trading environment, which help in fulfilling some specific trading goals. The whole procedure is given below.
1. Traders place their orders through a specific pathway (protocol). Usually the orders are placed anonymously.
2. The system evaluates the orders, and then route them to most suitable cross-matching systems. Cross-matching systems are order matching systems for specific symbols.
3. At specific time intervals, the systems check for matching orders against trader entered orders.
4. If a matching order found, the order is executed instantaneously and reported back. This order execution is usually done on a time-priority basis.
5. If no matching order, then the order is held in the systems and the ask or bid price of the order is shown to all traders involved in the system.
Matching systems offer some advantages over centralized stock exchanges. 1) All trades and done electronically and automatically and thus fast with lesser errors, 2) They are less vulnerable for price manipulations, 3) all trades are done on a pure quote-driven environment, 4) no broker involvement in execution of orders, 5) they help big market players to achieve some specific goals like fast execution and achieving best prices, and 6) they can act as a backup trading system for traders. Most matching systems passively derive ask and bid price from National Best Bid and Offer (NBBO).
With matching systems there can be symbol limits and minimum order size requirements (usually 10,000 shares per order), making it less favorable for less-active traders. The order execution fees can also vary considerably.
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