Central Limit Order Book (CLOB)
Tue, Apr 15A central limit order book (CLOB) is a trading execution model that operates on a transparent system, matching customer orders (bids and offers) based on a 'price/time priority' principle. Outstanding buy and sell offers are organized in a queue and executed in a prioritized order, determined by price and the time of entry.
The price/time priority principle dictates how orders are prioritized for execution. Orders are first sorted by their price, and then, for orders with the same price, they are ranked according to the time they were submitted. The highest bid order and the lowest offer order together represent the best available market price.
Customers can frequently cross the bid/ask spread, allowing them to take advantage of low-cost execution. They have the option to place limit orders "in between" the bid and ask prices. Additionally, customers can observe market depth or the "stack," which displays bid orders at various sizes and prices on one side, compared to offer orders at different sizes and prices on the other side.
The CLOB is inherently transparent, operates in real-time, maintains anonymity, and offers low execution costs. This model is commonly used for highly standardized securities and smaller trade sizes. In the CLOB framework, customers can trade directly with dealers, dealers can trade among themselves, and most importantly, customers can trade anonymously with one another.
In contrast to the CLOB model is the Request For Quote (RFQ) trading method. RFQ represents an asymmetric trade execution model. In this approach, a customer requests quotes from a limited number of participant market makers, who provide a bid/offer ("a market") to the customer.
The customer can only "hit the bid" (sell to the highest bidder) or "lift the offer" (buy from the lowest seller). They are not allowed to enter the bid/ask spread to try to minimize their execution costs. Unlike the CLOB model, customers can only trade with dealers and cannot trade with other customers. Most importantly, they are not permitted to create markets themselves.
Trade execution costs tend to be lower when a greater number of market participants compete for order flow, as opposed to when orders are directed to a limited set of market makers who may provide non-competitive quotes.
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