Smart Order Routing (SOR)
Tue, Apr 15Smart order routing (SOR) is an automated process used in online trading that follows specific rules to seek out and evaluate trading liquidity. The primary objective of SOR is to identify the most effective method for executing a trade.
The concept is straightforward: "Smart" refers to the efficient use of intelligence to achieve the best possible outcome. An "Order" is an instruction given with the expectation that it will be acted upon. "Routing" involves setting a path to reach a final goal.
SOR automates the management of orders, aiming to secure the best available price across various trading venues. Forex brokers utilize smart order routing technology to explore liquidity across multiple platforms, enhancing their clients' chances of obtaining price improvements, such as avoiding slippage or achieving positive slippage.
Smart Order Routing is executed by Smart Order Routers, which are systems that evaluate the conditions of different venues and place orders in the most advantageous manner. These routers depend on established rules, configurations, and algorithms to address liquidity fragmentation by analyzing various offers and placing orders based on the best available options.
Most major institutional investors and brokers employ smart order routers to quickly identify the best possible prices for trades. Each smart order router is tailored to meet specific needs, and they are often integrated into automated trading systems, although the degree of automation can vary among different routers.
It is important to note that Smart Order Routing is NOT the same as Algorithmic Trading. The terms Smart Order Routing and Algorithmic Trading are frequently used interchangeably, but they represent distinct, albeit complementary, functions. Smart Order Routing focuses solely on where the order is directed and at what price, while algorithms may dictate what, how, and when the order will be placed.
Algorithmic trading is a system that employs mathematical models to make transaction decisions in financial markets. The strict rules embedded in these models aim to determine the optimal timing for placing an order to minimize its impact on an asset's price.
Becoming a smart order router begins with a clear investment and execution policy. First, consider what you aim to achieve and what commitments you have made to your clients or investors.
- Access to real-time market data from each venue or a consolidated stream from a commercial provider.
- Basic software to identify and direct messages to the appropriate destinations.
- Connectivity to the selected execution venues, which can range from simple links to Virtual Private Networks in the financial services sector to more complex setups involving dedicated lines to each desired venue.
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