Matching Orders

Matching orders is the process by which exchanges match buy orders, or bids, with sell orders, or asks, to execute securities trades. Most securities exchanges match orders using computer algorithms. Previously, brokers matched orders through face-to-face interactions on a trading floor in an open-outcry auction.

Matching orders happen when compatible buy orders and sell orders for the same security happen at the same time. Generally, a buy order and a sell order are compatible if the maximum price of the buy order matches or exceeds the minimum price of the sell order. From there, the order-matching systems of different exchanges use a variety of methods to prioritize orders for matching.

Quick, accurate order matching is critical component of an exchange. Investors, particularly active investors and day traders, will look for ways to minimize inefficiencies in trading from every possible source. A slow order-matching system may cause buyers or sellers to execute trades at less-than-ideal prices, eating into investors’ profits. Some order-matching protocols tend to favor buyers, while others favor sellers. Often, exchanges aim to prioritize trades in a way that benefits buyers and sellers equally.

Each securities exchange uses its own specific algorithm to match orders. Broadly, they fall under two categories: first-in-first-out (FIFO) and pro-rata.

Under a basic FIFO algorithm, or price-time-priority algorithm, the earliest active buy order at the highest price takes priority over any subsequent order at that price, which in turn takes priority over any active buy order at a lower price. For example, if a buy order for 200 shares of stock at $90 per share precedes an order for 50 shares of the same stock at the same price, the system must match the entire 200-share order to one or more sell orders before beginning to match any portion of the 50-share order.

Under a basic pro-rata algorithm, the system prioritizes active orders at a particular price proportional to the relative size of each order. For example, if both a 200-share buy order and a 50-share buy order at the same price are active when a compatible 200-share sell order arrives, the system will match 160 shares to the 200-share buy order and 40 shares to the 50-share buy order. Since the sell order is not large enough to fulfill both buy orders, the system will partially fill both. In this case, the pro-rata matching algorithm fills 80 percent of each order.