U.S. patent application number 12/236651 was filed with the patent office on 2009-03-26 for automated batch auctions in conjunction with continuous financial markets.
This patent application is currently assigned to ITG SOFTWARE SOLUTIONS, INC.. Invention is credited to David CUSHING.
Application Number | 20090083175 12/236651 |
Document ID | / |
Family ID | 23910147 |
Filed Date | 2009-03-26 |
United States Patent
Application |
20090083175 |
Kind Code |
A1 |
CUSHING; David |
March 26, 2009 |
AUTOMATED BATCH AUCTIONS IN CONJUNCTION WITH CONTINUOUS FINANCIAL
MARKETS
Abstract
A method and system for performing a batch auction whereby a
series of orders, according to a variety of predetermined order
types, are generated by qualified market participants and
communicated to an auction system. The auction system takes into
account each order and its impact upon relative supply and demand
to determine by a preset algorithm a price and share transaction
quantity. Trades are executed at the price, and a portion of the
transaction quantity is allocated to each investor on a fair basis
dependent upon their initial orders. In embodiments of the present
invention, the auction system uses a computer system or network
designed to automatically perform one or more steps of the above
method. Such a system is preferably connected to one or more ECNs
such that non-executed shares can be automatically sent to outside
sources for execution. In alternative embodiments, the invention
includes the use of a one or more intermediaries or market makers
to cover certain unexecuted trades at the determined price. The
present invention is preferably used to conduct batch auctions at
the opening and closing of securities trading markets.
Inventors: |
CUSHING; David; (Lexington,
MA) |
Correspondence
Address: |
ROTHWELL, FIGG, ERNST & MANBECK, P.C.
1425 K STREET, N.W., SUITE 800
WASHINGTON
DC
20005
US
|
Assignee: |
ITG SOFTWARE SOLUTIONS,
INC.
Culver City
CA
|
Family ID: |
23910147 |
Appl. No.: |
12/236651 |
Filed: |
September 24, 2008 |
Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
|
|
09480991 |
Jan 11, 2000 |
7430533 |
|
|
12236651 |
|
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Current U.S.
Class: |
705/37 |
Current CPC
Class: |
G06Q 40/04 20130101;
G06Q 30/08 20130101; G06Q 40/00 20130101 |
Class at
Publication: |
705/37 |
International
Class: |
G06Q 40/00 20060101
G06Q040/00 |
Claims
1. A method for conducting a financial batch auction after a first
period and before a second period, comprising: steps for receiving
orders from one or more qualified participants, said orders
defining a binding instruction to execute a trade regarding a
security according to respective trade parameters; steps for
concurrently with receiving said orders, transmitting information
regarding said orders to said qualified participants; steps for
terminating the step of receiving of orders; steps for discovering
an optimal price at which a maximum number of shares will be
executed amongst the orders; steps for executing a trade of said
maximum number of shares amongst the orders at said optimal price;
and steps for allocating said executed maximum number of shares
fairly among orders that qualify according to a predetermined
allocation procedure.
2. The method for conducting a financial batch auction according to
claim 1, wherein said trade parameters includes trade side,
security identifier, and quantity of shares to be traded.
3. The method for conducting a financial batch auction according to
claim 1, wherein said orders are selected from the group consisting
of unpriced orders, priced orders, and cross orders.
4. The method for conducting a financial batch auction according to
claim 1, wherein the batch auction is conducted concurrently with a
continuous trading financial market.
5. The method for conducting a financial batch auction according to
claim 1, wherein said information transmitted to said qualified
recipients comprises an indicated price and a net order
imbalance.
6. The method for conducting a financial batch auction according to
claim 1, further comprising: steps for receiving requests to cancel
orders and receiving requests to modify orders concurrently with
said receiving of said orders.
7. The method for conducting a financial batch auction according to
claim 6, wherein said steps for receiving of requests to cancel
orders is terminated a predetermined time before terminating the
receipt or orders, and said steps for receiving of orders and said
receiving of requests to modify orders are accepted subject to
pre-determined conditions.
8. The method for conducting a financial batch auction according to
claim 1, wherein during said steps for allocating, said executed
maximum number of shares is distributed pro-rata among orders that
qualify.
9. A method of performing a batch auction of a security,
comprising: steps for compiling an order book, wherein said
compiling comprises receiving order information from qualified
participants, and for entering orders into the order book and
modifying or canceling orders within the order book based upon said
order information; steps for discovering an optimal price, wherein
said discovering step comprises identifying one or more prices at
which the batch auction would produce a maximum number of executed
shares, and for selecting one of said one or more prices as an
optimal price; and steps for executing the batch auction at the
optimal price, wherein said executing step comprises crossing
orders within the order book at the optimal price, and for
allocating the executed shares pro-rata among orders having price
requirements consistent with said optimal price.
10. The method of performing a batch auction of a security
according to claim 9, wherein said order information comprises
parameters describing trade side, security identifier, and quantity
of shares.
11. The method of performing a batch auction of a security
according to claim 9, wherein said orders have order types selected
from the group consisting of unpriced orders, priced orders, and
cross orders.
12. The method of performing a batch auction of a security
according to claim 9, wherein the batch auction is conducted
concurrently with a continuous trading financial market.
13. The method of performing a batch auction of a security
according to claim 12, wherein the batch auction is performed at
the open or close of said continuous trading market.
14. The method of performing a batch auction of a security
according to claim 9, wherein said optimal price is selected based
upon a relative supply and a demand dictated by said order
book.
15. The method of performing a batch auction of a security
according to claim 14, wherein said selecting step further
comprises comparing said relative supply and demand to a
standard.
16. The method of performing a batch auction of a security
according to claim 9, wherein during compiling said order book
information comprising an indicated price and a net order imbalance
is disseminated to qualified recipients.
17. The method of performing a batch auction of a security
according to claim 9, wherein said canceling of and modifying of
orders within the order book is restricted a predetermined time
before said price discovering step begins.
18. The method of performing a batch auction of a security
according to claim 9, wherein a designated intermediary is
permitted to view said order book and to cover orders for
unexecuted shares at said optimal price.
19. A computerized system for performing a batch auction of a
security, comprising: a computerized network having one or more
computers in electronic communication with each other; computer
facilities configured to receive a plurality of messages containing
orders from one or more qualified participants, and to accept those
orders that meet certain predetermined criteria; an order book
database located on one or more of said computers, wherein said
order book database communicates with said order receiving program
and stores each of said accepted orders received by said receiving
program; computer facilities configured to calculate an optimal
price upon which to transact a maximum number of shares of the
security during the batch auction based upon the order book in said
order boob database; computer facilities configured to execute the
batch auction of said maximum number of shares of the security at a
given execution time, and to allocate said maximum number of shares
of the security among said accepted orders according to a
predetermined criterion; and computer facilities configured to
publish a predetermined selection of data from said order book
database, and wherein said notification program notifies said
qualified participants of results of said auction execution
program.
20. The computerized system for performing a batch auction of a
security according to claim 19, wherein said predetermined
selection of data published by said price notification program
comprises an indicated price and net order imbalance.
21. The computerized system for performing a batch auction of a
security according to claim 19, wherein said messages can contain
order types selected from the group consisting of unpriced orders,
priced orders, and cross orders.
22. The computerized system for performing a batch auction of a
security according to claim 19, further comprising an electronic
connection for forwarding unexecuted orders to outside markets.
23. The computerized system for performing a batch auction of a
security according to claim 19, further comprising communication
connections whereby said qualified participants may remotely submit
said messages to said order receiving program electronically.
Description
CROSS-REFERENCE TO RELATED APPLICATIONS
[0001] This application claims priority to and it a continuation of
application Ser. No. 09/480,991 which was filed Jan. 11, 2000, the
entire contents of which are hereby incorporated by reference.
BACKGROUND OF THE INVENTION
[0002] 1. Field of the Invention
[0003] This invention relates generally to securities markets.
Particularly, the invention relates to a system and method for
batch auctions which are designed to occur at preset times. This
can facilitate securities trading particularly either preceding or
following periods of trade stoppage or inactivity.
[0004] 2. Description of the Related Art
[0005] A securities trading mechanism can be thought of as a set of
protocols that translate the investors' latent demands into
realized prices and quantities. The trading mechanism employed at
market opening represents the first opportunity to trade after the
overnight or weekend non-trading period. Market openings are often
characterized by uncertainty over fundamentals, such as share
volume and price, and the presence of multiple potential trading
parties. For this reason, opening protocols play an especially
important role in facilitating "price discovery," or the price
which will maximize the number of trades at the resumption of
trading in securities markets.
[0006] The closing or halting of trading on securities markets also
is important because closing stock prices are widely used as
benchmarks of the securities' values. Portfolio returns and mutual
fund net asset values are computed using closing prices.
Additionally, after-hours trading on various alternative trading
systems ("ATS") and electronic communications networks ("ECNs") are
based on prices of stocks at closing. Thus, large trading volumes
often occur near the end of the trading day which has led to
concerns regarding price stability and the ability of the markets
to provide adequate liquidity.
[0007] Thus, it is desirable to have a method or system for
facilitating price discovery and providing liquidity in securities
markets at the opening and closing of trading as well as during the
course of trading throughout the day.
[0008] Securities markets have recognized a need to use special
protocols to open trading at the start of the day or following
periods of non-trading, or to close trading at the end of the day.
Opening protocols employed in some securities markets play an
especially important role in facilitating price discovery following
the enforced trading halt induced by the overnight or weekend
non-trading period. Thus, various attempts have been made by
markets to introduce special opening procedures designed to provide
traders with information regarding market clearing prices with a
view towards enhancing liquidity and reducing intra-day price
volatility.
[0009] The protocols employed vary greatly in significant ways. By
way of example, some markets, such as the New York Stock Exchange
("NYSE") are intermediated and rely on designated dealers, market
makers and specialists, to select opening prices. Other markets
simply rely on accumulated overnight public limit orders to
calculate mathematically an equilibrium price at which to open
trading. Markets also vary widely with respect to the amount of
transparency they provide to investors. For example, in the Paris
Bourse, traders obtain a sequence of indicated prices prior to the
opening which reflects the current market clearing prices, and are
allowed to revise their orders based upon this information. In
other markets, only limited pre-open price and volume information
can be observed at the time orders are submitted.
[0010] Most securities markets, with the notable exception of
Nasdaq, therefore use special protocols such as single-price batch
auctions to open and close their markets. Similarly, single-price
auctions are often used as the blueprint for new, automated trading
systems such as that disclosed by U.S. Pat. No. 5,873,071 to
Ferstenberg et al. and the system in use by the Arizona Stock
Exchange ("AZX"). The prior art approaches employed during market
openings and closings, and the protocols followed during batch
auctions in general vary significantly.
[0011] On the NYSE, special protocols apply to the market opening
each morning and following periods of suspended trading. As
depicted in FIG. 1, the NYSE conducts an "intermediated open"
whereby market orders 1 and limit orders 2 accumulate in the limit
order book 3 overnight and are reviewed by an intermediary, the
specialist, prior to opening. The specialist then uses his or her
knowledge regarding the order book and market conditions to set or
stabilize security opening price 6 by offsetting large trade
imbalances (by personally buying or selling or allowing other floor
traders to buy or sell the security as necessary). This system has
the inherent drawback in that the specialist has goals which work
against accurate price discovery: to provide price continuity, and
to maintain a desired inventory of the security. Thus, the price at
opening often does not accurately reflect the price dictated by
market supply and demand.
[0012] The Nasdaq, conversely, currently employs no differentiated
opening protocol. During a period prior to the opening of
continuous trading on the Nasdaq, market makers and ECNs can enter
non-binding price quotes which are broadcast to market subscribers.
Although these quotes can be modified at any time prior to the
open, they are made to provide a mechanism for dealers to share
information and coordinate their pricing decisions. These quotes,
however, are at no point binding such that the market makers are
under no obligation to execute trades at the quoted price. There
are a number of related drawbacks to such a non-differentiated
opening. First, there is significant price volatility as
accumulated overnight orders are executed in an uncoordinated burst
in the first few minutes after the start of trading. This
volatility in turn provides an increased potential for price
manipulation.
[0013] The Paris Bourse and Toronto Stock Exchange ("TSE") operate
as continuous limit order markets. The TSE, unlike Paris, employs a
designated intermediary, termed the Registered Trader, for each
stock who is responsible for maintaining the limit order book. The
TSE is transparent as it displays the order book and disseminates
an indicated price, the calculated opening price ("COP"), based
upon current system orders. The COP is continuously updated based
upon new orders and fluctuations in relative supply and demand. To
discourage gaming by traders the TSE has implemented anti-scooping
rules whereby non-client orders entered within the final two
minutes before opening are figured into the COP, and thus
guaranteed a fill at the COP, only if they impact the COP.
Non-client orders not impacting the COP are not guaranteed a fill
at the COP, and are automatically treated by the TSE as the
equivalent of a limit order having a price equal to the COP. In the
event that there is a "guaranteed fill imbalance" (not all
guaranteed orders can be filled by matching orders due to order
imbalance), the Registered Trader is required to either provide the
requisite liquidity at the COP, or to delay the opening until
sufficient orders offsetting the imbalance enters the TSE.
Additionally, orders having a price equal to the COP (such as a
market order) are allocated executed shares only after all market
orders and orders having prices better than the COP are filled.
Thus, the priority and allocation rules of the TSE system gives it
the inherent drawback in that limit orders at a price equal to the
COP can get frozen out of the trading process and are not treated
the same as market orders and better priced limit orders.
Furthermore, if there are no intersecting limit orders for a
particular security, no COP is calculated and no limit orders are
executed.
[0014] In the Paris Bourse, a similar batch auction system is
employed except that traders can observe the limit order book away
from the current price. This high degree of transparency allows
traders to assess the likely impact on the opening price of new
orders, but similarly encourages gaming as orders may be readily
canceled up to the open. Furthermore, there is no designated
intermediary to provide liquidity when there is an order imbalance.
The Paris Bourse also has introduced a closing call auction using
similar priority, cancellation, and transparency parameters. This
system suffers from several drawbacks, including: significant
gaming incentives, price instability, and no guaranteed
liquidity.
[0015] The Arizona Stock Exchange ("AZX") operates solely in a
batch auction market format. Thus, its open (the first trade of the
day) and its close (the last trade) do not have protocols which
differ from other trades during the day. Like the Paris Bourse, the
AZX has a high degree of transparency in that traders are permitted
to see the entire order book prior to an auction and can view
beforehand the exact price at which trades would occur. This again
leads to gaming which prevents accurate price formation.
[0016] The OptiMark electronic trading system employed by the
Pacific Stock Exchange ("PSE") conducts repeated batch auctions
over the course of a market day similar in manner to the AZX, but
offers less transparency and generates multiple prices such that
all trades of a particular stock during a given auction are not
made at the same price.
[0017] U.S. Pat. No. 5,950,176 to Keiser et al. discloses an
electronic securities trading system which uses a computer program
to project price movement of securities and set suggested prices
for trading in continuous trading markets. This system does not
solve the problems attendant in batch auction methods and systems
where providing optimal price determination is hampered by gaming
and low liquidity.
[0018] The prior art approaches to using batch auctions at the open
and close of a financial market, as well as repeatedly throughout
the market day along with continuous trading, have encountered
numerous drawbacks. Open order books combined with lack of
restrictions on the message space prior to the open introduce
gaming problems, for example as experienced by traders in the Paris
Bourse. The existence of multiple order books with different levels
of transparency and different execution priority rules, as used by
the AZX, produce undesirable disparities in fill rates. An
additional drawback is that simple batch auction design is not
sufficient to produce accurate pricing in low liquidity, high
volatility markets as is present for thinly traded stocks. Further,
intermediated exchanges depending upon human intervention, such as
by specialists on the NYSE and TSE, introduce exterior forces upon
market price determination, such as the specialists' inventory
concerns. Additionally, price discrimination among traders within a
single auction based upon their order types, as done by the PSE
OptiMark system, can cause dissatisfaction among participating
traders with the outcome produced by the auction system.
[0019] Due to the above mentioned and other drawbacks, there
remains a need in the art for improved methods and systems to
conduct batch auctions of financial securities in financial
markets, particularly both following and preceding periods of trade
stoppage or inactivity.
SUMMARY OF THE INVENTION
[0020] Therefore, it is an object of the present invention to
provide a method and system for performing securities transactions
via a batch auction, whereby the system is incentive compatible in
the sense that traders do not have the incentives to game or
manipulate the order messages they send to the system.
[0021] It is also an object of the present invention to provide a
method and system for performing batch auctions of securities which
is particularly suited to being conducted either directly preceding
or directly following a trade stoppage or period of inactivity.
[0022] Further, it is an object of the invention to provide a
method and system for performing such transactions which is
computationally feasible, and therefore lends itself to broad-based
electronic implementation.
[0023] Additionally, it is an object of the present invention to
provide a method and system for performing such transactions which
provides accurate pricing information.
[0024] Finally, it is an object of the present invention to provide
a method and system for conducting batch or call auctions having
allocations for participation by a market-making intermediary.
[0025] The present invention provides a method and system for
gathering orders from qualified market participants, determining
(or "discovering") a price and share quantity based on the
aggregate supply and demand represented by all orders submitted,
executing the resulting quantity, and "fairly" allocating the
executed shares back to the submitters of the orders. The method
and system can be advantageously used to periodically initiate
("open") and terminate ("close") trading in financial instruments
as well as to operate concurrent with "continuous" trading systems,
such as the "continuous auction" operated by the NYSE and by
electronic trading on Nasdaq and in ECNs. Financial instruments
according to the present invention include stocks, bonds,
commodities, options, futures contracts, pollution rights and other
tangible and intangible goods. A full iteration of the system,
comprised sequentially of an order acceptance period, a price
discovery period, and an order execution period, is referred to as
an "auction cycle". Auction cycles according to the present
invention operate at pre-determined times that are known to
qualified auction participants, such as (but not limited to)
traders.
[0026] In general, the markets that have recognized the special
nature of trades performed either at market openings or market
closings have instituted specialized, or differentiated, protocols
for trades occurring at these times. Commonly, these special
protocols have come in the form of a call or batch auction. Each
iteration of a batch auction (or an "auction cycle") is typified in
that a series of investors simultaneously trade, i.e., buy or sell,
a stock at a single price.
[0027] In determining the protocols and rules for the batch auction
mechanism of the present invention, a series of parameters must be
taken into consideration. The first is in regard to transparency
and informational parity. The rules adopted regarding these
parameters reflect the decision as to what extent each trader
participating in the auction can have access to information
detailing the buy and sell orders of other traders, the "limit
order book," and how it impacts on the amount of "gaming" occurring
in the market and perceived marked reliability. A second and
related parameter is whether orders may be made and then later
canceled or modified. The ability to modify or cancel, like the
presence of excess transparency and complete informational parity,
may lead to increased gaming by traders. Additionally, rules have
to be established regarding a third parameter which is priority of
trade orders in the event that there is an imbalance in supply or
demand. Finally, a fourth parameter reflects the decision as to
whether intermediation will be employed (as is done on the NYSE and
TSE with specialists), and to what extent such intermediation will
require participation by a designated market maker.
[0028] One aspect of the invention comprises a method for
performing a batch auction whereby a series of orders, according to
a variety of predetermined order types, are generated by qualified
market participants and communicated to the auction system. The
system takes into account each order and its impact upon relative
supply and demand. For each security in question, bids and offers
are crossed to determine by a preset algorithm a "discovered" price
and share transaction quantity. Trades are executed, and a portion
of the transaction quantity is allocated to each investor on a fair
basis dependent upon their initial orders.
[0029] In preferred embodiments of the present invention, the
auction method is performed using a computer system or network
designed to automatically perform one or more steps of the method.
Qualified market participants therefore may submit orders to the
auction system electronically whereby the orders are then stored in
a computer database until such time as the orders are modified or
canceled by the submitting participant or until commencement of the
price discovery period. During the price discovery period, orders
received during the order acceptance period are crossed according
to a present price discovery algorithm being performed by a
computer. Using the algorithm, the computer identifies an optimal
price and allocation of trades. These trades are then executed at
the optimal price and returned to the qualified participant during
the subsequent order execution period.
[0030] Another embodiment of the present invention comprises an
electronic system for conducting batch auctions of securities. Such
a system can be comprised of a computer network designed to accept
a plurality of orders from a variety of sources. At a predetermined
time, all current orders are crossed according to a preset
algorithm to determine a share price and quantity for each security
being traded. A trade of shares in an amount equal to the quantity
is automatically executed by the system, and then fairly allocated
to each order source. Such a system is preferably connected to one
or more ECNs such that non-executed shares can be automatically
sent to outside sources for execution and to ensure compliance with
"trade-through" rules.
[0031] In alternative embodiments, the invention includes the use
of an intermediary or market maker. Such an intermediary would have
access to otherwise confidential information of the limit order
book in exchange for a guarantee to cover certain unexecuted trades
at the discovered price.
[0032] The present invention will become more fully understood from
the forthcoming detailed description of preferred embodiments read
in conjunction with the accompanying drawings. Both the detailed
description and the drawings are given by way of illustration only,
and are not limitative of the present invention as claimed.
BRIEF DESCRIPTION OF THE DRAWINGS
[0033] FIG. 1 is a schematic diagram of the interaction between an
intermediary and several types of market participants according to
a prior art mechanism.
[0034] FIG. 2 is a flow chart depicting the algorithm whereby new
and modified orders are handled during the order acceptance period
in embodiments of the present invention.
[0035] FIG. 3 is a flow chart depicting the algorithm whereby an
optimal price is discovered during the price discovery period in
embodiments of the present invention.
[0036] FIG. 4 is a schematic diagram demonstrating the interaction
of various factors during operation of a preferred embodiment of
the present invention.
[0037] FIG. 5 is a schematic diagram of a preferred embodiment of
the present invention wherein an intermediary is employed.
DETAILED DESCRIPTION OF THE INVENTION
[0038] A batch auction cycle of the present invention is comprised
of three sequential periods: an order acceptance period, a price
discovery period, and an order execution period. During the order
acceptance period, the system accepts orders from qualified
participants. The definition of a qualified participant will vary
as is known in the art depending on how the system is implemented,
as well as on the types of financial instruments traded and the
country in which it is operated. This definition will often depend
on whether the system is implemented as a facility of an
established market or exchange. In this case, who are deemed
qualified participants will likely be defined or limited by the
exchange's rules.
[0039] Each order submitted essentially represents the bounds, as
defined by the order-submitting trader, within which a
purchase/sale of a particular security is desired. All orders
generally are comprised of a trade "side" (buy or sell), a security
identifier (such as the name or symbol of the security), and a
quantity. In embodiments of the present invention, a variety of
order types can be used by traders to more thoroughly describe the
conditions under which they desire to trade.
[0040] A first order type is an "unpriced order." The submission of
an unpriced order to the system identifies a desire by the
submitter to participate in the auction at whatever price is
discovered (if any) during the later price discovery period. An
unpriced order for a given auction cycle is fully specified by the
above three basic elements: a security identifier, an order
quantity, and a trade side.
[0041] Optionally, a maximum (minimum) acceptable transaction price
can be specified in an unpriced buy (sell) order ("I will not sell
for less than $100.00 per share"). This price, however, will not
influence the price discovery algorithm as it is described below
with respect to the price discovery period.
[0042] Another order type which can be submitted to the system is
the "priced order." Priced orders are fully specified by four
elements: security identifier, order quantity, trade side (i.e. buy
or sell) and a desired price. This desired price represents an
offer by the trader (e.g., "I will sell X shares for $100.00 per
share"), and is used during the price discovery period, described
in detail below, to determine the price at which the auction will
take place. At the user's option, any unexecuted shares (due to a
mismatch in buy and sell orders) of a priced order after the order
execution period can be automatically forwarded to another
("secondary") destination at the end of the auction cycle. While
not all destinations will necessarily be supported, the user will
be able to choose among supported destinations. Where practical,
support for unique order attributes of a particular secondary
destination, such as "reserve quantity," or "pegging", etc., will
be provided.
[0043] In preferred embodiments of the present invention, the
supplied price stated in priced orders may be supplied in terms of
the quoted market for the underlying security, such as equal to the
bid, offer, or the mid-point of the bid-offer spread.
Alternatively, the supplied price can be made dependent upon
fluctuations in the known market indicators (futures price
movement) and indices (the S&P 500) occurring between the time
the order is submitted and the time the auction begins.
[0044] A third type of order which may be submitted according to
embodiments of the present invention is the "cross order." A cross
order is similar to an unpriced order in that it contains quantity
and trade side terms, but is distinguished in that two sides (both
buy and sell) of a transaction are submitted to the system as a
unit to be crossed at the discovered price. Such an order type is
essentially a tool to allow large blocks of shares of a particular
stock to quickly be traded between two traders at a market
determined price (the discovered price). The opposing sides of a
cross order cannot be broken up. If no price is discovered by the
execution of priced orders within that particular auction cycle,
cross orders will have the option of being returned unexecuted,
being held over for the next auction cycle, or being crossed at a
reference price that will be computed as part of the auction
process. A suitable algorithm for determining both a discovered
price and a reference price is described in detail below.
[0045] As described above, the amount of transparency present
during a batch auction cycle for trading securities is of major
concern. A balance must be struck regarding the extent of
information regarding other traders' orders which should be
supplied during the order acceptance period to each trader
participating in the particular auction cycle. If each potential
trader has full access to information detailing the buy and sell
orders of other traders, known as the "limit order book," an
incentive is placed upon traders to try and affect discovered price
to their liking by altering their order parameters. The extent of
such practice, known as gaming, within the auction system can lead
to perceived unreliability.
[0046] The system of the present invention provides partial
transparency during the order acceptance period of the auction
cycle. Specifically, two pieces of information are disseminated
continuously in the first of two stages comprising the order
acceptance period: an "indicated price" and a "net order
imbalance." As each new order is received, the indicated price and
net order imbalance is recalculated and disseminated to qualified
participants. The indicated price is defined as the price at which
an auction would occur if it were to take place at that moment, and
is calculated according to the price discovery algorithm detailed
below. The net order imbalance is the excess supply or demand in
the financial instrument being auctioned (i.e. 1500 surplus shares
bid). If there are no intersecting orders (i.e., no possible
trades), then "N/A" will be disseminated for the net surplus. At a
minimum this information will be made available to some or all
qualified participants. Preferably, this information will be made
available via market data services and other real-time information
providers.
[0047] At any time during the first stage of the order acceptance
period, any qualified participant may cancel or modify any order
they have previously placed during that particular auction cycle.
However, the ability to modify or cancel orders, especially when
combined with transparency, provide incentives for traders to
participate in gaming.
[0048] To limit this gaming incentive, the present invention
employs an order acceptance algorithm. According to this algorithm,
qualified participants who have submitted an order will not be
allowed to cancel, reduce the quantity of, or make the price less
aggressive than previously placed orders within a specified time
window (the "order entry cut-off window") prior to the beginning of
the price discovery period. (Modified orders seeking to increase
quantity or make the price more aggressive are treated like a new
order having the attributes of the order as modified.) This window
just prior to the beginning of the price discovery period
constitutes the second stage of the order acceptance period. New
orders will not be accepted automatically during this stage as they
were in the first stage. Such second stage orders will be accepted
only to the extent that they offset a published net order
imbalance. Thus, buy (sell) orders for a given security will only
be accepted if there is an excess supply (demand). Furthermore, the
size of any such new second stage order may not exceed the
then-current size of the net order imbalance. With respect to new
second stage priced orders, the order price must be at least as
aggressive (greater than or equal to for bids, less than or equal
to for offers) as the then-current indicated price in order to be
accepted.
[0049] Referring to FIG. 2, an exemplary order acceptance
algorithm, preferably performed by a computerized system using
software, according to one embodiment of the present invention
receives an order request 100 and first makes a determination at
101 as to whether the order request constitutes a new order 101a or
a modification 101b. The system screens the new order at 102 and
makes a determination as to whether it was submitted during the
first or second stage of the order receiving period. If the new
order was received during the first stage 102a, then this order
automatically gets entered into the limit order book 103.
[0050] If the new order was received during the second stage 102b,
the system then screens the order at 104 and 106 to determine if it
would offset a current net order imbalance, and if the price is at
least as aggressive as the current indicated price. If the new
order satisfies both criteria, then the new order still would be
entered into the order book 103 as shown by paths 104a and 106a in
the figure. If the new order fails to meet either of these criteria
104 and 106, the order is rejected as late and not entered into the
limit order book 105 as shown by paths 104b and 106b.
[0051] In the event that the order request received at 100 is found
not to be a new order at 101, but instead a modification or
cancellation 101b of an order already in the order book, a
different set of anti-gaming rules apply. If at 107 the system
finds that the modification or cancellation order was received in
the first stage 107a of the order receiving period, then the
modification or cancellation order would be used to appropriately
update the limit order book 108. If at 107 the system finds that
the modification or cancellation order request was received in the
second stage 107b of the order receiving period, then the system
determines whether the request cancels a previous order 109,
reduces the quantity of a previous order 110, or makes the price of
a previous order less aggressive 111. If the request does any of
these three things, then the request is not permitted to update the
order book 105 as seen by paths 109a, 110a, and 111a. As shown by
paths 109b, 110b, and 111b, requests seeking to modify orders to
increase quantity or make the price more aggressive only modify the
limit order book 108 if, as with new orders received in the second
stage, the request would offset 112a a net order imbalance 112.
[0052] After the time window has elapsed and the second stage has
ended, no order requests are accepted. The auction itself begins
with the commencement of the price discovery period whereby buy and
sell orders for each security are crossed at a discovered price.
This discovered price is individually calculated for each auction
cycle by the price discovery algorithm described in detail below
and depicted by FIG. 3, and represents a market optimal price at
which to execute submitted orders.
[0053] In the event of extreme market conditions, the pre-auction
period of auction cycles of the present invention can be extended
by successive pre-defined time intervals (e.g. five minutes). This
time interval will be applied only to the first stage of order
taking, and will in essence push back the window wherein the second
stage occurs and push back the time at which the batch auction
actually occurs. Preferably, rules will be established for
automatic extensions on the basis of order imbalance and movements
in certain broad market indexes (as defined and permitted by stock
exchange rules and regulations, if any). A human operator in charge
of monitoring the system also will have discretionary ability to
invoke an extension.
[0054] The price discovery algorithm employed during the price
discovery period of auction cycles in embodiments of the present
invention uses the information contained in priced orders in the
limit order book for each auction cycle to calculate, based upon
relative supply and demand, a discovered price. This is the price
at which all trades of a given security will occur for that
particular auction cycle. Preferably, the operation of the price
discovery algorithm is automated, such as by software running on a
computerized network.
[0055] As depicted by FIG. 3, a price discovery algorithm according
to the present invention first operates by examining the limit
order book 200 to identify a price 201 for a given security at
which the volume of shares traded will be maximized. In the event
that a single security price 202, a "discrete" price, is identified
which will cause a maximum amount of shares (from priced orders) to
be executed, then that discrete price is identified as the
discovered price 203.
EXAMPLE 1
[0056] Buyer A enters a priced order offering to buy 10,000 shares
for 1/2.
[0057] Buyer B enters a priced order offering to buy 10,000 shares
for 3/8.
[0058] Seller X enters a priced order offering to sell 10,000
shares for 3/8.
[0059] Seller Y enters a priced order offering to sell 10,000
shares for 3/8.
[0060] At a price of 1/2, only A is willing to buy, thus only
10,000 shares would be executed. At a price of 3/8, 20,000 shares
would be executed as both A and B are willing to buy 10,000 apiece
while X and Y are willing to sell 10,000 apiece. Since there is a
single volume maximizing price, the discovered price equals
3/8.
[0061] The volume of unpriced orders will be included in the
cumulative supply and demand of volume. For example, if there are
50,000 units of unpriced buy orders and 25,000 units of unpriced
sell orders, these shares will be added to volume of priced buy and
sell orders, respectively, at each price. If unpriced orders meet
priced orders that do not intersect, these unpriced orders will
cross at the volume-maximizing price with the corresponding priced
orders.
[0062] In the event that there are only unpriced buy and sell
orders, the unpriced orders will trade at a predefined reference
price.
EXAMPLE 2
[0063] Buyer A enters a priced order offering to buy 10,000 shares
at a price of 50.00, and an unpriced order offering to buy 50,000
shares at the determined price.
[0064] Buyer B enters a priced order offering to buy 5,000 shares
at a price of 50.10.
[0065] Seller X enters a priced order offering to sell 20,000
shares at a price of 50.30, and an unpriced order offering to sell
25,000 shares.
[0066] Seller Y enters a priced order offering to sell 15,000
shares at a price of 50.20.
[0067] Between A, B, X, and Y there are unpriced and
non-intersecting priced buy and sell orders on for the particular
auction cycle. At a price of 50.00, buyer A would be willing to buy
a total of 60,000 shares and buyer B would be willing to buy a
total of 5,000 shares. Thus, aggregate demand at a price of 50.00
is 65,000 shares. At this price, neither of seller X's or seller
Y's priced orders would be executed. Thus, aggregate supply would
equal the total number of unpriced order shares, 25,000.
[0068] At a price 50.10, buyer B is willing to buy a total of 5,000
shares, buyer A is willing to buy a total of 50,000 shares (this
number being the number of unpriced shares ordered by buyer A). For
this price, again neither seller X nor seller Y are willing to buy
any priced shares. Therefore, aggregate supply is 25,000
shares.
[0069] At a price of 50.20, aggregate demand equals 50,000 shares
(this being the number of shares represented by unpriced buys), and
aggregate supply is 40,000 shares (this being the number of shares
available for sale at a price of 50.20 plus the number of unpriced
shares offered).
[0070] At the price of 50.30, aggregate demand equals 50,000 and
aggregate supply equals 60,000.
[0071] Taking the smaller of aggregate demand and aggregate supply
at each of the above prices, we will find the total number of
shares which will transact at that particular price. Thus, at a
price of 50.00, 25,000 shares would be transacted, at 50.10, 25,000
shares would be transacted, at 50.20, 40,000 shares, and at 50.30,
50,000 shares. Therefore, the maximum amount of shares will
transact at a share maximizing price of 50.30 wherein 50,000 shares
will be executed.
[0072] Often, a discrete price cannot be identified. In these
circumstances, the price discovery algorithm used in embodiments of
the present invention will identify a range of prices 204 that will
cause a maximum amount of shares to be executed. Along this range
of prices, the amount of shares traded would be constant. In
instances where a discrete price cannot be identified, the price
discovery algorithm uses the relative amounts of bids (offers to
buy) and offers (offers to sell) to determine which price along the
range of volume maximizing prices will be discovered.
[0073] The price discovery algorithm according to embodiments of
the present invention in circumstances where no discrete price is
identified first makes a determination 205 as to whether the bid
shares are substantially equal to the offered shares. This can be
done, for example, by mathematically computing an imbalance ratio
("R") defined as
R = B - O L Equation 1 ##EQU00001##
wherein "B" is defined as the number of shares bid to buy at the
highest price within the volume maximizing range, "O" is the number
of shares offered to sell at the lowest price within the volume
maximizing range, and L equals the lesser of O or B. This imbalance
ratio is then compared to a predefined standard ("S") for the given
security.
[0074] Next, the price discovery algorithm compares the imbalance
ratio R to the standard S 206. If the imbalance ratio is less than
the appropriate standard 207, the discovered price is identified as
the mid-point price within the share volume maximizing range of
prices 208. This represents a determination that the net order
imbalance is not large enough to significantly impact price.
EXAMPLE 3
[0075] Same facts as example 1, except that X and Y only wish to
sell 5,000 shares apiece for 3/8.
[0076] The standard "S" for the particular stock in question is
0.25 (representing a belief that a 25% excess of supply over
demand, or vice versa, would constitute a large enough net order
imbalance to significantly impact price).
[0077] Using equation 1, B is 10,000, O is 10,000, and L is 10,000,
thus R is calculated to equal 0.00 (i.e., no net order imbalance).
Since R is less than S, the net order imbalance is deemed to not
significantly impact price.
[0078] Given that X and Y will sell 5,000 shares apiece (10,000
total) whether the price is 1/2 or 3/8 (there is no single volume
maximizing price) and that R is less than S, the discovered price
will be the mid-point of the volume maximizing range (3/8 to 1/2).
Thus, the price is 7/16.
[0079] If the imbalance ratio is greater than the appropriate
standard 209, the imbalance of supply and demand of the particular
stock within the volume maximizing range is considered to have
become large enough to impact price. Where the number of bids is
found to significantly outnumber the number of offers 210 (B>O),
the market price is considered demand driven 211 and results in a
discovered price equal to the highest price within the share
maximizing range. Conversely, where offers significantly outweigh
the number of bids (O>B), the market price is supply driven 213
and results in a discovered price equal to the lowest price within
the share maximizing range 214.
EXAMPLE 4
[0080] The same facts as in example 3, except that a third buyer,
Buyer C, submits a priced order to buy 10,000 shares at 1/2.
[0081] Using equation 1, B is 20,000, O is 10,000, and L is 10,000,
thus R is calculated to equal 0.50. Since R is greater than or
equal to S (in this instance S=0.25), the net order imbalance is
deemed to significantly impact price.
[0082] This net order imbalance creates a demand driven price, thus
the discovered price is set to the highest price within the volume
maximizing range, namely 1/2.
[0083] In alternative embodiments of the present invention, more
than one standard may be used. In addition to the standard S which,
if exceeded, denotes order imbalances which are large enough to
warrant completely tipping the price to either the highest or
lowest price within a range, a lower preliminary standard S' can be
used to measure when a predetermined partial tipping of price
should be employed. Thus, if B>O, and S>R>S', the price
would not be demand driven, but only demand pressured. In
situations where price is demand or supply pressured, the
discovered price would be offset somewhere between the midpoint and
the appropriate endpoint of the price maximizing range.
EXAMPLE 5
[0084] Buyer D enters a priced order offering to buy 75,000 shares
of stock IOU for 50.35.
[0085] Seller Z enters a priced order offering to buy 50,000 shares
of stock IOU for 49.95.
[0086] Stock IOU has a standard, S, set within the auction system
equal to 0.60, and a preliminary standard, S', set within the
auction system equal to 0.40.
[0087] For this example, at any price within the range of 49.95
through 50.35, 50,000 shares of IOU will be exchanged. Using
equation 1, the imbalance ratio, R, is calculated to be 0.50, which
is less than S, but larger than S'. Thus the price is considered to
be demand pressured, but not demand driven. Thus, the determined
price will be selected from a price somewhere between the demand
driven price, 50.35, and the mid-point of the bid-offer spread,
50.15. A suitable price, for example, could be 50.25, the mid-point
of the range of demand pressured price range.
[0088] As will be readily apparent to those of ordinary skill in
the art, the standard(s) with which to compare the imbalance ratio
to can vary from security to security and upon prevailing market
conditions. When embodiments of the present invention are performed
electronically, the standard can be linked to market indicators
(security Beta and volatility, for example) preferably provided
continuously by an independent electronic wire service. Further,
the value of the standard for a single security can be dependent
upon whether there is a demand driven (B>>O) or supply driven
(O>>B) imbalance.
[0089] For those auctions where no price is discovered, such as in
the case where there are no priced orders which intersect which
define a share maximizing price, a default price, termed the
reference price ("P.sub.R"), that is derived from a combination of
the orders currently in the order book and continuous market quotes
will be computed and disseminated at the end of the auction cycle.
This reference price in turn, as described above, will be used to
execute cross orders and unpriced orders. Details of the reference
price calculation will depend on the specific implementation of the
system.
[0090] In preferred embodiments of the invention, the reference
price calculation algorithm will be performed by software running
on one or more computers and will vary depending upon whether the
particular auction cycle is being conducted as a closing, an
opening, or as a normal periodic auction in conjunction with
continuous trading on a continuous trading market.
[0091] For a batch auction cycle occurring at the close of trading
or during trading, the order acceptance period occurs while the
continuous market is open. Thus, an accurate measure of an optimal
price, assuming no volume maximizing price is identified by the
price determination algorithm employed, may be identified as being
the mid-point of the of the most recently published unqualified
complete quotation (quotation having a valid bid, bid size, valid
offer, and offer size) reported by the continuous market prior to
the beginning of the price discovery period.
[0092] For a batch auction occurring at the opening of the
continuous trading market, the order acceptance period occurs while
the continuous trading market is closed. Thus, quotes from trading
in the continuous market cannot be used to set the reference price.
Thus, in situations where there are only priced offers and no
priced bids, and the highest bid is higher than the most recently
published unqualified trade price ("MRPUTP"), as obtained from a
consolidated tape system or other real time quote service, the
reference price is set equal to the highest bid price. Where there
are no priced offers, and the lowest offer is lower than the
MRPUTP, the reference price is set equal to the lowest offer price.
In all other scenarios with opening auction cycles, such as when
there are no priced orders within the system, the reference price
is defined as the MRPUTP.
[0093] After a discovered price is identified by the price
discovery algorithm, the price discovery period ends and the final
part of the auction cycle, the order execution period, begins.
During this final period, the volume maximizing amount of shares
which are executed at the discovered price are fairly allocated
among "qualifying" orders. Qualifying orders include all unpriced
orders as well as priced orders that are at least as aggressive
(bid orders having a price greater than or equal to the discovered
price, and offer orders having a price less than the discovered
price) as the discovered price. During the order execution period,
each qualifying order will receive a pro-rata allocation of the
available liquidity, i.e, the shares of the given security which
will be traded during that particular auction cycle.
EXAMPLE 6
[0094] Given the facts according to example 3, the full 10,000
shares sold by X and Y at 7/16 is allocated to A because the
discovered price is higher than the price entered by B. Thus, A is
the only buyer willing to pay the discovered price.
EXAMPLE 7
[0095] Given the facts according to example 4, the 10,000 shares
sold by X and Y at 1/2 is allocated pro-rata to each buyer willing
to meet that discovered price. Buyers A and C are both willing to
buy up to 10,000 shares apiece at a price of 1/2, thus the shares
are allocated equally between them. Thus, A and C are each
allocated 5,000 shares at 1/2.
[0096] After the trades are allocated among qualifying orders, each
trader is notified of the results of their order, including whether
a trade did or did not occur, whether their order was a qualifying
order, the price at which trades occurred (if applicable), and the
quantity traded shares allocated to him (if applicable).
Optionally, in embodiments of the present invention, other
information can be provided to the trader post auction including
the net order imbalance and total number of shares executed. When
qualifying orders were electronically submitted, trader
notification of auction results can be performed electronically as
well.
[0097] A batch auction system in preferred embodiments of the
present invention is connected to one or more ECNs such that
non-executed shares can be automatically sent to outside sources
for execution. Thus, participants who had submitted priced orders
having less aggressive prices than the discovered price, or having
a net order imbalance, could attempt to have their desired trades
executed outside the batch auction.
[0098] In an alternative embodiment of the present invention as
depicted by FIG. 5, one or more designated intermediaries will be
responsible for filling all eligible orders that would otherwise be
unfilled, at the auction price. Thus, no unmatched orders would be
generated. All unpriced orders as well as priced orders that are at
least as aggressive as the discovered price will be filled in their
entirety. In return for fulfilling this obligation, the
intermediaries receive the benefit of viewing the entire limit
order book for each security for which they are the designated
intermediary during the auction process.
[0099] In embodiments of the present invention which employ an
intermediary, the designated market maker will have discretion to
extend the auction. As with specialists on the NYSE and TSE, the
intermediary will be subject to pre-defined market or exchange
guidelines and will be subject to sanctions in the event that an
inappropriate extension is made.
[0100] As will be apparent to one of ordinary skill in the art, the
present system can be modified in a variety of manners to provide
additional functional features. By way of example, the permissible
order types may be modified, or new order types introduced in
alternative embodiments of the present invention. Such a new order
type could be in the form of a "contingent order" which represents
a desire by the trader to "only buy security A if I can sell
security B and the price ratio of A:B is less than X." Also by way
of example, order types may be modified to allow the specification
of portfolio dollar constraints. Such constraints would permit a
series of orders for different securities to be linked as a
portfolio, and only permit orders in that portfolio to be executed
to the extent that maximum levels (in value terms) of net buying
and selling are not exceeded.
[0101] The invention being thus described, it will be apparent to
those skilled in the art that the same may be varied in many ways
without departing from the spirit and scope of the invention. Any
and all such modifications are intended to be included within the
scope of the following claims.
* * * * *