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NASDAQ order routing systemsWhen it comes to the NASDAQ order routing systems, the order entry rules change quite frequently. The exact order handling routes are also more complex than described in this book. The descriptions in here are just meant to give you an overview of the most important aspects. Please study your broker’s manual very carefully before making any trades. ECN’s ECN’s are relatively new. Changes in the late 90’s made it possible for the average investor to get access to level 2 data and compete with market makers thru the use of ECN’s. In order to use ECN’s you need a broker that gives you direct access to them. Most “traditional” online brokerages won’t offer that, only direct access brokers will. Make sure your broker at least offers you access to Island (ISLD) and ARCA. ECN’s are little exchanges itself. There are many competing bids and offers from every single stock each ECN. Of course this depends a lot on the interest in the stock you are watching...you might only find very little interest from ECNs in particular stocks, sometimes none. By default, you will only find the best bid and ask from every ECN displayed in your level 2 window. Most software systems allow you to display at least the ISLD order book in full depth. Try it, and then you see what I am talking about. Generally each ECN is only able communicate with the same ECN, i.e. if you are trying to buy via ISLD you can only buy from another ISLD offer. There are “intelligent” ECN’s though, that are looking for execution taking all other ECN’s into account. You are able to display your own bids and offers thru ECN’s. The major advantage of ECN’s is that your orders are send directly to the market, with no middlemen involved. They are kept in an electronic environment. Let’s assume you are trying to buy 500 shares of Microsoft on ISLD and someone is willing to sell 500 shares or more for $24. By entering an order for $24 your order gets executed immediately since there is a matching sell order. If the seller would only be willing to sell 200 shares, you would only get executed on 200 shares. Since ECN orders are kept in an electronic environment. They can be immediately changed or canceled at any time. I think you will be amazed by the speed and ease of execution offered by direct access systems. Imaging hitting the button on your computer and split seconds later, the whole world is able to see your order. Next, I want to go a little about the details regarding ECN’s. Please always also refer to your brokers order entry guide. The Island ECN (ISLD) The electronic Island network is the most popular order route of the NASDAQ order routing systems among daytraders. It is very inexpensive (small to none EON fees) amazingly fast and offers tremendous liquidity. You can place your own bids and offers. There is no limit to the amount of shares you can trade. You can only place limit orders. Island allows you to enter price limits with less than one cent increments. This can be a great advantage if a stock only has a one cent spread and you want to bid or offer a better price than the other market participants. Some of the big NYSE stocks can also be traded via Island. Some direct access brokers will allow you to enter Island subscriber orders. Those orders are only displayed on the Island order book. This can be an advantage in the following situation: Let’s assume the best offer in XYZ is $26.25 and there are only market makers on the best offer. If you are now trying to enter a buy order on ISLD with a limit of $26.25 , the order would be rejected because it would lock the market. By using the subscriber option, the order would not lock the market because it is not displayed in the level 2 window. In addition, when you are trying to trade larger amount of shares it is not seen by every trader and therefore is less likely to move the market, but this is obviously an advanced strategy and you won’t likely need to do this for a while, if at all… Island accounts for a large percentage of the total trades made on NASDAQ. Archipelago (ARCA) ARCA is an intelligent order routing system in the NASDAQ order routing systems. It has its own order book but is also able to communicate with other market participants. ARCA is a very useful system for day traders. The only disadvantage is that if ARCA sends your order to the selectnet system, it can be “stuck” there for 10 seconds without you being able to cancel the order, which can be a problem in fast moving markets. Whenever there are ECN’s inside of your price limit ARCA is generally a very good choice. The following examples are all for active order routing where you are trying to buy from the ask or sell to the bid. Limit orders • It first searches for ARCA inside of your specified price limit, i.e. if the offer is at 28$ and you are entering a buy order with a limit at $28.5 it will search for ARCA at a price of $28.5 or lower. • If ARCA is not available, it will target other ECN’s to seek execution. It will first target the ECN with the best available price. If there is more than one ECN available at the best price then it will target the most liquid one for that particular stock. • If there are no ECN’s available it will start targeting market makers thru selecnet preference orders Market orders • The order will be sent to a market participant at the inside price versus limit orders that are sent to ECN’s first. In many cases, it may be better to just pay a “penny” more and to get immediate execution thru an ECN (assuming there are only market makers at the inside price). If there are ECN’s available at the inside price, the same logic than the one for limit orders is applied. General rules • If there is a better price coming into the market, ARCA tries to target that price. • ARCA can only accept round lots for smart order routing. Odd share numbers can only be executed against AROA itself. • If you get a partial fill ARCA will keep resending your order until it is completely filled or you become bid or ask yourself. • You can place your own bids and offers via ARCA. Small order execution system (SOES) The NASDAQ order routing system called SOES was developed in the middle of the 80’s and was made mandatory after the 1987 stock market crash. During the crash market makers were ignoring their posted prices and therefore clients weren’t able to execute their orders. SOES made it mandatory for market makers to execute orders at the market makers displayed price. SOES is for trading with market makers only. It cannot execute to ECN’s SOES used to have many limitations to it, such as a maximum number of shares that one could execute, as well as a time restriction for executing orders on the same stock. The biggest problem with it was, that a market maker was only required to execute one SOES order every 15 seconds. With the introduction of the new super SOES system these rules have changed significantly. Market makers are now required to execute every order they receive up to the size they are displaying, unless they decide to change their offer. You can now execute up to 999.999 shares via super SOES. Since market makers now have to execute every SOES order they receive it has made SOES executions much faster and it has become a very interesting route for daytraders again. But it has also changed the market; market makers are now much more inclined to change their existing offers since they don’t want to risk getting too many SOES executions at a point where they don’t want to. This has made the stocks more jumpy in general adding more risky situations for daytraders. You cannot display your own bids and offers thru SOES. The old SOES system still exists for small cap stocks. Selectnet (SNET) Selectnet was developed by market makers in order to execute their trades electronically and to avoid the verbal communication process via telephone. Nowadays, amongst the, NASDAQ order routing systems Selectnet is available to direct access traders as well. Thru SNET preference you can send your order to every market participant available on the Nasdaq. There are 2 types of SNET orders 1. Selectnet preference sends your order to one particular market maker or ECN only. If you preference a market maker he has time to decide whether to execute your order or not.2. A Selectnet broadcast order (with no preference to a particular market participant) gets send out to every market maker available. The market maker who accepts your order first has to do the trade with you. If you are trying to execute thru an ECN via Selectnet you can only do so by sending a preference order to that particular ECN, not by broadcasting your order. When using SNET you have the option to send your order as an “all or nothing” (AON) order, meaning that you are not willing to except partial fills. Especially important are the following points: When you are placing an order thru SNET you can NOT cancel it for 10 seconds!If you are privileging a market maker, he has 30 seconds to decide whether to execute your order or not! There is no requirement for him to execute your order. The fact that you can’t cancel your order for 10 seconds is the reason why Selecnet is not very popular amongst day traders. Imagine being in a stock that is falling fast and trying to sell it thru SNET; you might not get executed and have to reenter your sell order at an even lower price. Instinet (INCA) Finally, the last of the NASDAQ order routing systems we will look at here is the Instinet, or INCA. Market makers frequently use the lnstinet order route. INCA will often be the “Ax”. It was implemented in 1969 as an alternative exchange for banks and institutional traders. Since the ECN’s are implemented into level 2, INCA is providing very good liquidity to the market. That's it! Remember to study your broker’s manual very carefully before making any trades. OK, let's change gears and go to the money management section entiltled "risk factor". 
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