Smart Order Routing

Smart order routing exists because the same share can trade in many places at once. In the United States, equities trade across more than a dozen exchanges and a larger number of off-exchange venues, each with its own fees, rules and participants. Deciding where to send an order is an optimisation problem, and this course treats it as one.

Why do markets need smart order routers?

Since rules such as Regulation NMS in the United States and MiFID in Europe opened markets to competing venues, liquidity for a single stock is spread across many of them. A broker owes clients best execution. A router has to find the liquidity, respect price protection rules, and avoid venues where fills tend to come just before the price moves against you.

How do you model the best place to send an order?

You estimate, for each venue, the probability that an order of a given size fills within a time limit, the fee or rebate, and the expected price move after the fill. Then you choose an allocation that minimises the expected total cost. Cont and Kukanov showed how to solve a version of this problem; the course works through it and tests it.

Who is this course for?

Quantitative developers and researchers working on execution, and students preparing for the High-Frequency Trading course. It counts toward the Certificate in High-Frequency Trading.

What you will be able to do

• Describe how equity markets fragmented and what best-execution rules require.
• Model fill probability and adverse selection per venue from historical data.
• Compare fee structures, including maker-taker and inverted venues.
• Formulate order allocation across venues as an optimisation problem and solve it.
• Evaluate a routing policy with simulation and explain its sensitivity to assumptions.

Syllabus, module by module

1. Fragmented markets

   Exchanges, alternative trading systems, dark pools and internalisers; Reg NMS and MiFID II in outline.

2. Venue economics

   Maker-taker, taker-maker and flat fees; rebates and their effect on queue length.

3. Fill probability

   Queue models, hazard rates and estimating fill rates by venue.

4. Adverse selection

   Markouts after a fill, and why the venue that fills you fastest may cost you most.

5. Routing as optimisation

   The Cont-Kukanov allocation problem and its solution.

6. Learning a routing policy

   Adapting allocations from observed fills, and the exploration problem.

7. Assessment preparation

   Supervised work on the written assessment.

How the certificate is earned

A written paper-style assessment: you formulate and solve a venue allocation model, test it in simulation against a naive router, and discuss its assumptions and limits. On a pass you receive the Course certificate in Smart Order Routing, issued by the Institute with a verification code. Read how certification works.

Before you start

Probability, optimisation to the level of constrained problems, and the material of Limit Order Books and Execution Algorithms.

• Limit Order Books
• Execution Algorithms: VWAP, TWAP and Beyond