Smart Order Routing Meaning | A Comprehensive Guide

In trading, “route” denotes the trajectory an order follows to reach the market. The vast majority of traditional discount brokers manage order routing on their own, but day trading brokers allow clients to have direct control over their order flow. 

Key takeaways

• Smart order routes are preconfigured programmatic routes that can also be customized in order to suit specific preferences.
• When utilizing the services of many day trading brokers, you have the option to bypass intermediaries and directly route your orders.
• What’s important, smart routes offer simplicity, speed, convenience, and automation.

If you are a trader utilizing a day trading platform, you should have the option to route your orders. 

Nonetheless, a simpler and more efficient way to take care of order routing is through the use of smart order routing (SOR), a service offered by many day trading brokers. Let’s take a closer look at “smart order routing meaning.”

In the stock market, “route” refers to the method of how your trade order is processed. When you place an order with a standard brokerage, it’s sent first to the broker and then to market makers or partners involved in order flow agreements for execution.

Brokers frequently have agreements with external liquidity providers, sending orders to them in return for a fee.

However, with most day trading brokers, there’s an option to skip these intermediaries. You can directly send your orders to the chosen destination, potentially resulting in quicker and more effective executions.

How to differentiate between various types of stock market routes

When you submit a trade order, it can be executed through various stock market routes. Nevertheless, not everyone is able to control which route a trade order takes.  

One option is through market makers, in most cases in-house or outsourced to third parties through order flow arrangements. 

It is worth noting that market makers, as well as specialists, process the orders sent to exchanges like the NASDAQ and NYSE. 

For traders utilizing direct market access (DMA) brokers, they can pick their order routes to electronic communication networks (ECNs). Importantly, ECNs are electronic order books that automatically match buyers and sellers based on the best available price.

While they offer freedom of choice and liquidity, they come with pass-through fees, which can also result in rebates for providing liquidity (buying at the bid and selling at the ask in the vast majority of cases). 

Smart order route (SOR) and its importance

Without a doubt, it is important to have at least a general understanding of “smart order routing meaning” 

Most DMA brokers also offer smart order routing (SOR), which involves using algorithms to route and scan for the best price as well as liquidity when carrying out orders. 

Smart order routes simplify the order routing process and are preferred by many new and experienced traders. They eliminate the need for manual order routing and provide an efficient way for self-directed traders to use order routing.

Types of Smart Order Routes

Smart order routes are preconfigured programmatic routes that can also be customized to suit specific preferences. 

Their primary objective is to locate the best route for order execution, which may involve breaking up an order into numerous pieces and executing them on different routes simultaneously. 

Smart order routes are typically set up to achieve specific goals, with some prioritizing execution speed while others prioritize price. 

Access to these routes depends on your broker, which offers varying sources for order routes and access to dark pools.

Advantages of smart routes

They offer simplicity, speed, convenience, and automation, eliminating the need for manual order routing. The advantages of utilizing smart routes for market participants can be summarized in three key benefits.

Firstly, they excel in execution quality due to their lightning-fast algorithms that simultaneously analyze routes, ensuring execution preferences are met faster than human intervention allows.

As a result, they can enhance liquidity by employing algorithms that distribute orders across numerous destinations to meet your desired share size amounts.

For instance, if you seek thousands of shares of XYZ at a specific limit price, a smart order route can efficiently fill your order by partially executing it across various ECNs and a dark pool in a matter of seconds. This results in improved fill prices as the smart route searches for the best fill prices simultaneously.  

Should you use smart routes?

Whether to use smart routes or not depends on your trading objectives. If you have a preferred ECN or alternative trading system (ATS), you may continue using it as your primary source. However, if you’re open to utilizing multiple routes for execution, smart routes can be a valuable option. 

You can often configure smart order routes to specify preferred destinations and the order of scans. For instance, if ARCA is your preferred ECN, you can select it as the main priority in the smart route. 

All in all, your choice should align with your trading goals, whether they prioritize price or liquidity. Testing several routing options provided by the broker is crucial to finding the best executions for your trading style and strategy requirements.