What is smart order routing?
Smart order routing is an automated online trading method, applied by bots or algorithms which based on given conditions will detect and execute the best available opportunity throughout a range of different trading venues.
With a boost in the volume and number of trades across venues and the possibility of fragmented liquidity, Smart Order Routing provides a solution to overcome this fragmentation by assessing the different offers and placing orders based on the best option available.
How smart order routing is implemented?
By theory, Smart Order Routing starts by scanning the given markets and find the best place to execute a given order for an investor. Smart Order Routing implementation starts with receiving data of the incoming orders through many channels. Such integration is implemented by different API protocols such as FIX gateway, a custom gateway, webhooks and etc. Then, the basis of the algorithm itself which is the assessments of different venues to find the best price amongst them, and further enhancement with adding investors particular preferences into the algorithm or the bot and the positions of different venues. We later talk about possible preferences in the most common variable configuration section of this article.
The venue itself could have different characteristics such as the latency available, the fees and commissions of orders and etc which should be also taking into account when developing Smart Order Routing Algorithms or bots.
Within the next stages of Routing orders and executing them FIX API or custom API gateways such as JAVA API or File Protocols can also be utilized. While implementing Smart Order Routing algorithms or bots its good to take into account the dynamism required for routing the orders, one reason for that is to update investors portfolio once orders are implemented.
In summary, Smart Order Routing Algorithms contain the available gateways for receiving incoming orders, there is the Market Gateway to send orders based on the Smart Order Routing conditions and the execution of the Smart Order Routing itself. In between, there are also feed handlers for decision making and some interface for monitoring and parameterizations.
Technically Smart Order Routing technology will search for available liquidy across given trading venues, and with mid-point matching will get the best possible chance of price improvements.
Tools for smart order routing
There are few characteristics that make a good Smart Order Routing algorithm or bot, having a good API integration to find and asses best liquidity across different exchanges would be one. Fast, precise and complete execution with the ability to combine trading strategies with low latency. Customizability and parameterization of the Smart Order Routing algorithm or bot also imperative.
As well as the importance of computational capabilities for Smart Order Routing, applying a precise logic on which decides the operation of the Smart Order routing is crucial. Predictability, consistency and low latency are al equally important to achieve a good Smart Order Routing.
Smart Order Routing tool providers should also be compilable with regulatory requirements, e.g. in Europe MiFid2 requires the transparency of information and transactions for the third party.
Most common configuration variables for Smart Order Routing:
There are many tools in the market that employ Smart Order Routing within trading bots and algorithms. These tools are programmed to facilitate the best execution and implement investors preferences within Smart Order Routing process. To name some of these parameterized variables Price, Cost, Broker venues are the most common ones. Followed by Hit ratios, or the status of volatility, probability of execution, the latency, value limits for FX, Position for Derivatives, last Look Aware, Liquidity hunting (for ghost liquidity), level market depth, Rejection Rates, Market Impact, transaction costs and internalization (executing simultaneously on internal public).
What are the pros of smart order routing?
To note down the things that make Smart Order Routing a successful process for trading we can mention the simultaneous access to multiple venues which provides a range of options and based on the automated search across trading venues will find the best price to trade. Smart Order Routing is also an insightful process to receive validations, control and statistics.
What are the cons of smart order routing?
There are a few noticeable disadvantages of using Smart Order Routing, we can mention added latency to the execution of the orders. Smart Order Routing could bring additional complexity to trading results.
Smart order routing in Crypto market
With consideration to the lack of liquidity within the Cryptocurrency markets, Smart Order Routing could be a very valuable asset for Cryptocurrency traders. There are illiquid trading venues across Cryptocurrency market that the price of the same token within one order book could vary dramatically which makes institutional trades very inefficient. We do have witnessed many online and stand-alone service providers including Smart Order Routing into their Cryptocurrency trading platform, so maybe the technique is not that widespread within Cryptocurrency but soon it will become a norm.