Saturday 22 December 2007

Life Cycle of a Trade (Part 2)

In my previous post, I had mentioned about 5 steps involving in the trade’s life cycle. In this post, I shall discuss about the Risk Management and Order Routing and the Order Matching and Conversion into Trade.

Risk Management and Order Routing


Regardless of how an order gets generated or delivered, it passes through a risk management matrix. This matrix is a series of risk management checks that an order undergoes before it is forwarded to the exchange. The onus of getting the trades settled resides with the broker. Any client default will have to be made good to the clearing corporation by the broker. Credit defaults are thus undesirable from the point of view of the broker who puts money and credibility on the line on behalf of the customer. Hence, these credit and risk management checks are deemed necessary.

Institutions are normally considered less risky than retail customers. That is because they have a large balance sheet compared to the size of orders they want to place. They also maintain a lot of collateral with the members they push their trades through. Their trades are hence subjected to fewer risk management checks than retail clients.

The mechanisms followed when orders are accepted and sent to exchanges for matching are the same for both institutions and retail clients. However, for retail customers the orders are subjected to tighter risk management checks and scrutiny. The underlying assumption in all such risk management checks is that retail clients are less credit worthy and hence more susceptible to defaulting than institutions. A recent extension of retail trading has been trading through the Internet. This exposes brokers to even more risk because the clients become faceless. In the good old days of “call and trade” (receiving orders by phone), most brokers executed transactions of clients they knew. With the advancement in trading channels, the process of account opening became more institutionalized, and the numbers came at the expense of client scrutiny. Most brokers who operate on behalf of retail clients these days operate on the full-covered concept. This means that while accepting orders from retail clients, they cover their risks as much as possible by demanding an equal value of cash or near cash securities.

The steps below show how a retail transaction is conducted and the benefit provided by risk management. The method utilized is more or less the same in call and trade as in Internet trading. The order delivery mechanism changes, but the basic risk management principle implemented remains the same. Here are the steps:


  1. The client calls the broker to give the orders for a transaction (in Internet trading the client logs on to the Internet trading site, provides credentials, and enters orders).
  2. The broker validates that the order is coming from a correct and reliable source.
  3. In case the client gives a buy order, the broker’s system makes a query to ascertain whether the client has enough balance in a bank account or in the account the client maintains with the broker. In case the client does not have enough balance, the order is rejected even before forwarding to the exchange. If the client has the balance, the order is accepted, but the value of the order is deducted from the client’s balance to ensure that he does not send a series of orders for which he cannot make an upfront payment. Many brokers still do not have direct interfaces to a banking system. In such cases, they ask the client to maintain a deposit and collateral in the form of cash and other securities; they keep the ledger balances of a client’s cash and collateral account in their back-office system and query this system while placing the order to ensure that the client has enough money in his account. The figure below illustrates this process.

  4. In case a client gives a sell order, the broker checks the client’s custody/demats account to ensure that he has a sufficient balance of securities to honor the sale transaction. Short selling is prohibited in most countries, and brokers need to ensure that the client is not short of securities at the time of settlement, especially in markets that do not have an adequate stock-lending mechanism in place. Most markets have an auction mechanism in place for bailing out people with short positions, but such bailouts could be very expensive. Once the sale transaction is executed, the broker keeps a record and updates the custody balance’s system if it is in-house or keeps reducing the figures from the figures returned by the depository to reflect the client’s true stock account position. In many countries, brokers have a direct interface with the depository system that lets them query the amount of shares of a particular company in which the client has balances. Wherever a direct interface is absent, the broker maintains the figures in parallel; the broker then does a periodic refresh of this data by uploading the figures provided by the depository and maintains a proper intraday position by debiting figures in his system when the clients give sale orders that are executed on the exchange. The figure below illustrates this step.

  5. Once the risk management check passes, the client’s order is forwarded to the exchange.
  6. On receipt of the order, the exchange immediately sends an order confirmation to the broker’s trading system.
  7. Depending upon the order terms and the actual prices prevailing in the market, the order could get executed immediately or remain pending in the order book of the exchange.

You can appreciate the role technology plays when you consider that the entire process of receiving the order, doing risk management checks, forwarding the order to the exchange, and getting back the confirmation is expected to take a few hundredths of a second. Any performance not conforming to this standard is considered unacceptable and could be a serious reason for clients to look for other brokers who can transact faster and get them more aggressive prices.

One of the ways of implementing risk management is through margining. A margin is an amount that clearing corporations levy on the brokers for maintaining positions on the exchange. The amount of margin levied is proportional to the exposure and risk the broker is carrying. Since positions may belong to a broker’s clients, it is the broker’s responsibility to recover margins from clients. Margins make the client stand by trades in case the market goes against the client by the time the trades get settled.

To protect the market from defaulters, clearing corporations levy margins on the date of the trade. Margins are computed and applied to a client’s position in many ways, but the underlying philosophy of levying margins is to tie the customer to a position and preserve the integrity of the market even if a large drop in stock prices occurs.

Order Matching and Conversion into Trade

All orders are aggregated and sent to an exchange for execution. Stock exchanges follow defined rules for matching all the orders they receive. While protecting the interests of each client, the exchange tries to execute orders at the best possible rates. The broker’s trading system communicates with the exchange’s trading system on a real-time basis to know the fate of orders it has submitted.

A broker keeps a record of which orders were entered during the day, by whom, and on behalf of which client. A broker also maintains details of how many orders were transacted and how many are still pending to be executed. Using this system, a broker can modify the order and order terms, cancel the order, and also split the order if required depending upon the behavior of the market and instructions from the clients. Once the order is executed, it gets converted to a trade. The exchange passes the trade numbers to the broker’s system. The broker in turn communicates these trade details to the client either during the day or by the end of the day through a contract note or through an account activity statement. The contract note is a legal document that binds the broker and the client. Contract note delivery is a legal requirement in many countries. Apart from the execution details, the contract note contains brokerage fees and other fees that brokers levy for themselves or collect on behalf of other agencies such as the Clearing Corporation, exchange, or state.

On my next post, I’ll discuss about the last two steps. Have a nice day.

59 comments:

suri said...

this information is really helpful...thank u much...looking for more information on trading life cycle,stocks,boonds etc.,

Neaven said...

Hi Suri, thanks. If I can find information on those, I'll post it on my blog. Have a nice day.

Anonymous said...

Hi Neaven,

The information was realy v good. Do you have any information about the clearance and settlemnt processes of Fixed income bonds in the US domestic markets. This includes the services pprovided bt FICC for OTC trades .

Thanks HEnry

Neaven said...

Hi Henry, I'm sorry for the late reply. Currently I do not have information for settlement process for Fixed Income in the US domestic market. I'll do some research and shared with you and my readers once I can get some information. Have a nice day.

Anonymous said...

Hi Navean,

Thanks ,this is kiran Kumar.
Could you please send me your contact mail id to kiran.kumar@ubs.com.

Anonymous said...

Seems the source here http://books.google.com/books?id=kVXdT24pX-YC&pg=PA250&dq=applied+.net+financial+markets. Page 18

Unknown said...

Hi Neaven,

This is Harsha..i am new to Investment Bank and wants to know the basic things first..like what is meant by instrument,Counterparty,life cycle of trade.
can you please breifly explain what all the above terms.so that i will go ahead to start.

Thanks,
Harsha.

Unknown said...

Hi All,

Can anyone please explain what the above terms are , Instrument , counterparty , trade...Am new bee to Investment Bank...so its bit hard to know....Can anyone please explain..

Thanks in advance...

Regards,
Harsha.

Unknown said...

Hi,
Can you please share me the link for Part 1?
Its really interesting.

Term Papers said...

I completely agree with the above comment, the internet is with a doubt growing into the most important medium of communication across the globe and its due to sites like this that ideas are spreading so quickly.

Anonymous said...

Hi How can I find ur first post?
5 steps involving in the trade’s life cycle

Anonymous said...


After exploring a number of the articles on your web site, I seriously appreciate your way of writing a blog. I saved it to my bookmark webpage list and will be checking back in the near future. Please visit my web site as well and tell me your opinion.

Anonymous said...

Hello, i read your blog from time to time and i own a similar one and i was just
wondering if you get a lot of spam feedback? If so how do you
protect against it, any plugin or anything you can
advise? I get so much lately it's driving me crazy so any assistance is very much appreciated.

My homepage darlizclip.com

Anonymous said...

Laughter is a best solution of fear, anger and boredom.
That is why we have dedicated this page to help you renew your spirit
and perhaps have a few laughs too. By looking at funny pictures and funny dog videos on the internet,
the hours will slip away easily.

Here is my website ... www.howmuchjoy.com

Anonymous said...

The majority of the answer would depend on where you want to redeem them.

For instance , there are some "regular clinics" where they have got alternative solutions available where they
can apply a number of00 insurance coverage, FlexPlan dollars, or additional "non-cash payments" to the of
their alternative remedies. However , there are several smaller offices (whether it become Chiropractic, massage therapy, or
any of the same providers how the other clinics offer) where they en't offered as a choice to pay based on the restrictions of the payment choices. This depends upon the way the clinic/office/hospital can be registered, but sometimes it depends upon when the clinic/office/whatever decides not to accept the particular payment choices (as several don't wish to make use of the particular paperwork).
.. If it's a single practitioner or even hypnosis may be the only thing offered, you most likely defintely won't be capable of use "Care Credits"
to pay for, but you could always call the practitioner and ask
if that will be an alternative to pay. Good luck and am
hope I helped!

Here is my web-site; natural weight loss pills for women

Anonymous said...

Genuinely no matter if someone doesn't know then its up to other visitors that they will help, so here it occurs.

Feel free to surf to my web blog: xerox 8560 service manual

Anonymous said...

Hi, I do believe this is an excellent web site.

I stumbledupon it ;) I will come back once again since i have book marked it.
Money and freedom is the best way to change, may you
be rich and continue to help other people.

my blog - www.kutno.faceonline.pl

Anonymous said...

Good day! I just would like to give an enormous thumbs up for the nice information you will have right here on this post.
I will probably be coming back to your blog for more soon.

Review my web-site ... ikea shoe rack thrones

Anonymous said...

Good day! I just would like to give a huge thumbs up for
the nice info you’ve got here on this post. I might be coming again to
your weblog for extra soon.

my webpage: 飛梭雷射

Anonymous said...

I'm linking this webpage from my private weblog . this has all the usefull information necessary.

Here is my page; i'm having trouble getting pregnant

Anonymous said...

I reallу like what you guyѕ are up too. Such cleνer
work and repoгtіng! Keep up the excellent ωorks guys I've included you guys to blogroll.

my site diamondlinks review

Anonymous said...

Good day! I simply wish to give a huge thumbs up for the nice info you’ve gotten right here on this
post. I might be coming back to your weblog for more soon.

my website - musicman sub bass guitar

Anonymous said...

Good day! I simply wish to give an enormous thumbs up for the great info you
have got here on this post. I will be coming again
to your weblog for extra soon.

Check out my webpage step above home improvement

Anonymous said...

Hi there! I just want to give a huge thumbs up for the nice information you have here on this post.
I will likely be coming again to your weblog for extra soon.


Also visit my webpage: korean stars plastic surgery clinic

Anonymous said...

Hi there! This article could not be written much better!
Reading through this post reminds me of my previous roommate!
He constantly kept preaching about this. I most certainly will send this post to him.

Fairly certain he'll have a great read. Thank you for sharing!

Stop by my web site ... Stall Mats For Gym Floor

Anonymous said...

Wow, that's what I was searching for, what a data! existing here at this weblog, thanks admin of this site.

Look at my homepage; garage rubber mats

Anonymous said...

Hello! I just want to give a huge thumbs up for the good information you have
here on this post. I will be coming back to your blog for more soon.



Here is my blog top 10 best love quotes of all time

Anonymous said...

Whats up! I simply want to give a huge thumbs up for the nice
information you might have here on this post. I will likely be coming back to your weblog
for extra soon.

Look into my blog: bumbleride lightweight stroller

Anonymous said...

Howdy! I just wish to give a huge thumbs up for the good data you’ve here on this post.

I will probably be coming again to your blog for more soon.


Feel free to visit my web site :: before i die audiobook free

Anonymous said...

Hello! I simply would like to give a huge thumbs up for the nice data you have here on this post.
I will be coming back to your weblog for more soon.

My page - best seo tools for mac

Anonymous said...

This is a topіc whiсh iѕ nеar to my heart.
.. Cheerѕ! Wherе arе уour cοntaсt details though?


My web site: www.Glassrattler.com

Anonymous said...

Hiya! I simply would like to give an enormous thumbs up for the nice information
you’ve got right here on this post. I can be coming
back to your blog for extra soon.

my web-site: high school musical posters to print

Anonymous said...

Hey! I just want to give an enormous thumbs up for the great information you’ve here
on this post. I can be coming back to your weblog
for more soon.

Here is my weblog :: semi automatic 22lr rifles

Anonymous said...

Whats up! I just would like to give an enormous thumbs up for the good information you could have here on this post.
I will likely be coming back to your blog for
extra soon.

My web blog ... laser printer photo paper samsung

Anonymous said...

I was suggested this web site through my cousin. I'm not positive whether or not this submit is written by means of him as nobody else realize such particular about my difficulty. You are wonderful! Thank you!

my web site ... best hosting companies

Anonymous said...

I really enjoyed this radiant post. Kindly continue this exceptional do business.


Feel free to visit my blog post :: xerox phaser 8560 driver

Anonymous said...

Whats up! I simply would like to give an enormous thumbs up for the nice data you may have right here on this post.

I will be coming back to your weblog for extra soon.



Look into my page ... 2013 lincoln mkx commercial

Anonymous said...

Hello! I just want to give a huge thumbs up
for the good information you may have here on this post.
I might be coming again to your blog for extra soon.



Feel free to visit my homepage :: semonin commercial

Anonymous said...

Howdy! I just would like to give an enormous thumbs
up for the great info you have got here on this post.
I will likely be coming again to your blog for more
soon.

Here is my webpage ... queen seon deok episode 62 download

Anonymous said...

Hello! I simply would like to give a huge thumbs up for the good
information you’ve right here on this post. I will probably
be coming back to your weblog for extra soon.

Here is my web-site seobook keywords

Anonymous said...

Hi there! I just wish to give a huge thumbs
up for the good info you have here on this post.
I might be coming again to your weblog for more soon.

Here is my site - semi prone

Anonymous said...

Hey! I simply would like to give an enormous thumbs up for the nice data you’ve got here on this post.
I will be coming back to your weblog for more soon.


Here is my website ... seo companies in india review

Anonymous said...

Whats up! I simply wish to give an enormous thumbs up for the nice information
you have got right here on this post. I
can be coming back to your weblog for more soon.

my page - seohyun and yonghwa ep 11

Anonymous said...

Good day! I simply would like to give an enormous thumbs up for the good info you will have here on
this post. I might be coming again to your
weblog for more soon.

my webpage letmewatchthis apple

Anonymous said...

Whats up! I simply wish to give a huge thumbs up for the great data you will have right here on this
post. I will be coming back to your blog for extra
soon.

Also visit my site; xem phim hanh dong thanh long

Anonymous said...

Hiya! I simply would like to give a huge thumbs up for the nice info you
could have here on this post. I will probably
be coming again to your blog for more soon.

my blog post: seminole county clerk of court public records search

Anonymous said...

Hiya! I simply would like to give an enormous thumbs up for the great data you’ve got here on this post.
I can be coming again to your weblog for more soon.

Review my web-site seo

Anonymous said...

Hello! I simply would like to give a huge thumbs up for the nice info
you might have here on this post. I will probably be coming again to your blog for extra soon.


Look at my web-site; seo

Anonymous said...

Piece of writing writing is also a excitement, if you be familiar with afterward you
can write if not it is complicated to write.


Also visit my web blog; xerox 8560 error codes

Anonymous said...

Hey! I simply wish to give an enormous thumbs
up for the great data you have got here on this post.
I will be coming again to your blog for extra soon.



Also visit my blog post semi trucks for sale in amarillo texas

Anonymous said...

Hi there! I just would like to give an enormous thumbs up for the good data
you’ve got right here on this post. I can be coming back to your blog for
more soon.

my blog post seoul garden food menu singapore

Anonymous said...

Hi there! I just wish to give an enormous thumbs up for the
nice info you could have right here on this post. I will be coming back to your blog for extra soon.


Have a look at my blog post; my semi-permanent hair color is too dark

Anonymous said...

The other day, while I was at work, my sister stole my iPad
and tested to see if it can survive a forty foot drop, just
so she can be a youtube sensation. My iPad is now destroyed
and she has 83 views. I know this is completely off topic but I had to share it with someone!


Here is my web page ... xerox 8560dn printer

Anonymous said...

Hiya! I just wish to give an enormous thumbs up for the nice info you
may have right here on this post. I will probably be coming again to your weblog for more soon.


my web-site: semaphore flags for sale long beach ca

Anonymous said...

SUPERB !!!!!!!!!! Made my day !!!!!!!

Here is my blog; xerox phaser 8560mfp - -

Anonymous said...

Samsung Luxia Lcd Series Television

my web-site :: checked

Anonymous said...

good luck! give it a try.

Feel free to surf to my web page; xerox phaser 8560 ink

Anonymous said...

Hello. I was searching the web with the life cycle of a trade and was able to view and scan the pages. It was really of big help Neaven. My concern was where I can be able to access the part 1 of the life cycle. It would be of big help if I will be able to read it. Thank you in advance Nieven.

Unknown said...

With this phase of trade and also using intraday SGX signals, let me do trade with more with new strategies.