US Equity Market Structure (5): The Plays – Order Types and Algorithms

This is the fifth post of a series on US Equity Market Structure (a total of 6).

I didn't write any of these posts; while I was learning the fundamentals about investment, I came across this series on Interactive Brokers' IBKRCampus. If you are interested you can go to their site here.

（Disclosure: I'm using Interactive Brokers for my personal investing, but I'm not paid by them to write about it.)

This series is mostly platform-agnostic, meaning that you don't have to be on Interactive Brokers to find this series useful. Enjoy.

Welcome back to our introduction to U.S. equity market structure. In the last lesson, we talked about the key players—broker-dealers and investors. Now, let’s explore what happens on the "field" of trading and how broker-dealers execute trades, either for themselves or on behalf of clients.

Speed of Trading

A critical component in today’s market is the speed of trading. Decades ago, the action on the New York Stock Exchange floor was the heartbeat of the market, but today, trading happens in nanoseconds. Stock prices can rise or fall in seconds, far too fast for humans to process. This high-speed trading is a result of technological advancements and fierce competition. The faster a trader can act, the more of an advantage they have, similar to being able to watch the game in slow motion while others are at normal speed.

While this technological evolution has made markets more efficient—allowing prices to quickly reflect new information—it has also raised concerns about fairness. Speed can lead to an uneven playing field, where certain participants profit by trading based on minute price movements over very short time periods.

Order Types

When a broker-dealer is ready to trade, they must use order types—instructions that tell the trading venue how to execute the trade. Order types specify the conditions for buying or selling a stock. Some basic order types include:

• Market Orders: These orders instruct the broker to buy or sell immediately at the current market price, prioritizing execution over price.
• Limit Orders: These orders set a maximum (for buying) or minimum (for selling) price at which the trader is willing to execute. They are less aggressive than market orders since they wait for the price to reach a specific level.

Beyond these, there are more complex order types. One example is pegged orders, which adjust their price relative to the prevailing market quote. A midpoint peg, for instance, will price itself halfway between the best bid and offer, while a near-touch peg will rest at the best bid (for buying) or best offer (for selling). Pegged orders are often hidden, meaning they don’t display their price to the market until they execute.

There are also instructions that can modify orders, such as specifying the time of day when the order should be executed or setting a minimum number of shares that must be traded at once. These added details help broker-dealers and investors fine-tune their trades to fit specific strategies.

Algorithmic Trading

In today's market, algorithmic trading plays a dominant role. Algorithms are pre-programmed sets of rules that automatically manage trades based on market conditions. For example, an algorithm designed to buy 10,000 shares of Apple will determine how to split the order, which order types to use, and how to react to changes in the market—all without human intervention.

Algorithms enable trades to happen incredibly quickly, reacting to new market conditions in real time. Just as a sports team follows a defensive strategy without needing to stop and consult the coach, these algorithms follow pre-set rules that allow them to adapt instantly to market movements.

There are many types of trading algorithms, each designed with different goals in mind. Some algorithms aim to minimize market impact, while others are programmed to execute trades at the Volume Weighted Average Price (VWAP) or seek liquidity in dark pools (private trading venues that don’t display order book data). These strategies, like the zone defense in basketball, are built to respond automatically to market changes.

Conclusion

In this lesson, we’ve covered the mechanics of modern trading, from order types to the algorithms that have revolutionized the speed and efficiency of the market. In the next and final lesson, we’ll follow a simple trade from the moment it’s placed to its final execution, tracing the full journey of an order through the U.S. equity market system.