Since its creation, the stock market has greatly evolved thanks to various new tools and strategies. They allow retail and institutional investors to trade efficiently. Despite these technological advancements, some tools benefit one type of investor rather than the entire community. One example is an Intermarket Sweep Order (ISO). It is a sophisticated trading strategy primarily utilized by institutional investors and high-frequency traders (HFT) to execute large orders across multiple exchanges simultaneously.
ISOs leverage the electronic trading infrastructure to fill orders quickly and at the best possible prices. There are plenty of benefits but just as many criticisms. Here is everything you need to know about ISOs.
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What Is an Intermarket Sweep Order (ISO)
An Intermarket Sweep Order is a market order that allows traders to bypass the Order Protection Rule, also known as the Trade-Through Rule (Rule 611), in the US and execute trades (buy and sell) across multiple trading venues simultaneously.
This rule, introduced by the SEC in 2005, requires that orders route to the exchange, offering the best price.
However, ISOs provide an exception to this rule. They allow traders to simultaneously access liquidity across multiple market centers, even if better prices are available elsewhere.
How an ISO Works
When an Intermarket Sweep Order initiates, the order (stocks, options, futures, etc.) splits into smaller orders. Each is sent to different exchanges to capture liquidity at various price points.
Next, the order fills by taking all available shares at the best price. Then, it moves to the next best price, and so on, until the entire order fills or reaches the specified limit price.
Let’s look at an example. A trader wants to buy 10,000 shares of a stock. There are only 4000 shares available at $100 on one exchange and 6000 at $102 on another.
An ISO would allow the purchase of all 10,000 shares in a single transaction rather than being limited to only the 4000 shares at the best price.
The Order Protection Rule is violated, but the transaction fills since ISOs are part of the exception.
Intermarket Sweep Order Benefits
An Intermarket Sweep Order offers several advantages to traders.
- Speed of Execution: ISOs prioritize rapid execution over obtaining the absolute best price for every share, which can be crucial in fast-moving and volatile markets. In high-frequency trading environments, every millisecond counts.
- Hidden liquidity: Some exchanges have hidden orders not visible in the public order book. Thanks to ISOs, traders can tap into this hidden liquidity and potentially secure better prices and larger volumes than they would through conventional orders.
- Increased Fill Rates: By accessing liquidity across multiple exchanges simultaneously, ISOs can often achieve higher fill rates than traditional order types.
- Reduced Market Impact: Large orders can be executed more discreetly, potentially minimizing their impact on market prices.
- Flexibility: You can combine ISOs with limit orders. As a result, this allows traders to control the maximum price they’re willing to pay or the minimum price they’re willing to accept.
ISO Regulations
In the US, the SEC regulates and oversees the stock market to ensure it remains fair and orderly and protects investors. One of its missions is to regulate and scrutinize ISOs. Briefly, here are its regulations.
- Concurrent orders: When using an Intermarket Sweep Order, traders must simultaneously send orders to execute against the full displayed size of any protected quotations priced better than the ISO.
- Best execution: Despite the exemption from the Order Protection Rule, brokers still must seek the best execution for their client’s orders.
- Surveillance: Firms must have robust systems to monitor ISO usage and ensure compliance with regulatory requirements.
ISO Market Impacts
Institutional investors, high-frequency traders, and other sophisticated market participants primarily use ISOs. They represent a significant portion of market activity.
Some estimates suggest that an Intermarket Sweep Order accounts for over 40% of trades and volume in certain markets. Remember that institutional investors represent around 80 to 85% of all trades by volume in the US.
Because these systems are complex and require significant investments in technology and infrastructure, they may not be available for everyone. Thanks to today’s technology, they are often incorporated into trading algorithms. In this case, retail investors find themselves at a disadvantage.
They will likely never use ISOs because their order sizes are too small. Thankfully, many platforms offer retail traders advanced tools and customizable features to help them stay competitive with the big guns in the stock market industry.
ISO Criticisms
Like many financial market tools, ISOs have their advantages and criticisms. One of their main criticisms is that they can contribute to market fragmentation. By executing orders across multiple exchanges, ISOs can create disparities in pricing and liquidity.
As a result, this can lead to inefficiencies and market manipulation. Intermarket Sweep Order critics argue that this fragmentation undermines market integrity and makes it more difficult for investors to obtain accurate price information.
Another concern is the potential for abuse by high-frequency traders (HFTs). HFTs can exploit the speed and complexity of ISOs to gain an unfair advantage over other market participants. For example, HFTs can use ISOs to detect large orders and front-run them.
They buy shares ahead of the order and sell them at a higher price. This practice is known as order anticipation and can harm other investors and distort market prices.
Final Thoughts: Intermarket Sweep Order
To conclude, Intermarket Sweep Orders (ISOs) represent a significant evolution in electronic trading. They offer a powerful tool for executing large orders efficiently. While they provide clear benefits regarding execution speed and fill rates, they also come with increased regulatory responsibilities and potential market structure implications such as market fragmentation and technological vulnerabilities.
Nonetheless, they allow large orders to be filled rapidly across multiple exchanges. Are they really necessary for retail traders? Maybe not. However, they give a certain advantage to institutional and HFT traders.
If you want to learn more about profiting from the stock market, head to our free library of educational courses. We have something for everyone, including trading options for those with small accounts.
Frequently Asked Questions
It is an order that picks up as many shares as possible to fill an order at the best available price. ISOs are an exception to the Order Protection Rule, which says that orders must fill at the best price.
Also known as the Order Protection Rule or Trade Through Rule, it guarantees that trades fill at the best available price.
ISO offers institutional and HFT traders rapid execution and increased fill rates. Some argue that it also provides more liquidity to the stock market.
