Understanding how your stockbroker carries out your instructions to buy or sell investments will help you see whether you’re getting the best price available.
What’s going on behind the scenes isn’t always your first thought when you place a trade through your stockbroker. After all, you’re concerned about making the right investment decision. Carrying out the trade and making sure you get the best price for it is your broker’s responsibility.
However, understanding more about how your orders are executed (carried out) can help to make you a more effective trader. In particular, it’s important to know that when two investors deal in exactly the same shares at exactly the same time through two different brokers, one may get a better price than the other.
To see why, let’s take a look at what happens when you click the ‘Buy’ or ‘Sell’ button on your stockbroker’s website.
The role of the RSP
You may be surprised to hear that when you trade a share that’s listed on the London Stock Exchange (LSE), your trade doesn’t actually go to the LSE. Instead, your order will be placed with a Retail Service Provider (RSP), also known as a market maker.
A market maker is a company that’s always ready to both buy and sell a stock at all times, aiming to make a profit from the difference between the bid price and the offer price. When you place your order, your broker sends an electronic request for a price quote to a pool of RSPs. It then picks the best quote from those it gets back from the RSPs and passes it to you. This takes a fraction of a second.
That quote will be guaranteed for a certain period of time – usually 15 seconds – while you choose whether to accept the price. If you do nothing or cancel the order, the quote lapses. If you accept, your order goes to the RSP and the deal is executed.
Quality matters as much as quantity
As you can imagine, the price you’re offered will depend on which RSPs your broker asks for a quote. If an RSP offering a better quote isn’t included in your broker’s pool, the price you get from your broker won’t be as good as the best price available from the other RSP.
Each stockbroker scans a different selection of RSPs when requesting a quote. For example, Barclays Smart Investor polls a group of up to 25 selected RSPs. However, it’s important to note that getting the best price isn’t only about the number of RSPs your broker will deal with – it’s also about which RSPs are included in that group.
Barclays Smart Investor selects RSPs on a number of criteria including quality and timeliness of execution. We actively monitor the performance of the RSPs that we use against these criteria to maintain our quality of execution for clients.
Beating the exchange price
By now, you may be wondering why stock trading works this way. The main advantage of the RSP system is that there should always be somebody willing to buy when you want to sell, and to sell when you want to buy.
To use a technical term, market makers provide ‘liquidity’. Without them, there might be times when nobody wants to take the other side of your trade. The RSPs ensure that you can deal immediately, even in smaller and less liquid securities.
Of course, large investors – pension funds, insurance companies and other institutions – don’t place trades through the RSP network. Their orders often go directly through the London Stock Exchange’s electronic system for matching buyers and sellers, which is known as the ‘order book’.
There will usually be a number of different ‘bid’ prices and ‘ask’ (or ‘offer’) prices from market participants posted on the order book – the bid price is the price at which traders are offering to buy and the ask price is the price at which they’re offering to sell. The highest bid price and the lowest ask price will be highlighted on trading screens with a yellow strip. You can see an example of the yellow strip in the picture below, which shows the order book for Vodafone.