Market making with algos

- [Instructor] One of the two major types of algorithmic trading is what's called market making. Market making, as the name implies, is all about making an effective market, it's about helping to match up buyers and sellers. Computers are really good at this type of repetitive minutiae that helps to markets to function more efficiently. Now, as part of the market, we have two specific types of orders that comes in, offers and bids, often called bid and ask. Essentially, bids just represent individuals who are willing to come in and bid or buy a stock and they put in an order at a specific price. So in this particular example, we have a stock trading for around $113.10. We have one party willing to buy 600 shares at $113.10. Another party willing to pay to buy 725 shares at $113.9, and then another party willing to buy 150 shares at $113.8. We have this bid side of the book built up, higher prices go to the top of the book. Those represent the best possible purchase orders. On the other side of the coin, we have the asks or offers, these represent offers to sell. In this particular case, again, just like the bid side, we have them stacked up over time. So we have someone willing to sell 1,255 shares at 113.13. We have someone willing to sell 480 shares at 113.12, someone willing to sell 825 shares at $113.11. These bids and asks have to match against one another in order to make the market effectively. In this case, our price is going to be $113.10 based on those bids and asks. Now, there's a variety of different types of orders that'll come in over time to the market. To begin with, we have market orders. These are the simplest types of orders. Essentially, an investor comes in and says they want to either buy or sell a stock at whatever the best available price is. That order will then get executed immediately, just like that. Second, we have limit orders. Limit orders really represent haggling. We have somebody who comes in and says, "Well, I want to buy 500 shares, but only if I can get it for $113.1." They have a specific price in mind. And then finally, we have what are called iceberg orders. These are large orders that get divided up into smaller lots so that they don't overwhelm the supply and demand in the market and push that price in the wrong direction for the order entrant. In addition to the type of order, there are also specific terms and conditions around the order. So one of those terms and conditions is the time and force. Day orders are orders where they're valid for less than a day. This order needs to get filled before the end of the day or it gets canceled. We also have what called good till canceled orders. These get executed immediately or else they get put in the order book and left there until the person that entered that order goes through and cancels it. Good till canceled orders are valid if they get executed immediately, or alternatively, if they're not executed immediately, then they get left on the order book until they are either executed or canceled by the individual that put in the order, whom I'm calling the entrant. Finally, we have fill or kill orders. These are orders where they need to be either immediately executed or they get canceled. In addition to the basic types of orders and the conditions, we also have what are called conditional orders. So these are orders where they're going to be put in if a specific condition occurs. A stop order, for example, says we're going to sell a specific security, specific stock, if that stock's price falls to a particular level. Alternatively, we could offer to buy a specific stock if the price rises to a particular level. The idea here is that we're putting in an order and then we let a computer handle the details. We set what the limits are when that order should be executed or not, and then the computer waits until we have conditions that match our orders. Similarly, we have what's called a stop limit order. This is an order that gets executed at the exact price we specify or better. It's very similar to the standard stop order. It's just that we put in a limit order rather than a market order once those particular conditions are met. And then finally, and this type of order would not be algorithmic, we have what are called discretionary orders. This is when a traditional human broker decides when to place the order, what the price should be, et cetera. Prior to the advent of algorithmic trading and prior to the rise of the internet, this was sort of the traditional order where you called up your broker, the broker would then put in the order on your behalf and try to do the best job for you. In essence, this is what algorithmic trading competes against.