Smart Order Routing (SOR): definition and function explained simply

Choosing the right trading venue can significantly impact your trading results. "Smart Order Routing" (SOR) is an automated process that ensures that your orders are executed on the market at the best possible prices and with the highest liquidity. This process optimises trading by ensuring fair trading conditions and best execution practices. In this guide, we explain how smart order routing systems work and the advantages and disadvantages of using them.

• Smart Order Routing (SOR) is an automated process that optimally executes trading orders across different trading platforms. 

• Smart Order Routing systems use algorithms to analyse factors such as liquidity, fees and prices in real time and select the best execution venue for an order.

• The benefits of Smart Order Routing include automatically searching for the best possible price, reducing slippage, and increasing trading efficiency.

• Smart Order Routers help both institutional and private traders to achieve the best prices and lowest costs.

What is Smart Order Routing (SOR)?

Smart Order Routing (SOR) describes the automated process by which trading orders are optimally executed across different trading platforms. A Smart Order Routing system analyses all the trading venues it is connected to in real time and selects the one that offers the best possible execution for an order. 

Due to the large number of exchanges on which the same product is traded, prices and trading volumes may vary at different execution venues. By using Smart Order Routing, brokers and trading platforms can significantly increase trading efficiency. Smart Order Routing is often also referred to as "Multi-Exchange Order Routing" or simply "Order Routing".

How does a Smart Order Router work?

Smart Order Routing systems use advanced algorithms to ensure the optimal execution of trading orders across different trading venues. Smart routing strategies are used to increase the efficiency of order execution. The process begins as soon as a trader places an order. The Smart Order Router analyses a variety of factors in real-time to select the best execution venue.

The important criteria here are the liquidity of a market, the level of fees charged on the respective exchanges and the available prices. The goal of the router is to execute the order in the most efficient way by offering the best price and the highest liquidity while minimising unnecessary costs. Smart Order Routers take all market conditions into accountand ensure that a trader's order is automatically executed at the best possible trading venue.

Advantages and disadvantages of Smart Order Routing

Smart Order Routing offers numerous advantages for traders as Smart Order Routers enable access to various trading venues. With the help of advanced algorithms, the Smart Order Routing system has the main advantage of the best possible price execution, as the system automatically routes the order to the trading venue with the best price and the highest liquidity. This also significantly reduces the risk of slippage – i.e. the difference between the expected and actual execution price. Smart Order Routers also offer the opportunity to view additional statistics about the market and increase trading efficiency. 

Despite these advantages, there are also some challenges with Smart Order Routing. One of these is latency, which is the delay in the forwarding and execution of orders that can occur due to the processing speed of the system. In addition, different fees on the various exchanges can lead to price deviations. Another problem is the splitting of orders, where large orders are split between several exchanges, which may not always lead to optimal execution.

Smart Order Routing strategies in practice

Smart Order Routing is used in both private and institutional trading and is particularly useful for high-frequency trading, as it makes quick decisions about the best execution venues, thus maximising efficiency. Traders who rely on tiny price differences can use Smart Order Routing to place their orders optimally and increase their success.

For institutional traders, Smart Order Routing systems offer the opportunity to manage large orders discreetly and efficiently. By distributing orders across different exchanges, market movement is minimised, which prevents prices from changing too much due to the influence of significant transactions. In addition, institutional players can reduce trading costs as the Smart Order Router automatically selects the trading venues that offer the lowest fees and the best price.

For private traders, Smart Order Routing democratises access to products with competitive prices and high liquidity, which were previously often only available to institutional traders. By using this system, private investors also have the opportunity to benefit from the same advantages as institutional market participants and to execute their orders on the best terms.

Regulatory authorities see Smart Order Routing systems as a mechanism that increases the efficiency and fairness of the market. By consistently executing orders at the best available prices, Smart Order Routing helps to create a fairer trading environment and access to global markets.

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Regulations for Smart Order Routing

Smart Order Routing is subject to strict regulatory requirements in various markets to ensure transparency and fairness in trading. In the European Union, the Markets in Financial Instruments Directive (MiFID II) regulates the use of Smart Order Routers to ensure that brokers act in the best interests of their clients and guarantee the best possible execution of an order. Brokers must provide evidence of the measures taken for this purpose. The Regulation National Market System directive (Reg NMS) takes on this role in the USA.

As Smart Order Routing systems operate across borders, complying with the various regulations in different countries can be a challenge. Brokers must stay informed and up to date with the rules and regulations in their active markets to avoid sanctions or penalties.

Summary: Importance of Smart Order Routing for efficient trading

Smart Order Routing (SOR) systems help with the efficient execution of trading orders – whether for ETFs, cryptocurrencies or other financial products. By using advanced algorithms, Smart Order Routers ensure that orders are automatically forwarded to the execution venue with the best conditions. This improves trading efficiency and minimises risks such as slippage. Particularly in markets with high liquidity and volatility, Smart Order Routing enables you to implement your own trading strategies in the best possible way. For institutional traders and brokers, the use of Smart Order Routing is therefore essential in order to remain competitive and achieve the best results for their clients.

Frequently asked questions about Smart Order Routing

What is Smart Order Routing?

Smart Order Routing (SOR) is an automated process that optimises your trading orders across different trading platforms. A Smart Order Router analyses all available trading venues in real-time and selects the one that offers the best possible execution for an order.

How does Smart Order Routing work?

Smart Order Routing systems use advanced algorithms to ensure the optimal execution of trading orders. The process begins as soon as a trader places an order. The Smart Order Router analyses a variety of factors, such as liquidity, fees and prices, to select the best execution venue.

What advantages does Smart Order Routing offer?

The benefits of Smart Order Routing include automatically searching for the best possible price, reducing slippage and increasing trading efficiency. Smart Order Routers help institutional and private traders achieve the best prices and lowest costs.

How can I use Smart Order Routing?

To use Smart Order Routing, you must ensure that your broker or trading platform supports this technology. Many modern trading platforms offer Smart Order Routing as a standard function to enable their clients to achieve the best possible execution of their orders.

How can I optimise my orders?

To optimise your orders, make sure you use the right order types and keep an eye on market conditions. Smart Order Routing systems can help you by automatically routing your orders to the best available trading venue. Make sure that you make full use of the functions and options of your Smart Order Router to achieve the best results.

Further topics relating to order types

Are you interested in what other order types are available? In the Bitpanda Academy you will find a variety of guides and tutorials to help you learn more about topics such as order types, blockchain networks, crypto trading and more.