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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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21.2 Key Components of an Algorithmic Execution Framework

21.2.1 Smart Order Routing (SOR)

A core competitive element within any algorithmic framework is the ability to receive and interpret market data from multiple destinations as quickly as possible, in order to be able to act on the intelligence gathered before opportunities pass. The same infrastructure is used to manage order placement on the range of exchanges or liquidity pools you can trade on.

While the software required to implement a market aggregation capability is easily acquired via a growing number of EMS vendors (execution management system), they will not on their own provide the “smarts” required to deliver an edge in terms of SOR (smart order routing). To get this right, you need to be constantly refining the logic that determines the best destination at a point in time to hit a price or post an order. Best price can mean more than just the absolute value of a price available (net of brokerage). An aggressive algorithm will take into account different factors to a passive algorithm when prioritizing order flow. If there are identical prices available on two electronic broker platforms, a passive strategy will generally be directed toward the price with the most volume behind it and may very well consume only a subset of the volume available in order to avoid signaling to market. On the other hand, it may avoid the more liquid destination, if the market participants on that platform are more predatory and the ...

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