A two-gate liquidity filter for futures order routing

Two gates for an executable order

The archive describes futures execution as a choice of contract size, matching method, and marketplace. TradersWeek editorial: read that workflow as two gates. First run a liquidity filter so only a contract size and book you can enter and exit remain. Then route the surviving order to the concentrated venue rather than the faster-looking screen.

A liquidity filter is a pre-trade screen that keeps only contract sizes and venues where an order can be placed and closed without outsized implementation cost. Implementation cost is the combined effect of spread, impact, and venue choice on the price received versus the intended price.

Keep only a size you can exit

The archive used a reduced-size crude oil futures contract as the first-gate example. That listing was described as half the notional size of the standard contract, lowering exposure for a given position.

A reduced-size contract is a listed futures specification with smaller notional exposure than the standard contract, used to lower capital at risk per fill. The filter is not a forecast of price. It only keeps an order that can be placed and closed without outsized implementation cost.

Match electronically when the pit is congested

Electronic matching of that smaller energy contract was presented as a way to obtain quicker, more accurate fills and confirmations when open-outcry pits were congested by volume and volatility. Electronic matching is screen-based matching that can run nearly around the clock and confirm fills when a floor book is congested.

An open-outcry pit is floor-based matching that, in this period, still hosted the main book for several futures products. Several widely traded futures products were described as remaining mostly or only executed in open-outcry pits rather than on electronic platforms. Speed of the screen does not, by itself, make the book executable.

Route to the primary market

Order routing is the choice of marketplace that receives an executable order, based on depth, spread, and expected fill and exit quality. Order flow was described as gravitating to the marketplace with the deepest liquidity, on the presumption of fairer pricing, better execution, and easier exits.

The primary market is the venue that holds most volume and is treated as the reference for pricing and exit. In one archive comparison of a single day, an incumbent gold futures venue printed more than 56,000 contracts while a newer electronic listing printed about 1,100, or 1.9 percent of total 100-ounce gold futures volume. Attempts by one exchange to take share from an incumbent were characterized as typically struggling to dislodge the liquid primary market.

What electronic-only access can miss

Access limited to electronic markets was said to risk trading away from the primary venue, where liquidity, pricing, and execution were often superior, and in some cases to prevent trading certain products altogether.

TradersWeek editorial: a faster-looking screen is not the second gate if it is not the primary market. After the liquidity filter keeps a size and book you can enter and exit, route the order to the venue that actually holds the concentrated book.