Trading 101: What is a Trade Matching Engine and How does it Work?

2021/05/21 04:10:25

Asset trading has dramatically transformed with the improvements that globalization brought over the years. Investors no longer have to make long queues on exchange floors waiting for an expert opinion to determine the best investments with the best returns. This improvement introduced an era where anyone can trade virtually any asset from the comfort of their home.

Modern markets are powered by trade matching engines and order matching systems. Electronic trade has significantly matured, and floor trading has become a thing of the past. This has also lowered transaction costs by a great deal where you are charged only a tiny percentage for every traded share.

Just like you can tell from the name, a trade matching engine matches buy and sell orders performed in an electronic trading network. An example of an electronic trading network is NASDAQ.

How Does The Trade Matching Engine Work?

The first thing that comes to mind when talking about software is speed and efficiency. Surely, the liquidity of an exchange also affects trading speed and efficiency. However, a trade matching engine enables high-frequency trading using a complex algorithm system. This feature is mainly available in electronic markets.

No one wants to spend hours before executing a trade because a minute lost in a highly volatile market equates to returns lost. A trade matching engine enables rapid order execution, which is certainly advantageous to both retail and institutional traders.

The servers that co-host the software powering this engine are decentralized to different locations. However, exchanges can still leverage for arbitrage trades between other exchange locations within milliseconds. This means you can buy and sell in real-time despite your location.

Which Order Types Does it Support?

Different trade matching engines support different order types. Consult before settling on an engine to ensure it can fill your maker order. Some of the most prevalent orders in the market fulfilled by a trading and order matching system include:

Limit Order: A limit order is an order that can only be fulfilled if the market price reaches a specific price. A buy limit order is executed at the limit price or lower while a sell limit order is performed at the limit price or higher.

Market Order: A market order is bought or sold at the best available market price. The order can be fulfilled at multiple prices if not completed in a single match.

Stop Order: This order is fulfilled when the market price reaches a specified price. A sell stop order is set to below the current market price.

Based on the aforementioned types of orders, matching engines work in the following ways:

A matching engine can partially fulfill an order or not meet it at all in the case of a limit order.

Cancel orders are given the highest priority, followed by market orders. A market order is filled if there is an opposite order in the market.

Matching engines will always attempt to match a buy order before a sell order.

Buy orders are sorted from the highest bid price to the lowest bid price. Orders with the highest bid price are executed first, while those with equal bid price are performed in terms of the order that arrives first.

Sell orders are sorted from the lowest sell price to the highest sell price. Orders with the lowest sell price are executed first.

Once a matched order is filled through cancellation, fulfillment, or expiration, the party that submitted the order receives a notification. An order matching engine eliminates the risk that any of the parties involved will default on the transaction.

Components of a Matching Engine

The matching engine is connected to an electronic trading network. The system is made up of the following features:

A transaction router links the market participants who submit orders and receive orders. When an order is sent to the router, it submits it to the queue to be fulfilled as either a market, limit, or cancel.

A cancel queue contains canceled requests.

A market order queue contains market orders awaiting execution.

A limit order queue contains limit and stop orders.

The orders at the top of the queue are entered in the order book. The order displays the best market prices for buy and sell. Order processing is reflected in the order book. The bid and ask prices on the book are gotten from the previous market prices.

Conclusion

Now that you have learned a bit more about trade matching engines, you are ready to set foot into the trading sector. Check out KuCoin’s trading section and start trading some of the most popular crypto assets.