Order Splitting

What Is Order Splitting?

The term order splitting refers to the practice of dividing a large order into a series of smaller ones. This allows securities to be traded — whether they're bought or sold — with ease and can also make the order eligible for more rapid trade executions.

Order splitting can help when market liquidity may be insufficient to satisfy a large order. Orders for securities on the Nasdaq were split through a special system, while other exchanges did so through stockbrokers. Most exchanges now execute these trades automatically.

How Order Splitting Works

Institutional investors are companies or other organizations that collect money from different investors and invest that capital by buying and selling big blocks of securities. This gives them an edge over individual investors — they have many more opportunities because of the sheer volume of trades they can make. That's where order splitting came into play.

Order splitting was common before automated systems became the norm. It was a common technique used by stockbrokers to help their clients achieve optimal results. This process allowed individual investors to buy and sell a smaller amount of shares rather than forcing them to buy a large order that they couldn't afford.

Traditional order splitting has become less common in recent years. That's because fully automated trading platforms are now more adept at splitting orders automatically into sizes that optimize for the best speed and terms available.

For instance, individual traders were able to benefit from preferential order fulfillment provided they submit orders equal to 1,000 shares or less using the Small Order Execution System (SOES) — a network that executed trades automatically for securities traded on the Nasdaq. Retail investors were able to gain the same quality of market access and execution speeds that were previously reserved for larger investors. In practice, though, brokers acting on behalf of large investors would often use order splitting to route their clients’ orders through the SOES.

Since the entire Nasdaq exchange now operates as an automated electronic platform, the SOES is no longer in use. Investors, whether large or small, automatically benefit from order splitting by the Nasdaq platform in a manner that ensures the best possible execution price. Although some markets, such as the New York Stock Exchange (NYSE), continue to involve human brokers, the vast majority of trading — and, thus, order splitting — is now automatically conducted through electronic platforms.

Although most markets use automated trading platforms to split orders, some exchanges continue to use human brokers to conduct order splitting.

Example of Order Splitting

Suppose you are a large institutional investor who wants to purchase a significant stake in a security that is thinly-traded. Given its small market capitalization, there is a good chance that the stock’s market price would rise based on the sudden demand caused by your purchase order. This, in turn, could increase the total cost of your purchase, as the share price may rise during the period in which you are purchasing shares.

To mitigate this risk, a broker could break up that institutional investor’s order into a series of smaller ones which would then be submitted gradually. If the orders are placed over time and set to match against the existing liquidity of the stock, it may be possible to prevent or substantially reduce the price-inflationary effect of the new purchase.

In this scenario, order splitting could enable the institutional investors to purchase their stake in the company at a lower cost, while also avoiding unwanted publicity. Similarly, the reverse scenario could also apply, in the case of large investors looking to discreetly exit or reduce their position.