Continuous Trading

Continuous trading is the form of trading in which a transaction can take place at any time during a market's opening hours, whenever an incoming order can be matched with one already waiting. Each trade may occur at a different price, and prices change from moment to moment as orders arrive. It is the normal daytime mode of stock, futures and options exchanges.

The alternative is the call auction, in which orders are collected over a period and executed together at a single price. Most exchanges combine the two: an opening auction starts the day, continuous trading runs through the main session, and a closing auction ends it. Both are forms of auction market.

In an order-driven market, participants send orders to the exchange's matching engine. An order that cannot be executed immediately rests in the order book, which lists buy orders by descending price and sell orders by ascending price. The combined structure is commonly called a central limit order book (CLOB).

When a new order arrives, the engine checks whether it can trade against resting orders on the opposite side. A buy order priced at or above the lowest sell order executes at once, at the resting order's price. If the incoming quantity is larger than the best resting order, it continues to the next price level until it is filled or its limit is reached. Any unfilled remainder of a limit order joins the book.

Priority among resting orders usually follows price first and then time: the best-priced order trades first and, at the same price, the earliest. Some derivatives markets instead allocate fills pro rata among orders at the same price. The gap between the best buy and best sell prices is the bid-ask spread, and the quantities available at each level make up order book depth. Prices can only be entered in multiples of the tick size.

The two basic instructions are the limit order, which specifies the worst price the trader will accept and may rest in the book, and the market order, which trades immediately at the best available prices. Traders who post limit orders supply liquidity; those who trade against them take it. Many exchanges charge lower fees to, or pay rebates to, liquidity suppliers.

Exchanges offer many refinements, such as orders valid only for immediate execution, stop orders triggered at a set level, and iceberg orders that display only part of their size.

Continuous trading offers immediacy. An investor can trade at once at a known price, and can react to news as it arrives without waiting for the next auction. Prices adjust continuously, so the market provides a running signal of value that feeds derivatives pricing, index calculation and risk management. Because the book and recent trades are visible, the process supports price discovery throughout the day.

The model works best for instruments with many participants and frequent orders. A market maker may be appointed to quote continuously on both sides in less active securities, so that an order can always be executed.

Liquidity in a continuous market is spread across time. At any instant, only the orders then in the book are available, so a large order may exhaust several price levels and move the price against the trader. Institutions therefore split large orders into small pieces, or seek counterparties away from the displayed book through dark pool trading.

Continuous matching also rewards speed. The first participant to react to new information can trade against orders that have not yet been updated. This has produced an expensive competition in technology and has raised costs for slower liquidity suppliers, who widen their quotes to protect themselves. Some economists propose replacing continuous trading with frequent batch auctions, held at very short intervals, to remove the advantage of tiny differences in speed.

Thin order books can produce erratic prices. A single large or mistaken order may cause a sharp, brief move. Exchanges limit this with price collars and by interrupting continuous trading with a short auction when the next trade would fall outside a set range, a safeguard described under volatility interruption.

In most developed equity markets, the same share trades continuously on several exchanges and alternative venues at once. Brokers use automated routers to send each order to the venue with the best price, and rules on best execution and, in the United States, on protecting displayed quotations link the separate books into something close to a single market. The share of volume traded in the continuous session has fallen in recent years as activity has shifted towards closing auctions and off-exchange venues, which has prompted debate about how well intraday prices reflect supply and demand.

Less liquid securities are often not traded continuously at all. Exchanges may assign them to periodic auctions, and markets for most bonds and many derivatives rely instead on dealers and requests for quotes.