Quick definition Order routing is the decision of where to send a customer order. A broker can route to an exchange, an ATS, a market maker, or internalise the order. What it is When a client places an order, the broker decides where to send it. Brokers are required to route to achieve best execution, which typically means routing to the venue with the best price (NBBO). Modern brokers use routing algorithms that: - Check the NBBO across venues - Route to venues offering the best price - Split large orders across venues - Use dark pools for large orders seeking anonymity Why it matters Order routing determines execution quality. Poor routing increases costs for clients. Brokers that route poorly lose business to competitors with better routing. Best execution rules require proper routing. Brokers that route poorly face regulatory scrutiny. Internalisation Some brokers internalise orders, matching them against their own inventory rather than routing to an exchange. This is legal if: - The price is at least as good as the NBBO - The broker discloses the practice - The broker complies with disclosure and reporting rules Internalisation can benefit clients (faster execution, reduced fees) but can also harm them if the broker takes the other side of the trade. Practical example A retail client places a market buy order for 1,000 shares. The broker checks the NBBO: bid 100.40, ask 100.41. The best ask is on NASDAQ at 100.41. The broker routes the order to NASDAQ. The order executes at 100.41. The client receives best execution. If the broker had routed to a different venue with ask 100.50, the client would have been overcharged. The broker would face regulatory penalties. Venue conflicts Brokers sometimes face conflicts between best execution and business relationships. If Venue A is the best price but Venue B pays the broker a rebate, the broker may be tempted to route to Venue B. Regulations prevent this. See also - Best Execution - Venue Selection - Internalization - Direct Market Access (DMA)
