What is preset trading?
Preset trading can refer to trading that takes place at specific prices, which were mutually agreed upon prior to execution. Conditional orders are generally based on the concept of preset prices that allow an investor to set a specific price to execute on an exchange. Over-the-counter (OTC) orders are also preset in most cases.
- Preset trading is where the counterparties to a market transaction specify the price and terms of the trade in advance.
- Conditional orders are generally based on the concept of preset prices that allow an investor to set a specific price to execute on an exchange.
- Preset trading is a common practice in over the counter (OTC) markets and with some block orders.
- Preset trading is illegal when it involves the exchange of securities by market makers at preset prices.
Understanding preset trading
Preset trading can help an investor specify a price to execute a trade on the open market. Conditional orders are largely based on the concept of preset trading, allowing an investor to manage their risk by designating specific buy and sell prices. Bulk orders are also pre-arranged in many cases and can be crossed on regional exchanges or electronic cross-over networks without breaking any rules.
The preset trading of stocks, futures, options and commodities between market makers is illegal. Most stock exchanges also have pre-established trading rules and, in the commodities market, the Commodity Exchange Law expressly prohibits this.
In all types of market exchanges, orders are executed based on a supply and demand process that relies on market makers to match buyers and sellers. Market makers include a wide range of trading entities and systems. Investors can place a variety of different types of orders in a variety of different securities available for trading. If an order is executed, whether market or limit, it will be done through the supply and demand process facilitated by a market maker.
Pre-established illegal trade
Preset trading is illegal when it involves the exchange of securities by market makers at preset prices. Market makers work to facilitate the orderly exchange of securities available for trading on the open market. They match buyers with sellers and benefit from the margin of the operation.
Exchange rules, such as NYSE Rule 78 and certain laws such as the Commodity Exchange Act, prohibit these market makers from collusively trading securities with each other. Trading rules find that this practice creates a messy and unfair market for brokers, traders, investors, and any other market participant. In addition, these operations are also not exposed to market prices or market risks associated with standard securities exchange operations.
Examples of this type of negotiation between market makers in the stock market may include an offer to sell in conjunction with an offer to buy back. Conversely, a market maker could arrange a buy order in conjunction with an offer to sell to another market maker at the same price or some other preset price that benefits traders participating in preset trading.
In a commodity market example, two commodity dealers could use preset trades to execute risk-free trades at set prices rather than market prices. This type of illegal trade would limit the risk and be potentially profitable for the traders involved. However, since it is not based on price factors from market makers, it inhibits the market and the market prices available to other participants.