There are a variety of algorithms for auction trading, which is used before the market opens, on market close etc. However, most of the time, continuous trading is performed. The trading mechanism on electronic exchanges is an important component that has a great impact on the efficiency and
liquidity of financial markets. The choice of matching algorithm is an important part of the trading mechanism. The most common matching algorithms are the
Pro-Rata and
Price/Time algorithms. Comparison of Price/Time and Pro-Rata Following are few basic remarks about the two basic algorithms and their comparison.
Price/Time algorithm (or First-in-First-out) • Motivates to narrow the spread, since by narrowing the spread the limit order is the first in the order queue. • Discourages other orders to join the queue since a limit order that joins the queue is the last. • Might be computationally more demanding than Pro-Rata. The reason is that market participants might want to place more small orders in different positions in the order queue, and also tend to "flood" the market, i.e., place limit order in the depth of the market in order to stay in the queue.
Pro-Rata algorithm • Motivates other orders to join the queue with large limit orders. As a consequence, the cumulative quoted volume at the best price is relatively large. ==Efficiency==