What Is a Trade-Through?
A trade-through is an order that is carried out at a suboptimal price, even though a better price was available on the same exchange or another exchange.
Regulations to protect against trade-throughs were first passed in the 1970s and were later improved upon in Rule 611 of Regulation NMS that passed in 2007.
- A trade-through occurs when an order is executed at a worse price than the best price available, essentially trading through or bypassing the better market price.
- Trade-throughs shouldn't occur in typical market conditions since, by regulation, orders must be routed to the best price.
- Trade-through rules don't apply to manual quotes (only electronic ones) and the one-second rule also provides a bit of leeway in fast-moving markets.
Trade-throughs are illegal since regulations state that an order must be executed at the best available price. If a better price is quoted elsewhere, the trade must be routed there for execution, and not "traded through" so the execution occurs at a worse price.
Rule 611 of Regulation NMS, also known as the Order Protection Rule, aims to ensure that both institutional and retail investors get the best possible price for a given trade by comparing quotes on multiple exchanges. These regulations extend the old trade-through provisions that existed at the NYSE to all NASDAQ and AMEX-listed stocks, as well as many smaller exchanges.
The current Order Protection Rule also protects share blocks of less than 100 shares, which in the past could be traded by brokerages without penalty. In many ways, these regulations have helped smaller retail investors avoid unfair price execution and compete on level playing fields with larger institutional investors that purchase stock in large blocks.
Trade-throughs typically should not occur on U.S. stock markets.
Exceptions to Trade-Through Regulations
Trade-throughs are defined as the purchase or sale of a stock that is listed on an exchange with consolidated market data disseminated, during regular trading hours, at a price that is lower than a protected bid or higher than a protected offer. While Regulation NMS applies broadly to all types of venues that execute trades in modern equity markets, including registered exchanges, alternative trading systems (ATSs), off-exchange market makers, and other broker-dealers, there are a few instances where trade-through regulations may not apply.
Manual quotes are not considered protected by Regulation NMS since consolidated market data is not disseminated electronically. Only electronically-delivered price quotes fall under the new regulations and the best prices, or top-of-book orders, must be posted across all exchanges that are subject to Regulation NMS.
The other big exception is the so-called "one-second window" that is designed to deal with the practical difficulties of preventing intramarket trade-throughs during a fast-moving market when quotes are rapidly changing. If a trade is executed at a price that would have not been a trade-through within the previous one second, then the trade is exempted from trade-through regulations.
Example of a Trade-Through Occurring in a Stock
Assume an investor wants to sell their 200 Berkshire Hathaway Class B (BRK.B) shares. The stock has 500 shares being bid at $204.85, and another 300 shares being bid at $204.80.
The highest bid is currently $204.85 with 500 shares, so if our investor sells, the order should execute at that price assuming the price and shares don't change before the sell order reaches the exchange.
The sell order for 200 shares should fill at $204.85, leaving 300 shares on the bid at that price.
A trade-through would occur if the order was executed at $204.80, or some other price lower than $204.85 even though there were shares available at a better price ($204.85) to fill the sell order.
Similarly, assume an investor wants to buy 100 shares of BRK.B. There are currently 1,000 shares being offered at $204.95. Since there are more than enough shares being offered at $204.95 to fill the buy order, the investor wanting to buy should get their shares at $204.95. A trade-through occurs if the buyer ends up paying a higher price, like $205, even though there are shares listed at the better price of $204.95.