A discretionary reserve order combines the features of a discretionary order with those of a reserve order. As such, it can be used to control both the size of orders sent to exchanges and the sizes of bids and offers sent to exchanges.
As with a reserve order, investors can specify the full amount of a security or asset which they want to buy or sell, and specify a smaller amount which they would like the full order to be broken up into. The broker breaks up the full order into multiple small orders of the specified size, which are then sent to the exchange.
The discretionary order feature allows the investor to specify the size of the bid and offer which they want displayed on exchanges. In order to do this, the investor specifies their maximum bid or offer in the order. Instead of passing this maximum bid or offer on to the exchange, the broker places the order with the exchange at the going bid or offer and raises the bid or offer steadily until the investor’s maximum bid or offer is reached.
Reserve orders are useful for investors who want to buy or sell large volumes of an asset or security without strongly influencing supply and demand for that asset – and therefore its market price.
Example: An investor wants to purchase 1 million shares in a specific company. If their broker were to send an order for 1 million shares to the exchange in one go, the sudden high demand for that stock would temporarily outstrip supply, causing the price of the stock to climb before the order can be fully filled. The result would be that the investor would pay more for the 1 million shares, and the value of the shares would be artificially inflated by the investor’s own order, which would reduce their chance of making capital gains. Using a reserve order, the investor instructs their broker to break down the 1-million share order into 40 orders of 25,000 shares each. The broker places these orders one at a time. Because the supply is more than sufficient to fill an order of 25,000 shares, the price of the stock does not increase significantly. After each 25,000-share order has been filled, the broker sends the next one until the full order has been fulfilled.
Discretionary orders allow investors who are willing to pay a high price for an asset or security to buy the asset without causing its price to climb as they buy it. By using discretionary reserve orders, investors can prevent both fluctuations in market rates caused by sudden high demand, and fluctuations caused by high bids. This allows large orders to be filled at high maximum bid prices without heavily impacting supply and demand and resulting market rates and helps brokers to fill large orders without triggering runs on the corresponding securities.
Example: An investor wants is willing to pay up to 50 Swiss francs per share for shares in a specific investment fund whose listed price at the time is 43 francs per share. If their broker were to place the investor’s 50-franc bid on the exchange, the sudden high bid would cause seller to up the price of their offers. As a result, the cost of the shares would increase significantly based on the higher offer. If, triggered by the sudden climb in the value of the shares, other investors choose to buy shares in the same fund, the price of the shares may climb above the 50 francs per share which the investor was willing to pay.
Using a discretionary order, the investor instructs their broker to bid just 43 francs per share, but to raise the bid to match the best available counterbids up to a maximum of 50 francs. Because the bid price does not increase significantly, the price of the shares remains stable until the order is fulfilled.