The price of any market security is proportional to its demand. If an investor places a large order for a particular stock, its price may steeply rise. Iceberg orders help avoid this. Iceberg orders are large single orders that have been split into smaller unit orders. This trading strategy is used by institutional investors to make big trades in the market without triggering a noticeable price change.
In this article, we explore what iceberg orders are, how they work, and why they are beneficial.
What is an iceberg order?
An iceberg order is an order to buy or sell substantial quantities of a security. However, rather than being entered as a single large order, it is broken into smaller incremental orders. The term ‘iceberg’ comes from the fact that each visible small order is just ‘the tip of the iceberg’. The iceberg order strategy is used to essentially hide the actual size of the order. Like smart order routing, iceberg orders are usually used by institutional investors for buying or selling large quantities of a security.
The rationale is that substantial buy or sell orders put pressure on the demand and supply in the market, impacting the current market price of a security. For instance, a substantial sell order of, say, 50,000 shares may induce panic among investors and result in a steep fall in the security’s price. Alternatively, a single large buy order of 50,000 may result in hoarding and increase the price of the security. To avoid these circumstances, large buy and sell orders are placed as iceberg orders.
How do icebergs work?
Understanding what an iceberg order is in trading also helps understand how these orders work. Iceberg orders work by concealing the real size of the order. When iceberg orders are placed, only a fraction of the order is visible to other traders. Once the first part of the order is executed, the next small part is placed. This way, the cycle continues until the entire order is executed to limit the impact on the stock’s prices.
Uses of iceberg order
- Concealing trading intentions: Institutional investors can use iceberg orders to execute large buy/sell trades without disclosing the actual size and intention of the trade. This prevents market participants from reacting to the full extent of the trade.
- Lower impact cost: Large buy/sell orders can lead to panic selling or hoarding, affecting the impact cost of the security. Impact cost is the cost the trader incurs when buying/selling the stock due to the prevailing liquidity levels of the stock. Iceberg orders lower the impact cost by breaking down a substantial order into smaller, inconspicuous orders.
- Regulatory compliance: Markets may limit the maximum size of orders. Iceberg orders help traders comply with these market regulations while still being able to execute their desired buy/sell trade.
- Avoid slippages: The difference between the trader’s expected price point and the real trade execution price is termed slippage. Slippage can occur when a large order is executed, but there is not enough volume at the chosen price to maintain the current bid-ask spread. Icebergs execute big orders incrementally to avoid slippages.
Also Read: after market orders
How to identify iceberg orders?
Now that you know what iceberg orders are and their uses, it is time to understand how to identify them. Remember that icebergs are created with the purpose of concealment. Thus, identifying them would mean looking for patterns. Here’s a list of ways you can identify iceberg orders:
- Repeated orders at the same price: Iceberg orders generally appear as a series of repeated orders at a single price point.
- Unusual trading volume: When a particular stock displays unusual trading volume without a proportionate change in its price.
- Order book: If the order book shows minimal changes in quantity despite active trading, it could signal to iceberg orders. This would suggest a continuous replenishment of orders at a specific price level.
- Algorithms: Advanced trading algorithms can not only place GTT orders, but also detect iceberg orders by analysing the market’s trading data to isolate patterns.
Example of an iceberg order
Let us suppose an institutional investor wants to sell 50,000 shares in company ABC and exit his position. If we assume that the current share price is Rs. 100, the investor should get Rs. 50,00,000 by selling his holdings. Placing a single large sell order for 50,000 shares would affect the price of the security. The exit of an institutional investor would spark panic selling among other investors, resulting in a fall in the stock’s market price to, say, Rs. 90. Selling his holding now would mean earning less than the initial valuation. To avoid this, the institutional investor uses an iceberg order to sell his position. The iceberg order splits the initial order of selling 50,000 shares into incremental orders of 5,000 shares at a time.
Icebergs to overcome order freeze limits
Indian exchanges have placed maximum order limits for equity derivative contracts. Freeze limit is the maximum number of contracts that a trader can buy or sell in a single order. For instance, the freeze limit for NIFTY is 1800, while that for Bank NIFTY is 900. So, traders who want to execute larger order quantities have to place multiple regular orders manually. Iceberg orders help avoid this issue since one large order can be broken down into smaller lots without going through the process of placing multiple orders.
Conclusion
Understanding what an iceberg order is and its significance can help traders gain valuable insights into market dynamics. Icebergs prevent the sharp rise and fall in the ask price of securities by concealing the actual size of the order. This strategy makes sense for active traders who deal with large quantities. While iceberg orders benefit institutional investors, they are rarely leveraged by small retail investors.
