What is iceberg order?

When a large single order is split into smaller orders by utilising any automated program, this process is known as the iceberg order. The purpose of the division is to hide the actual large size of the order. It is termed as iceberg order as like the iceberg, only the tip is visible and the larger part is hidden under the surface, similarly, in an iceberg order, the large quantity is hidden and only the smaller quantity is visible. It is also termed as reserve order sometimes.

Frequently Asked Questions (FAQs)

What is the working of iceberg order?

Those traders employ iceberg orders who generally trade in large quantities in the stock market. Trade in large volumes has the potential to change the market prices of the security substantially as a large quantity of sell or buy orders creates pressure on the supply and demand function of the market respectively.

For instance, a single order to purchase 100,000 shares of a stock represents a substantial rise in the demand for that stock. As a result, the price of the stock can be pushed higher by the other traders. Similarly, when a single order to sell appears in the market, then the pressure on the supply side increases and the prices of the security can decline.

Traders who are indulging in large quantity trade generally utilise iceberg orders while implementing their sell or buy orders by dividing the transaction into smaller quantities. An iceberg order is adopted with the view that the single large transaction does not create a significant shift in the prices and causes a negative effect on their trading strategy, that is, selling or buying shares at the prices not desired by them.

While executing a large quantity trade, the traders have a concern that if in case the other market participants came to know about the transactions then they might further create a supply or demand pressure and the trader will not be able to execute the trade on the price desired by them.

For instance, if Mr. X comes to know about the large quantity trade which will be executed by an institutional investor then they will be able to predict the rise in the share prices. Therefore, they will make investments in that stock. This may result in an increase in the prices as Mr. X will also start making investments in that stock only. In effect, the institutional trader must pay higher prices for investing in the security.

Image Source: © Rfischia | Megapixl.com

What are the basic concepts surrounding an iceberg order?

Iceberg orders are mainly employed by institutional investors when they want to make purchases or sales in larger quantities from their portfolios. The division in the smaller quantities ensures that the market is not tipped. At a specific time, only the smaller portion of the quantities traded are visible on order book’s level 2. By hiding the trade of larger quantities in the stock market, a significant and substantial amount of price movement can be avoided.

Researchers have indicated that placing orders in the form of an iceberg is a common practice among traders as it allows higher liquidity and the impact on the overall trading is minimised.

How to locate an iceberg order?

A market participant can locate an iceberg order by identifying a series of limit orders undertaken by a single market maker. The series will reappear constantly. To illustrate, an institutional investor wants to invest five million in a particular stock and might divide the same into a slot of 500,000 each. If a trader identifies a pattern, then they can take advantage of the same.

By identifying the iceberg pattern, a trader can make a profit as the prices will rise in the future. Therefore, the iceberg order can be considered as one of the technical indicators.

What is the significance of iceberg order?

Iceberg order ensures that the market is unaware that a single trader or institution is selling the same shares, therefore, iceberg orders are sneaky in their nature. If we look from a different perspective, then to some extent, iceberg order helps in stabilising the market and major swings in the particular stock are avoided. Due to these benefits, some exchanges extend services and support to execute a trade through an iceberg order, that is, the division of large order into a smaller one.

What is an example of an iceberg order?

Let’s assume there is an institution investor who wants to make an investment worth $1 million in a particular stock. If the news breaks out in the market that there is going to be a large investment in that stock, then the prices will hike in no time. Therefore, institutional investor employs iceberg order to avoid such disruptions in the prices and divide their investment into slots of $100,000 each.