What Is the Small Order Execution System (SOES) and How Does It Work?

The Small Order Execution System (SOES) was created to improve the execution of small trades in the stock market, particularly for retail investors. It emerged after the 1987 market crash when delays in order processing became evident. By automating trade executions for small orders, SOES provided faster and more reliable transactions.

This system helped shape modern electronic trading by increasing accessibility and reducing reliance on manual processes. While it has been replaced by more advanced systems, understanding SOES offers insight into the evolution of market structure and order execution.

How Orders Are Routed and Filled

When an investor placed a trade through SOES, the system automatically matched the order with a market maker at the best available price. Unlike traditional methods that required manual intervention, SOES ensured immediate execution by obligating market makers to honor their posted bid and ask prices for small trades.

Market makers registered in a stock had to accept incoming orders up to a predefined share limit, preventing them from ignoring smaller trades. The system operated on a first-in, first-out basis, ensuring orders were processed in sequence.

SOES orders were executed at the prevailing market price, meaning investors could not specify a limit price. While this guaranteed execution, it also exposed traders to price fluctuations, particularly in volatile stocks. Since orders were processed automatically, there was no opportunity to adjust pricing based on real-time market movements, sometimes leading to less favorable fills.

Eligibility Criteria

SOES was designed for retail investors, limiting order sizes to a maximum of 1,000 shares per trade to prevent institutional traders from exploiting the system.

Only Nasdaq-listed securities qualified for SOES execution, excluding those on the New York Stock Exchange (NYSE) or other exchanges. Eligible securities had to meet minimum price and volume requirements to ensure only actively traded stocks were available for automated execution.

Brokerage firms had to be registered members of Nasdaq and subscribe to SOES to route trades through the system. Not all brokers participated, as some preferred alternative execution methods that allowed for greater control over pricing. Investors using a non-SOES broker would not have access to its automatic execution benefits, influencing trading strategies and broker selection.

Liquidity Factors

The effectiveness of SOES depended on liquidity, influenced by trading volume and bid-ask spreads. Stocks with higher volume and tighter spreads minimized trading costs, while wider spreads in less actively traded securities increased costs.

The number of market makers in a stock also affected liquidity. Stocks with more market makers had more consistent pricing and deeper order books, ensuring trades could be executed without significant price disruptions. In contrast, securities with fewer market participants were more susceptible to price swings.

Time of day also influenced liquidity. Early morning trading often had wider spreads and lower volume as market participants adjusted to overnight news. Midday sessions typically saw reduced activity, while the final hour of trading attracted increased volume as institutional investors rebalanced portfolios. Executing trades during periods of lower liquidity could lead to less favorable pricing.

Regulatory Oversight

SOES was regulated by the National Association of Securities Dealers (NASD), which enforced compliance requirements on market makers to ensure they honored their posted quotes. Firms violating these rules faced disciplinary actions, including fines, trading suspensions, or expulsion from Nasdaq participation.

The Securities and Exchange Commission (SEC) also monitored SOES activity to detect abuse, particularly among day traders who exploited its automatic execution features. Some engaged in “SOES bandit” strategies, rapidly executing small trades to take advantage of price discrepancies before market makers could adjust their quotes. Regulators introduced rules limiting the frequency of trades a single participant could execute within a short time frame to curb excessive speculation.

Costs and Fees

While SOES itself did not impose direct fees, brokerage firms often charged commissions for executing orders through the system. These fees could be higher than those for traditional order routing methods, as brokers factored in the cost of maintaining access to SOES. Some firms offered discounted commission structures for frequent traders.

Beyond commissions, traders had to consider market conditions affecting execution prices. Since SOES orders were executed at the prevailing market price, investors faced the risk of slippage, where the execution price differed from the expected price. This was particularly relevant in fast-moving stocks, where small delays could result in meaningful price changes. Additionally, bid-ask spreads influenced the overall cost of trading, as wider spreads increased the effective cost of entering and exiting positions.