What are Iceberg Orders? Definition, Example, and Advantages

Key Highlights

• An iceberg order involves the purchase or sale of a large quantity of an asset divided into smaller orders.

• Large institutional traders use iceberg orders to hide large trades.

• Using iceberg orders allows a trader to execute a large order at a better price.

What is an Iceberg Order

An iceberg order is a trading strategy for hiding the size of a large order by dividing it into several smaller ones. It is valid for both buy and sell orders. Traders use Iceberg orders for the following reason: Large sell orders may cause panic and result in a significant decline in prices. Conversely, traders may over-buy a stock when they see a large buy order made by an institutional investor. Panic and overbuying leads to impact cost, which is the additional cost incurred due to a large order. To avoid the impact cost, traders use Iceberg orders.

Example of an Iceberg Order

Let’s say, you are an institutional investor looking to sell 4 million shares of a stock. If the shares are priced at ₹150 each, you should receive ₹600 million. However, suppose the order is placed in one lot. In that case, investors will wonder why a large institutional investor is selling his stake in the firm. This results in a fall in its stock price. The impact cost also can be quite significant.

Assuming the average selling cost falls to ₹130, you will receive ₹80 million less than the initial valuation. However, if you reduce the order size to 80,000 shares, you may sell a large portion of the stock before the market understands the whole situation. As a result, the average selling price would be Rs 145 per share. Hence, the capital gain shall be more significant.

How to Identify Iceberg Orders

Finding a pattern is essential for spotting iceberg orders. The following are a few ways to identify them.

• Repeated orders at a single price point: If you notice a chain of orders at the same price, but the overall volume isn't changing, it may be an iceberg order. After the execution of each small order, you will find a new order with the same price.
• Unusual trading volume: Check securities that have an unusual trading volume but no change in price.
• Order book: Examine if market data indicates that there are continuous orders at a specific price level.
• Incremental order fills: A pattern of incremental fills at a given price level may also suggest an iceberg order.
• Algorithms: Advanced trading platforms and algorithms can spot iceberg orders by analysing market data and identifying trends.

Although there are some ways of identifying iceberg orders, you must remember that it may be difficult to spot them accurately. Retail investors who lack access to advanced market monitoring tools may find it challenging.

Advantages of Iceberg Orders

Iceberg orders can provide several benefits as mentioned below.

• Lower impact cost: As already mentioned, a large order may result in hoarding or panic. Iceberg orders can reduce impact costs by splitting big orders into smaller ones, which are not easy to notice.
• Strategic acquisition or sale: Sometimes, an investor may want to sell all his holdings in a firm or acquire a large stake in one instance. Iceberg orders allow him to execute large trades without disclosing his real intentions.
• Managing liquidity: If the market is low on liquidity, iceberg orders may help in reducing volatility.
• Regulations: Stock exchange rules may limit the number of orders that can be placed at once. Iceberg orders can help investors execute large trades while following the rules.

Using Iceberg Orders to Overcome Freeze Limits

Exchanges have established a maximum order limit for equity derivative transactions. Freeze limits are the maximum number of contracts that may be purchased or sold in a single order. This is inconvenient for traders looking to execute bigger volumes, as they must make several orders. Iceberg orders allow you to buy 10,000 or 200 lots of Nifty in a single order. This eliminates the need to place several orders during a large transaction and also helps to decrease the impact costs.

Conclusion

Iceberg orders only show a portion of the total order value and hide the remaining. This is because the orders are divided into small sizes and executed slowly. This helps to maintain the price at a steady level while making the transactions. Iceberg orders may be quite helpful, especially for large investors. However, there can be additional expenses if you wish to trade via iceberg orders. Some brokers charge higher charges on these types of orders as they are more complex. Hence, before implementing this trading strategy, you must carefully check the costs and benefits.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

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