[kasey_junk]

Ok, with the extra comments I now understand your proposal is much more radical than I originally thought. You are suggesting a completely obscured order book. I don't know of any markets that operate that way so I don't have any proof about how well price discovery would work in that system. My instinct is that most participants would become very nervous about setting their prices and therefore the spreads would be very wide, and not much trading would occur.

That said, your system still doesn't address the priority issue. Lets say in your new bid system we got lucky and a lot of people without knowledge of the order book picked the same price for both buying and selling an instrument. But there were more people on the buy side than the sell side (or vice versa). Who gets filled and who doesn't?

[logfromblammo]

If there were more numbers on the buyer side, all buyers exactly at the clearing price would have an equal fraction of their order filled.

If buyers at $10 or lower want 300, 100, and 10, and sellers at $10 or higher have 205, and the clearing price is $10, then each buyer at $10 or lower gets 50% of what he wanted.

Everyone who bid higher buys everything they wanted. Everyone who bid lower buys nothing.

Simply put, the algorithm to find the clearing price is similar to drawing supply and demand in your high school micro-economics class. The bids are put in order, highest price to lowest, forming the demand curve. The offers are put in order, lowest to highest, forming the supply curve.

At the point where they cross, if they cross, is the price and quantity that gets traded. The system knows, but does not publicly reveal, the amounts that the buyers and sellers who actually traded in this auction would have still traded at.

In continuous trades, the difference does NOT go to the buyer or seller. It usually goes to a professional middleman. Therefore, the current system is optimized to capture as much of this benefit as possible for the middleman. But it still leaves tiny sawtooth areas close to the curve that cannot be captured unless you can trade on infinitesimal time slices for arbitrarily precise fractions of a dollar.

Clearing multiple trades at once means that the arbitrageur can only capture value from the marginal buyers and sellers, if anyone, and everyone else can actually enjoy the benefit of trade. The amount taken by the exchange is one trangular area, rather than multiple rectangles, thus has no deadweight loss.

[kasey_junk]

I don't know of any systems that implement equal % matching algorithms but I'd expect it would encourage games where you just send in more smaller orders (hiding their relation to each other if you are particularly shady) so that you would improve your fill rates.

Your hidden book time auction idea is not one I've seen implemented. Again I think it would be very detrimental for price discovery but can't prove that.

Just trying to think of it as a market participant, how do I determine what price I should bid or offer?

I can also think of all kinds of ways for this system to be gamed. The first thing I would try if I were making markets in this system is to ladder small quantity orders right around the last trade price. Then when you get filled on these orders they would act as high/low water marks letting you zero in on the correct price.

Not sure why I would want to encourage this sort of gaming instead of an open book, but I'd certainly like to try it if you ever create your exchange.

[Edit] re-read original comment and realize it is not pro-rata matching.