Sonith ManakkatBefore any talk of orders or risk, it helps to know what a market actually is. This part explains it with one everyday picture, a farmers' market, and then adds an Expert view for readers who want the precise terms. It is general education about how markets work, not advice about what to do in them.
A market is a meeting place
Farmers' market
- Stallholders name a price for apples
- Shoppers walk around and compare
- A deal happens when a price is agreed
Financial market
- Sellers state the price they will accept
- Buyers state the price they will pay
- A trade happens when the two prices meet
Expert viewWhy organised markets exist
A market lowers the cost of finding a counterparty. Instead of searching for someone who wants the opposite of what you want, you post your wish in one place with agreed rules, and everyone can see and respond to it. Rules cover who may take part, how orders are matched, and what happens after a trade, which makes strangers willing to deal with each other.
Who is who
- The investorA person or organisation that wants to buy or sell
- The brokerAn intermediary that passes your order to the market and holds your account
- The exchangeA venue with rules where buy and sell orders are matched
- Market makersFirms that regularly post both buy and sell prices
- Other participantsIndividuals, funds and companies, with many different aims and time horizons
You normally cannot walk onto an exchange yourself. The broker is like a shopping agent: you tell them what you want, and they take it to the market square for you.
Expert viewMarket makers in general terms
A market maker is a participant that continuously quotes a price at which it will buy and a price at which it will sell. By doing so it adds orders to the book that others can trade against. It is paid by the gap between its two prices, and it takes on risk because the price can move while it holds what it bought. Arrangements differ between markets and products, so treat this as a general description only.
The order book: bids and asks
An order book is a live list of everyone's waiting orders. Buyers' orders are called bids. Sellers' orders are called asks (also called offers).
Buyers (bids)
- Wants to pay as little as possible
- Bids are listed highest first
- Best bid: the highest price a buyer will pay
Sellers (asks)
- Wants to receive as much as possible
- Asks are listed lowest first
- Best ask: the lowest price a seller will accept
| Side | Price (illustrative) | Quantity waiting |
|---|---|---|
| Ask | 100.30 | 400 |
| Ask | 100.20 | 250 |
| Ask | 100.10 | 150 |
| Bid | 99.90 | 200 |
| Bid | 99.80 | 300 |
| Bid | 99.70 | 500 |
All numbers here are illustrative. In this picture the best ask is 100.10 and the best bid is 99.90. Nobody is trading yet, because no buyer is willing to pay what any seller wants.
Expert viewDepth of book
The quantity waiting at each price level is the depth. A book with large quantities close to the best prices is deep: a large order can be absorbed with little change in price. A book with small quantities, or large gaps between price levels, is shallow. Looking beyond the best bid and ask shows how far the price might have to move for a given size to be completed. Not every venue shows the same amount of depth to every participant.
The bid-ask spread
The spread is the gap between the best ask and the best bid. In the table above it is 100.10 minus 99.90, which is 0.20.
- 99.90best bid, illustrative
- 100.10best ask, illustrative
- 0.20spread, illustrative
Expert viewWhy spreads widen in thin markets
When few participants are willing to trade, there are fewer orders near the middle price, so the best bid and best ask sit further apart. Anyone who quotes prices also faces more risk when trading is sparse or when news makes the price jump, so they ask for a wider gap to cover that risk. Spreads therefore tend to be wider for products with little trading, and can widen quickly when uncertainty rises.
How a trade happens
A trade happens when a bid and an ask meet: a buyer is willing to pay at least what a seller is willing to accept.
- A buyer sends an orderBuy 100 at up to 100.10
- It reaches the bookThe best ask is 100.10
- Prices meetThe buyer's limit is high enough to match
- A trade is recorded100 traded at 100.10, and the book updates
When the trade occurs, the matched quantity leaves the book, and the next waiting orders become the new best bid and ask.
Expert viewPrice-time priority matching
Many order books match by price-time priority: better prices go first (a higher bid or a lower ask), and among orders at the same price the one that arrived earlier goes first. This rewards both aggressive pricing and speed of arrival. Other matching rules exist, such as sharing a fill between orders at the same price in proportion to size, so the precise rule depends on the venue and product.
- Seller to Exchange A seller's order is already waiting in the book at 100.10.
- Buyer to Broker The buyer tells the broker what they want and their highest price.
- Broker to Exchange The broker takes the order to the exchange.
- Exchange (to itself) The buyer's limit is high enough to match the waiting ask.
- Exchange to Broker (reply) 100 traded at 100.10, and the matched quantity leaves the book.
- Broker to Buyer (reply) The buyer is told the trade happened.
- Exchange to Seller (reply) The seller is told their order was matched.
Takeaway. A trade needs two opposite orders whose prices meet, and the exchange does the matching.
- 1A new order arrivesIt is compared with the orders already waiting
- 2Best price firstA higher bid or a lower ask goes ahead of others
- 3Same price: earlier firstAmong equal prices, the order that arrived first goes first
- 4Match what fitsQuantity is matched until the new order is filled or nothing else meets
- 5The rest waitsAny quantity left joins the book at its price
Takeaway. In price-time priority, a better price wins, and a tie goes to whoever arrived first.
Sessions: when markets are open
Many markets are open only at certain times. The period when orders can be matched is a trading session, and most markets have an opening and a closing phase. Opening and closing times, breaks, and any special auction phases differ between markets and between products, so always check the rules for the market in question.
- Before opening: orders may be accepted but not yet matched.
- Opening: trading begins, often busy as news is absorbed.
- During the session: orders match continuously.
- Closing: trading ends and a closing price is recorded.
Settlement: the second half of a trade
Agreeing a price is only the first half. Settlement is when the money moves one way and the ownership moves the other way. The time it takes differs by market and by product.
Expert viewClearing and settlement are different
Clearing is the step between trade and settlement: confirming the details, working out each party's obligations, and often managing the risk that one side fails to deliver. Settlement is the final exchange of cash and ownership. In some markets a central counterparty stands between buyer and seller during clearing, so each deals with it rather than directly with each other. Settlement cycles are shorter in some markets than others and have changed over time.
Takeaway. Agreeing the price is only the first step: clearing checks it, and settlement finishes it.
Liquidity: crowded versus quiet
Liquidity means how easily something can be bought or sold quickly without moving the price much.
A crowded market
- Many buyers and sellers
- Narrow spread
- Large orders cause small price moves
A quiet market
- Few buyers and sellers
- Wide spread
- Even a modest order can move the price
Think of a busy high street versus a lonely country stall: on the busy street you can sell almost anything quickly, at a fair price. On the quiet road you may wait, or accept a lower price.
Price discovery
Price discovery is the process by which many people's wishes, news and views combine into a price. Each order is a small vote about what something is worth right now. The last traded price is simply where a buyer and seller most recently agreed. It is not a promise about the next price.
The price is set by one authority and just follows a rule
The price is formed by many buyers and sellers placing orders, and it changes whenever they change their minds
A price is simply where one buyer and one seller last agreed.
Frequently asked questions
Is the spread a fee?
Not in itself. It is a gap between prices, but it acts like a cost because buying and selling straight away happens at different prices. Fees are separate.
Does a trade finish when the price is agreed?
The price is agreed at the trade, but the deal finishes at settlement, when money and ownership change hands.
Why do some markets have wide spreads?
Usually because few people are trading them, which makes quoting prices riskier and leaves fewer orders near the middle.
Is the last price what I would get?
Not necessarily. The price you actually get depends on the orders waiting in the book when yours arrives.