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How orders are executed or view of the market from within

What do you see when you look at the chart of the asset's price? The most expanded answer is "only the price". It is really so, but what is hidden behind these prices? What makes them move up or down? In this article, we will consider the reasons for price movement, understanding of which will allow creating profitable trading systems.

Causes of market movement

What is an Auction Theory?

All the trading process on the financial markets is based on the Auction Theory – matching the opposite orders of buyer and seller. Orders execution is happening only when buyer and seller are ready to make a deal with the determined price. So, financial markets and exchanges with their psychology and nature are not different from the ordinary markets. Let's see how order matching really works.

Just like on an ordinary market, there is a great number of sellers on the exchange, that desires to sell their goods as expensive as possible. Every seller can set its own price, according to the primary spends and profit expectations. As the result, the sum of all the orders forms the offer on the market by prices, which is called "ask" or "offer".
In the same time, the more market participants offer the same goods, the more is the contest for the best (minimal) price for the buyer – Best Offer Price.

The buyers also form the sum of orders, which makes the demand on the market, and their price for the goods is called "bid". Because of a huge number of buyers on the market, they also have got a contest for the best (maximal) price for the seller – Best Bid Price.

As a result, the orders of buyers and sellers can be visualized in a table, which will consist of price and number of contracts. The common volume of positions for every price level consists of few parts, which represent every separate seller and buyer.

How an order book is formed

For example, with the price 2387.25, there are four offers for selling with different volume - 12, 22, 88 and 110. As a result, their total value for selling in this level equals 232 contracts. The order executions is happening in strict rotation.

How orders are executed?

If not to take into account unnecessary info, we will get Market Depth (or Depth of Market - DOM) – the table, which shows the number of limit (passive) orders for buying or selling for every price level. It is important to know that Market Depths doesn't show market orders.

market depth in action (gif)
Notice, that the number of limit orders is constantly changes because hundreds of traders are sending new orders and also change or cancel them.

Let's see an example of few traders and our previous table and get to know how order matching and execution happens.

For example, there are two buyers on the market who placed limit orders for buying on 37 and 84 contracts with the price 2386,75 and 2386,5 in accordance.

A few minutes later two sellers showed up to the market and also placed limit orders for selling for 53 and 12 contracts with the price 2387 and 2387,25 in accordance.

As a result, we see offers on every side, but none of these orders cannot be matched between each other, because sellers and buyers wishes are not coincided. Now imagine the trader, who agrees to the sellers offers and is ready to buy 45 contracts at a market price. This is the aggressive buyer, who doesn't care for the price but cares about the fact of orders execution.
The best price offer by the seller is 2387, which is equal to the price of the last deal. After execution of 45 contracts, the price has not changed, because there are 8 more contracts for this price (53-45=8).

After a while, another trader has decided to sell 22 contracts at a market price. At the current moment, the best price for selling is 2386,75, with 37 limit orders on it. As a result of this deal, the price has moved for one tick from 2387 to 2386,75, and 15 limit orders still remain (37-22=15) and stop the price of the further decrease. It is necessary for market order to execute remaining 15 contracts, for the price to decrease.

how orders are xecuted (gif)

So, it doesn't matter how many limit contracts are in the order book, because there will be no deal until the market order for buying or selling will appear. When trader sets the buy market order, it means that he agrees to buy N contracts of an asset for the current Best Offer Price on the market. If he places a sell market order, he is ready to sell N contracts of the asset for the current Best Bid Price on the market.

Remember:

  • Buy Market order is always matched with a Sell Limit order by the Best Offer Price;
  • Sell Market order always matches with a Buy Limit order by the Best Bid Price.
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