The impact of market orders on market liquidity

In this article, Jayna MELWANI (ESSEC Business School, Global BBA, 2019-2023) explains about the financial concept of market liquidity and specifically the impact of market orders on market liquidity.

What is a market order?

A market order is a type of order used in trading that instructs the broker to buy or sell a security immediately at the prevailing market price. Market orders are used when the trader wants to execute the trade quickly and does not want to wait for a specific price.

What is market liquidity and how do market orders affect it?

The impact of a market order on market liquidity can be significant. Market liquidity refers to the ability of traders to buy and sell securities quickly and easily without causing significant changes in the price. When a large number of market orders are executed, it can impact the liquidity of the market by causing sharp changes in the supply and demand for the securities being traded.

For example, if a large number of market orders are executed to sell a particular stock, it can result an increase in supply of the stock in the market, which can cause the price to drop significantly. Similarly, if a large number of market orders are executed to buy a particular stock, it can result in an increase in demand for the stock, which can cause the price to rise sharply.

In addition to impacting the price of the security being traded, market orders can also impact the liquidity of the market as a whole. When market orders are executed, it can cause sudden changes in the supply and demand for securities, which can impact the ability of other traders to buy or sell securities at favorable prices. This can make it more difficult for traders to execute their trades quickly and efficiently, which can reduce overall market liquidity.

Overall, the impact of a market order on market liquidity depends on several factors, including the size of the order, the liquidity of the security being traded, and the overall market conditions. Traders who use market orders should be aware of the potential impact on market liquidity and consider using other types of orders, such as limit orders or stop orders, to minimize the impact of their trades on the market. By doing so, traders can help to ensure that the market remains liquid and efficient, which benefits all market participants.

Why should I be interested in this post?

Understanding market liquidity is important for making informed investment decisions. As business school students, understanding market liquidity can help to make more informed decisions as assets with high liquidity are generally easier to buy and sell quickly and at a fair price.

By understanding market liquidity, students can gain insight into how financial markets work and how liquidity affects asset prices. This knowledge can help students better analyze market trends, predict market movements and make informed investment decisions.

Furthermore, for students pursuing a career in finance, understanding market liquidity can be a valuable asset. Financial institutions and investment firms value employees who possess a deep understanding of market dynamics, including market liquidity.

Related posts on the SimTrade blog

   ▶ Federico DE ROSSI Understanding the Order Book: How It Impacts Trading

   ▶ Lokendra RATHORE Good-til-Cancelled (GTC) order and Immediate-or-Cancel (IOC) order

   ▶ Clara PINTO High-frequency trading and limit orders

Useful resources

SimTrade course Exchange orders

About the author

The article was written in April 2023 by Jayna MELWANI (ESSEC Business School, Global BBA, 2019-2023).