Orders

The impact of market orders on market liquidity

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The impact of market orders on market liquidity

Jayna MELWANI

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 Trade orders

About the author

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

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

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

Lokendra RATHORE

In this article, Lokendra RATHORE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2022-2023) explains the Good-til-Cancelled (GTC) order and the Immediate-or-Cancel (IOC) used to trade in financial markets.

In addition to the types of orders that we discussed in Period1 of the SimTrade certificate (market orders, limit orders, best limit orders, stop loss orders and stop limit orders), I would like to elaborate on the following two other types or order that I have used in the past and found useful: Good-til-Cancelled (GTC) Order and Immediate-or-Cancel (IOC) Order.

What is Good-til-Cancelled (GTC) Order?

A Good-till-Cancelled (GTC) order is an order that remains in effect until it is either executed or cancelled by the investor. This type of order allows the investor to place a standing order that remains active until the investor cancels it or it is filled. For example, if an investor wants to purchase a stock when it reaches a certain price, they can place a GTC order, and the order will remain active until either the price is reached or the investor cancels it.

Significance

Flexibility: GTC orders provide investors with a high level of flexibility, as they remain active for an indefinite period of time. This allows investors to take advantage of market opportunities without having to send order every day.

Long-term Investment Strategy: GTC orders are particularly useful for investors who have a long-term investment strategy and are looking to accumulate shares over a period of time. The investor can place a GTC order at a specific price, and the order will remain active until the desired price is reached.

What is Immediate-or-Cancel (IOC) Order?

An Immediate-or-Cancel (IOC) order is a type of order that must be executed immediately, and any portion of the order that cannot be filled is cancelled. This type of order is used when an investor wants to ensure that an order is executed as quickly as possible, even if only part of the order can be filled. For example, if an investor wants to purchase a large number of shares of a stock, they may place an IOC order. If only a portion of the shares can be purchased immediately, the remainder of the order will be cancelled.

Significance

Time-sensitive: IOC orders are suitable for investors who need to execute a trade quickly, such as when they need to close a position or take advantage of a sudden market opportunity.

Partial Fills: The IOC order allows for partial fills, meaning that if only a portion of the order can be executed immediately, the remainder of the order is cancelled. This can be useful when an investor wants to limit their exposure to a particular stock.

What is the difference between Good-til-Cancelled (GTC) Order and Day order

Table 1. Comparison of GTC and IOC orders.
Comparison of GTC and IOC orders.
Source: production by the author.

In conclusion, both GTC and IOC orders are useful tools for investors who want to manage their trades and execute their investment strategies effectively. The choice of which type of order to use will depend on the specific needs and investment objectives of the investor.

Related posts on the SimTrade blog

▶ All posts about Orders

▶ Clara PINTO High-frequency trading and limit orders

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

Useful resources

SimTrade course Trade orders

U.S. Securities and Exchange Commission (SEC) investor.gov

Investor.gov (SEC) Good-til-cancelled order

Investor.gov (SEC) Understanding Order Types

About the author

The article was written in April 2023 by Lokendra RATHORE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2022-2023).

High-frequency trading and limit orders

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High-frequency trading and limit orders

Clara PINTO

In this article, Clara PINTO (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2023) explains about high frequency trading in a dynamic limit order market.

What is High-frequency trading (HFT)?

While the adage “time is money” applies to almost all economic operations, the rapid spread of computerized trading has carried this quote to its final extreme. High-frequency trading (HFT) is a type of algorithmic trading that relies on advanced computer programs to make trading decisions and execute trades in a matter of milliseconds. HFT has become increasingly popular in recent years, particularly in dynamic limit order markets (“A dynamic limit order market with fast and slow traders”, European Central Bank), where the bid and ask prices of securities are constantly changing. This allows them to take advantage of small price discrepancies in the market and generate profits on a large scale, this method known as statistical arbitrage, involves traders looking for temporary pricing inconsistencies across different exchanges and capitalize on it, using ultra-fast transactions.

What Exactly Is a Limit Order?

A limit order is an instruction to buy or sell a security at a specified price or better. For example, a trader may place a buy limit order for a stock at $50, meaning he or she is willing to buy the stock only if it is available at that price or lower. Similarly, a sell limit order may be placed at $60, meaning the trader will sell the stock only if the price is at that level or higher.

HTF and Limit Order

High-frequency trading (HFT) and limit orders are closely linked, as HFT traders often rely on limit orders to execute their trades. In fact, limit orders are a key component of many HFT trading strategies. HFT traders often use limit orders in conjunction with advanced algorithms to identify market trends and execute trades at lightning-fast speeds. They may place many limit orders at various prices to take advantage of small price movements in the market and use sophisticated algorithms to determine the best time to execute their trades.

However, the use of limit orders in HFT trading can also have downsides. For example, the large number of limit orders placed by HFT traders can lead to increased volatility in the market, as these orders can cause sudden price movements, for example flash crash when the prices of stocks or commodities suddenly plunges but then quickly recovers. Hence, the use of limit orders in HFT trading can also have downsides, and it is important for regulators to monitor HFT activity and ensure that it does not cause market instability or unfair trading practices.

Why should I be interested in this post?

For many business school students, finance and trading are part of the most preferred jobs. Understanding the trends in high-frequency trading is now a requirement for future institutional investors. Being quick allows traders to adjust outstanding limit orders in response to news arrivals when working with “slow” market players who experience a relative loss in bargaining power, leading them to strategically submit limit orders with a lower execution probability, limiting trade.

Related posts on the SimTrade blog

▶ Akshit GUPTA High-frequency trading

▶ Shruti CHAND High-frequency trading: pros and cons

▶ Akshit GUPTA Analysis of The Hummingbird Project movie

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

Useful resources

SimTrade course Trade orders

Hoffmann P. (2013) A dynamic limit order market with fast and slow traders European Central Bank Working Paper Series.

Lewis M. (2015) Flash boys Norton & Company.

About the author

The article was written in March 2023 by Clara PINTO (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2023).

Understanding the Order Book: How It Impacts Trading

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Understanding the Order Book: How It Impacts Trading

Federico De ROSSI

In this article, Federico DE ROSSI (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2023) talks about the order book and explains its role in financial markets.

Introduction

Understanding the order book is critical when it comes to trading in financial markets. In this article, we’ll go over what an order book is and how it affects trading.

What is an order book?

An order book for a stock, currency, or cryptocurrency is a list of buy and sell limit orders for that asset. It shows the pricing at which buyers and sellers are willing to negotiate, as well as the total number of orders available at each price. The order book is a necessary component of every trading platform since it gives a snapshot of the current market situation, of the price of the assets, and of the liquidity of the market. Thus, it is a crucial tool for traders who want to make informed decisions when entering or exiting deals.

How does an order book work?

The order book is a constantly updated record of buy and sell orders. When a trader puts a limit order, it is placed in the order book at the stated price. As a result, there is a two-sided market with distinct prices for buyers and sellers.

The order book is divided into two sections: bid (buy) and ask (sell). All open buy orders are displayed on the bid side, while all open sell orders are displayed on the ask side. The order book also shows the total volume of buy and sell orders at each price level.

In Tables 1 and 2 below, we give below two examples of order book from online brokers. We can see the two parts of the order book side by side: the “Buy” part and the “Sell” part. Every line of the order book corresponds to a buy or sell proposition for a give price (“Buy” or “Sell” columns) and a given quantity (“Volume” columns). For a given line there may be one or more orders for the same price. When there are several orders, the quantity in the “Volume” column is equal to the sum of the quantities of the different orders. Associated to the order book, there is often a chart which indicates the cumulative quantity of the orders in the order book at a given price. This chart gives an indication of the liquidity of the market in terms of market spread, market breadth, and market depth (see below for more explanations about theses concepts).

The “Buy” and “Sell” parts of the order book can be presented side by side (Table 1) or above each other (Tables 2 and 3) with the “Sell” part (in red) above the “Buy” part (in green) as the price limits of the sell limit orders are always higher than the price limits of the buy limit orders.

Table 1. Example of an order book (buy and sell parts presented side by side).
Order book
Source: online broker (Fortuneo).

Table 2. Example of an order book (buy and sell parts presented above each other).
Order book
Source: online broker (Cryptowatch).

Table 3. Example of an order book (buy and sell parts presented next to each other).
Order book
Source: online broker (Binance).

In a typical order book, the buy side is organized in descending order, meaning that the highest buy orders (i.e., the orders with the highest bid prices) are listed first, followed by the lower buy orders in descending order of price. The highest buy order in the book represents the best bid price, which is the highest price that any buyer is currently willing to pay for the asset.

On the other side of the order book, the sell side is organized in ascending order, with the lowest sell orders (i.e., the orders with the lowest ask prices) listed first, followed by the higher sell orders in ascending order of price. The lowest sell order in the book represents the best ask price, which is the lowest price that any seller is currently willing to accept for the asset.

This organization of the order book makes it easy for traders to see the current market depth and the best available bid and ask prices for an asset. When a buy order is executed at the best ask price or a sell order is executed at the best bid price, the order book is updated in real-time to reflect the new market depth and the new best bid and ask prices.

Table 4 below represents how the order book (limit order book) in trading simulations the SimTrade application.

Table 4. Order book in the SimTrade application.
Order book in the SimTrade application

You can understand how the order book works by launching a trading simulation on the SimTrade application.

The role of the order book in trading

As mentioned before, the order book is incredibly significant in trading. It acts as a market barometer, delivering real-time information about the supply and demand for an asset. Traders can also use the order book to determine market sentiment. If the bid side of the order book is strongly occupied, for example, it could imply that traders are optimistic on the asset. Thanks to the data in the order book, traders can get different information out of it.

Three characteristics of the order book

Market spread

The market spread, also known as the bid-ask spread, is the difference between the highest price a buyer is willing to pay for an asset (the bid price) and the lowest price a seller is willing to accept (the ask price) at a particular point in time.

The market spread is a reflection of the supply and demand for the asset in the market, and it represents the transaction cost of buying or selling the asset. In general, a narrow or tight spread indicates a liquid market with a high level of trading activity and a small transaction cost, while a wider spread suggests a less liquid market with lower trading activity and a higher transaction cost.

Market breadth

Market breadth is a measure of the overall health or direction of a market, sector, or index. It refers to the number of individual stocks that are participating in a market’s movement or trend, and can provide insight into the underlying strength or weakness of the market.

Market breadth is typically measured by comparing the number of advancing stocks (stocks that have increased in price) to the number of declining stocks (stocks that have decreased in price) over a given time period. This ratio is often expressed as a percentage or a ratio, with a higher percentage or ratio indicating a stronger market breadth and a lower percentage or ratio indicating weaker breadth.

For example, if there are 1,000 stocks in an index and 800 of them are increasing in price while 200 are decreasing, the market breadth ratio would be 4:1 or 80%. This would suggest that the market is broadly advancing, with a high number of stocks participating in the upward trend.

Market depth

Finally, market depth is a measure of the supply and demand of a security or financial instrument at different prices. It refers to the quantity of buy and sell orders that exist at different price levels in the market. Market depth is typically displayed in a market depth chart or order book.

It can provide valuable information to traders and investors about the current state of the market. A deep market with large quantities of buy and sell orders at various price levels can indicate a liquid market where trades can be executed quickly and with minimal impact on the market price. On the other hand, a shallow market with few orders at different price levels can indicate a less liquid market where trades may be more difficult to execute without significantly affecting the market price.

Analyzing order book data

Data from order books can be used to gain insight into market sentiment and trading opportunities. For example, traders can use the bid-ask spread to determine an asset’s liquidity. They can also examine the depth of the order book to determine the level of buying and selling interest in the asset. Traders can also use order book data to identify potential trading signals. For example, if the bid side of the order book is heavily populated at a certain price level, this could indicate that the asset’s price is likely to rise. On the other hand, if the ask side is heavily populated at a certain price level, it could indicate that the asset’s price is likely to fall.

Benefits of using order book data for trading

Using order book data can provide traders with a number of advantages.

For starters, it can be used to gauge market sentiment and identify potential trading opportunities.

Second, it can assist traders in more effectively managing risk. Traders can identify areas of support and resistance in order book data, which can then be used to set stop losses and take profits.

Finally, it can aid traders in the identification of potential trading signals. Traders can identify areas of potential buying and selling pressure in order book data, which can then be used to enter and exit trades.

How to use order book data for trading

Traders can use order book data to gain a competitive advantage in the markets. To accomplish this, they must first identify areas of support and resistance that can be used to set stop losses and profit targets.

Traders should also look for indications of buying and selling pressure in the order book. If the bid side of the order book is heavily populated at a certain price level, it could indicate that the asset’s price is likely to rise. On the other hand, if the ask side is heavily populated at a certain price level, it could indicate that the asset’s price is likely to fall.

Finally, traders should use trading software to automate their strategies. Trading bots can be set up to monitor order book data and execute trades based on it. This allows traders to capitalize on trading opportunities more quickly and efficiently.

Conclusion

To summarize, the order book is a vital instrument for financial market traders. It gives real-time information about an asset’s supply and demand, which can be used to gauge market mood and find potential trading opportunities. Traders can also utilize order book data to create stop losses and take profits and to automate their trading techniques. Traders might obtain an advantage in the markets by utilizing the power of the order book.

Related posts on the SimTrade blog

▶ Jayna MELWANI The impact of market orders on market liquidity

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

▶ Clara PINTO High-frequency trading and limit orders

▶ Akshit GUPTA Analysis of The Hummingbird Project movie

Useful resources

SimTrade course Trade orders

SimTrade course Market making

SimTrade simulations Market orders   Limit orders

About the author

The article was written in March 2023 by Federico DE ROSSI (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2023).