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Orders and the order book

For a trade to happen, there needs to be an order first.

Investors send orders to the exchange that transmit instructions to buy or sell. Buy 50 shares of Apple stock. Sell 20 shares of the SPDR S&P 500 ETF. While orders may or may not ever become actual trades, they’re the building blocks of some of trading’s most important concepts. In this explainer, we’ll break down the different types of orders and what they represent.

Below is a graphic of an order book (also known as a Central Limit Order Book, or CLOB). The order book lists all outstanding orders and quotes in a particular financial instrument posted by market makers and other market participants. Studying the order book, you can see how traders arrive at the bid-ask spread (subtract the best bid from the lowest offer/ask), as well as judge liquidity in the market (look at the bid and ask volume).

Many different types of orders go into an order book. Investors choose what type of order to use based on what’s important to them. Here are some of the most common ones:

  • A market order is an order to buy or sell a stock at the best price currently available in the order book. Market orders are primarily used by investors who wish to execute trades immediately. Using a market order normally ensures execution, but it doesn’t guarantee what price you’ll get.
  • A limit order is an order to buy or sell a stock that specifies a maximum price to be paid or a minimum price to be received. An investor will use a limit order when they want to avoid the risk of transacting at an unexpected price. Unlike a market order, execution isn’t assured. Any limit orders that aren’t executed immediately appear in the order book.
  • A stop-loss order is used by investors who want to limit their losses on a particular trade. This order type triggers an immediate buy or sell when the underlying security reaches a pre-defined level.
  • An iceberg order consists of a visible “peak” that is displayed on the order book and a hidden reserve quantity. Once the displayed peak of the iceberg is executed, it is refreshed with part of the hidden quantity. This process repeats until the order is fully executed or cancelled.
  • A trailing stop order is similar to a stop-loss order, except that it’s placed at a specific dollar amount or percentage above or below the most recent high/low. It’s also a way for investors to limit their losses on a trade.
  • A quote is a two-way order entered by a market maker to provide liquidity. Quotes are both bids to buy and offers to sell.

Most order books use price-time priority to decide which orders get executed first. Take another look at the order book above. The best buy price is 44.60, so it will be executed first, regardless of when it arrived at the exchange. If two orders come in at the same price, then the order that arrived first will be first in line to get executed.

When a buy order matches at the same price with a sell order, then a trade is born. Learn more about how an order passes from the investor all the way through to post-trade in How Today’s Stock Markets Work.

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To discuss this paper – or any other market structure topic – reach out to the Optiver Corporate Strategy team at [email protected]

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