Okay, let’s now jump to a scenario, in which we will see how the price really moves.
What you see in front of you is called 'Depth of Market'.
This Depth of Market displays how many limit orders there are at a particular price.
On the left, we will see buy limit orders and on the right, we will see sell limit orders.
This Depth of Market is nowadays a basic feature of any charting platform and you can commonly
find it as a 'DOM', which is abbreviation for 'Depth of Market'.
One important thing to mention is that DOM only displays limit orders - this is sometime
called a 'passive orderflow'.
On the DOM, you cannot see market orders - market orders are called 'active orderflow' and there
are different tools for displaying them.
Another important thing to bear in mind is that this DOM is not static, because markets
are not static.
DOM is dynamic and numbers of limit orders change all the time - simply because there
may be hundreds of people watching the market at any given time.
And they are sending orders, changing them or canceling them.
So to keep it clear and simple, in this scenario we are going to assume that there are only
a few traders who trade this market and we know about all of them.
Say that the market opens at 8 AM and the first trader comes in.
He want to buy.
He wants to buy 5 contracts at a price of 98, so he doesn't want to buy now but he specifies
the price.
Therefore, the sends a buy limit order to buy 5 contracts - and you now know that he
is a passive buyer.
On the DOM, his buy limit order will be displayed like this.
It will be on the bid side, because it is a buy limit order and DOM will show a quantity
of 5 on bid at a price of 98.
One minute later, another trader comes in.
He wants to sell - he wants to sell 10 contracts at the price of 99.
He specifies the price, so he uses a sell limit order and he is therefore a passive
seller.
His sell limit will be on the ask side - because he is asking somebody to buy 10 contracts
from him and he's asking for price of 99 per contract.
On the other hand, the first trader is willing to buy no higher than 98, therefore his order
is on the bid side.
Now, two more traders want to buy and sell.
Trader 3, who wants to buy 2 contracts at 97 and trader 4, who wants to sell 3 contracts
at a price of 100.
On DOM, we can already see these new limit orders.
None of these orders will be paired with each other and the price doesn't move - because
all these traders demand a different price.
At the moment, 2 buyers are willing to buy at 98 and 97 and 2 sellers are willing to
sell at 99 and 100 respectively - so there is no agreement between them.
Let's continue.
We've got one more seller, trader 5, who wants to sell 4 contracts at a price of 99 - so
same like trader 2.
So the ask is now 14.
And this ask size of 14 consists of: 10 contracts of trader 2 and 4 contracts of trader 5.
Still, nothing happens.
But suddenly, somebody comes in and says - 'I don't want to wait anymore.
I want to buy 5 contracts now'.
And this is our aggressive buyer that we were waiting for.
You should remember that he uses a buy market order and this order doesn't specify the price.
The buy market order buys the first available offer from a passive seller.
Where is this first available offer?
At the price of 99.
So this aggressive buyer buys 5 contracts at a price of 99.
By doing this, he cleared 5 sell limits on the ask side at a price of 99.
That means the ask at a price of 99 will be reduced from 14 to 9.
All of these 5 sell limits at a price of 99 belonged to trader 2, because he came first.
And therefore, he has got a sell limit for 5 contracts left, still waiting to be matched
with more aggressive buy market orders.
So at the price of 99, there are 9 sell limits left.
And they will be filled in the following order - firstly, all of the remaining sell limits
of trader 2 and then, sell limits of trader 5.
So it's like a queue - the limit orders are sorted chronologically with a logic of first
comes, first served.
So because the trader 5 came in later than trader 2, then he has got to wait until the
trader 2 will get filled all of his sell limits.
Now, aggressive seller comes in, making the price to move.
The actual price is 99, because that's the price at which the most recent trade took
place.
The aggressive seller wants to sell 3 contracts using a sell market order.
You should remember that the sell market order is paired with the first available bid from
a passive buyer.
In other words - it is paired with the first available buy limit order on the bid side.
Where is this first available buy limit?
At a price of 98.
So the aggressive seller send the sell market order and the passive buyer buys from him.
Now, because this passive buyer has got his buy limit at a price of 98, the price goes
down so it can match the sell market order to this buy limit.
The aggressive seller sold 3 contracts, therefore he clears 3 buy limits at a price of 98 and
there were 5 buy limits at this price in total.
Less 3 of them were cleared by this aggressive seller, that means that there are 2 more buy
limits left to filled at this price.
Notice that the price has moved down, yet the number of sell vs. buy orders is equal.
The price didn't move down because there were more sellers than buyers, but because sellers
were more aggressive than buyers.
Now, what needs to happen in order for the price to move from 98 to 97?
It's simple - there must be more aggressive sellers who will clear these 2 more buy limits
at a price of 98.
So it's like a barrier - this barrier of limit orders must be broken in order for the price
to move.
One aggressive sellers comes in - he sends sell market order to sell 3 contracts.
But you see that at the price of 98, there are only 2 buy limits - so this barrier of
buy limits is not strong enough to satisfy this aggressive seller.
So what happens?
2 sell market orders are paired with 2 buy limits at a price of 98 and this clears all
the buy limits at 98.
And then, there are no buy limits left at this price.
However - there's 1 more sell market order left to be paired.
Since there are no buy limits left at the price of 98, the market now must move lower
to find more buy limit orders.
So it moves from 98 to 97.
At 97, one sell market order left is paired with new buy limit.
This completes the order of aggressive seller - to sell 3 contracts.
This aggressive seller therefore moved the market down, because his market order was
paired with buy limits at 2 different prices.
His sell market order for 3 contracts was paired with 2 buy limits at 98 and 1 buy limit
at 97.
Now notice this - the price has moved from 98 to 97 despite there was 1 seller and 2
different buyers.
However, the number of buy and sell orders is equal - sell market order for 3 contracts
and buy limits for 3 contracts in total.
Now, what do you see at the price of 98?
There are no sell limit orders at this price.
Do you remember that the market order doesn't specify the price?
The price at which the market order is filled only depends on the availability of limit
orders.
So where are the first available sell limits?
First available sell limits are at 99.
Now, the aggressive buyer comes in and he wants to buy 1 contract by using a market
order.
The actual price is 97, there are no sell limits at 98, first available sell limits
are at 99.
Despite the actual price being 97, the aggressive buyer is filled for 99 - because that's the
price at which he finds somebody to buy from.
So he moved the market up from 97 to 99, because at 98, there was no liquidity - no sell limit
orders.
So the market has skipped this price and moved to 99 straight away.
This is called a 'gap' - the market has gapped up from 97 to 99.
The aggressive buyer has got what's called a 'slippage' - this means that he bought for
worse price than he was expecting.
He sent the buy market order when the actual price was 97.
He would be expecting to be filled for 98 because logically, there should be some sell
limits.
In reality, there were no sell limits so the market has gapped up and he bought for 99.
That means he has got a worse price and got a slippage.
So in this situation, there was 1 buyer and 1 seller.
One buy market order and one sell limit order and the price has moved from 97 to 99.
And now - the final situation that we will have a look at.
A big trader comes in and he wants to buy 15 contracts.
As you can see, in the meantime, some more passive sellers have appeared and sent their
limit orders into the market.
The last price is 99 - this is the price at which the most recent trade has taken place.
This is the price that the big trader is looking at when he decides to send his order into
the market.
This buy trader uses a buy market order to buy 15 contracts.
By doing this, he will move the price from 99 to 103.
You can see how his market order for 15 contracts was paired - take a moment to have a look
at this.
So, there was 1 buyer and many more sellers and the price has moved by 4 points.
However, the quantity of buy and sell orders was equal - 15 contracts to buy and 15 contract
to sell.
This is always equal and this is how the price moves.
However, in reality, such a big trader is likely to use a limit order to open a trade
- because he trades such big positions, that the potential slippage when using market orders
is very big.
So, to sum it up - the price moves in relation to market orders and available limit orders.
These limit orders are like a barrier - when this barrier is not strong enough to satisfy
market orders, the price moves.
However, number of buy and sell is always equal.
For example in this last scenario - the price has moved from 99 to 103 and there were 15
buy market orders and 15 sell limit orders.