Inside Quotes
Theinside quotes, which are also known as theBest Bid and OfferorBBO, are the highest bid, and lowest ask, in the order book.
They are the prices at which the next market buy (with the best offer) or market sell (with the best bid) will transact.
In the above book theinside quotesare 11.36/11.38.
In this case the bid/ask spread is $11.36 - $11.38 = $0.02, or `\frac{\$0.02}{\$11.38} = 0.1757\%`.
- The bid/ask percentage spread measures the cost to transact in that security—the larger the spread, the larger the transaction costs.
The Order Book and Liquidity
The smaller the bid/ask spread, and the more limit orders in the book, the greater the security’sliquidity.
Liquidityis a measure of your ability to cheaply transact (buy or sell) a security without moving the inside quotes by much.
Sufficient liquidity is an integral component of a well-functioning market.
The Market Maker
Amarket maker’sjob is to maintain, at all times, bids and offers in the order book. This provides liquidity to the market.
Themarket makerattempts to earn the bid/ask spread—repeatedly buying at the bid and selling at the ask.
The order book is comprised of the market maker’s limit orders, as well as limit orders entered by other investors and traders. However, the market makermustmaintain orders in the book, and other market participants do not have this requirement.
Entering a Market Order
If you want to buy or sell a stock, one type of order you can enter is amarket order. This will buy or sell the stock at the best available price in the market at the time the order arrives. With a market order, you are guaranteed that you will buy or sell; however, you are not sure of the price at which you will trade.
A market buy will buy at the lowest ask price. If it buys all available shares at the lowest ask, the next ask above will become the new lowest ask, and that is where additional shares will be bought.
A market sell will sell at the highest bid price. Similarly, if it sells all available shares at the highest bid, the next bid below will become the new highest bid, and that is where additional shares will be sold.
Use the app in the next slide to enter market orders and see the effect on the limit order book. On the left is the original book, and the right shows the book after the order is executed.
Entering a Limit Order
You can also buy or sell stock with alimit order. In this type of order, you specify the highest/lowest price at which you will buy/sell. With a limit order, you are guaranteed the price at which you will buy or sell (if the trade is executed); however, you are not guaranteed that you will actually trade.
Say you enter a limit order to buy shares at $50.03. Your order will sit in the limit order book until a sell order executes against your trade at $50.03.
Similarly, a limit sell will sit in the book until a buy order executes against your sell.
What if I enter a limit order to buy at $50.03 and the present ask is $50.01? Your broker will likely warn you, but if you enter the order it will immediately trigger, turn into a market order, and execute at $50.01. A limit buy simply specifies the highest price at which you will trade – you will always get the best available price when transacting.
