What you will learn
- Distinguish displayed prices from available depth.
- Explain the price-versus-execution tradeoff of a limit order.
Liquidity
Several features signal liquidity: a narrow bid-ask spread, large quantities displayed near the best prices (depth), steady trading volume, and prices that recover quickly after a large order. Liquidity is not constant, since it varies by instrument, time of day and market conditions.
When liquidity is thin, orders of the same size cause larger price moves, spreads widen, and exits can take time or cost more. Stress events can dry up liquidity suddenly even in normally active markets, so volume that looks sufficient in calm periods may not be there when needed.
Bid-Ask Spread
A trader who buys at the ask and sells at the bid pays the spread on a round trip, even if the quoted price does not change. Spreads are usually tighter for actively traded instruments and wider for small, thinly traded or volatile ones, and they can widen sharply around news, market opens and closes.
Spreads can be quoted in price units, in percent of the midpoint, or in basis points, so comparisons across instruments should use the relative figure. Posting a limit order inside the spread may fill at a better price, but it is not guaranteed to execute.
Limit Order
A buy limit placed below the current ask waits in the order book until sellers come down to that price; a sell limit placed above the current bid waits for buyers to come up. A limit that crosses the spread is marketable and executes immediately against resting orders, at the limit price or better.
Resting limit orders are usually queued by price and then by time, so a market can trade at your price without filling you if others are ahead. Orders can also fill only partly, leaving an unfilled remainder.
Worked example: Walking a fictional order book
Illustrative: the best ask is HK$10.10 for 100 shares and the next ask is HK$10.20 for 100 shares. An order for 200 shares that reaches both levels has an average price of HK$10.15 before costs. A limit of HK$10.10 would allow only the first 100 shares to execute immediately; the rest may wait or never fill.
Check your understanding
What is the pre-cost average for 100 shares at HK$10 and 300 shares at HK$10.20?
Show answer and explanation
(100 × 10 + 300 × 10.20) ÷ 400 = HK$10.15. The average is quantity-weighted, not the simple average of the two quoted prices.