Market Order Effects on the Orderbook

In a previous article, we discussed how the orderbook is essentially a list of buyers and sellers and at what prices and amounts they are willing to transact. These orders are entered as limit orders, and "rest" on the orderbook until another market participant is willing to transact at that price. So the question becomes: if everyone is waiting on the price at which they believe is most beneficial to them, how do any transactions occur? Enter Market Orders.

Market orders represent demand to take what is currently best available in the market, regardless of price. It simply says: "Buy (or sell) at the best available price immediately!" When a market order is entered, it seeks the best limit order and size to execute; removing whatever the lowest ask (or highest bid) limit order was resting in the orderbook. For a market buy order, it takes the best available ask price. For a market sell order, it takes the best available bid price. (Sometimes this is referred to by traders as "hitting the bid")

Executing a transaction at market can result in price slippage; meaning that your average execution price happens farther away from where you might see the market trading (last trade). How does this happen? Let's walk through a basic orderbook example using a market buy order. Let's say hypothetically, the orderbook looks like the below from excel. If the trader enters a market order to buy one Bitcoin, it will fill the resting limit sell order at $19,000 for .01BTC. Then it will fill the next piece of the order at $19,005 for .5BTC. And it will continue to lift the resting orders until the full amount of the market order is filled. So while the screen may have shown the current price as $19,000, the market participant was not able to buy 1BTC (using a market order) at that price. And instead received a much higher average price. In a fast moving market, this slippage can be significant. We will discuss liquidity implications of the orderbook depth in an upcoming article.

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