Market Microstructure: Confronting Many Viewpoints

2

Order Choice and Information in Limit Order Markets

Ioanid Rou

2.1 INTRODUCTION

In recent years, trading via limit orders and market orders has become the dominant form of trading in most exchanges around the world, whether these are pure electronic limit order markets or hybrid markets in which limit order traders are in competition with floor traders, specialists, or dealers.

A pure limit order market is defined as a market in which there are essentially only limit orders and market orders. A market order demands immediate execution, irrespective of the price. A limit order is an instruction to buy or sell only at a pre-specified price, and is placed in a queue based on price/time priority. A limit order is usually executed only after a market order clears it from the queue. A limit order that gets immediate execution because the price is already met is called a marketable order and is not differentiated from a market order. A sell limit order is also called an ask (or offer), while a buy limit order is also called a bid. The limit order book, or simply the book, is the collection of all outstanding limit orders. The lowest ask in the book is called the ask price, or simply ask, and the highest bid is called the bid price, or simply bid.1 This chapter does not discuss hidden limit orders, which are limit orders for which some of the quantity is not visible to the market.

Given ...