What causes prices to actually move up and down? This is a fairly basic and fundamental question that many people have not taken the time to understand.
First, we need to define some terms:
Bid: The bid price is the price at which another market participant is willing to buy from you; it’s price you will get if you want to sell immediately.
Ask (or Offer): The ask price is the price at which another market participant is willing to sell to you; it’s price at which you can buy right now.
Spread: The spread is the difference between the best bid and ask. If the highest bid is $37 and the lowest Ask is $37.5 then the spread is $.50.
Slippage: Slippage is the difference between the price your order is at and the price you actually get when your order is filled. If you have a stop loss at $50 but your order fills at $49.50 then you had slippage of $.50.
Market Order: A market order instructs your broker to sell or buy something immediately at whatever the best bid or ask is.
Limit Order: A limit order instructs your broker to buy or sell at a give price. A limit order to buy SPY for $300 means you want your broker to buy some stock for you at $300 or less.
To help us understand these concepts we will use a screenshot from ThinkOrSwim of the level 2 quote for SPY (the S&P500 ETF). A level 2 quote just shows the best bid and ask limit orders on various exchanges.
Level 2 View of SPY market
In this diagram the bids are on the left and the asks are on the right. The Ex column shows an abbreviation for each exchange, the bid/ask shows the bid/ask of the orders, and BS and AS stand for Bid Size and Ask Size.
In this instance, the highest bid is on the NASDAQ exchange. Someone is willing to buy 400 shares at $268.06. The lowest ask is also on the NASDAQ; 500 shares for $268.07.
What do you think would happen if you put in a limit order to buy at $265? Nothing, because the lowest anyone is willing to sell to you is $268.07. What if you put in a limit order to buy at $300? Your broker would try to get the best available price for you, so it would buy at $268.07.
What if you put in a market order to buy 100 shares? That would instruct your broker to buy immediately at whatever the current ask prices are, so they would buy 100 at $268.07.
But what if you put in a market order to buy 2000 shares? Only 700 shares are available at $268.07 (500 on NASDAQ and 200 on EDGA) so your broker would buy up all those. There is a big 5000 share block for sale at a higher price so your broker would then proceed to buy 1300 of those shares at the higher price of $268.08 from CHXE.
In this case your purchase of those 2000 shares would have actually caused the market to move up! The last trade would be reported at $268.08 and the best ask price that other market participants would see moved up from $268.07 to $268.08.
SPY is a very liquid market, and you can see that by looking at the level 2 quotes. There are many shares for sale at very similar prices across many exchanges. Compare that market depth to the one below for BLOK
Level 2 quote for BLOK
Compare the depth of the Bids to that for the Asks. There are many more shares for sale in a tight price range. There are 3100 shares for sale on the NASDAQ, 2100 on BSE, 2000 on EDGX. But there are only a handful of shares that people want to buy. If you wanted to sell 3000 shares right now you could only sell 900 for $19.40 or better, and you would only get $19.20 or worse for some of those shares. So that is a thin market.
Aggressive Buyers and Sellers
The market participants who are more desperate to get in or out right now use market orders because they are willing to accept a slightly worse price to get in or out immediately. These people are sometimes called ‘aggressive buyers’ or ‘aggressive sellers’. There are some indicators and tools that track the number of aggressive buyers and sellers at each price as some traders use that to help them determine what side of the market is stronger.
ThinkOrSwim tracks some statistics on aggressive buyers and sellers in the options market.
ThinkOrSwim Option Statistics
When you look at the row labeled ‘Traded at Bid or below’ that is showing aggressive sellers who were willing to sell at whatever the bid price was. That was 36% of all the calls traded this day, while 37% of the calls were bought by aggressive buyers. The other 25% were traded between the bid and the ask, so that tells you that those traders were willing to let their limit orders sit for some time between the bid and ask until another trader agreed to a trade at the price of their limit order.