How Markets Work · Beginner · 5 min

Supply, demand and the order book

You can explain how a trade happens in the order book and why prices rise or fall when one side is more eager than the other.

What really moves a price

You often hear that a share rose because of good news, or fell because of a bad chart pattern. That is the story. The mechanism is simpler.

A price changes only when orders meet in the order book and one side is more eager than the other. News, charts and opinions matter because they change how eager buyers and sellers are. Seeing that mechanism makes every chart easier to read.

Two sides of the book

The order book has two sides. Below the current price wait buy orders, the bids, from people who would like to buy, but only at their price or lower. Above the price wait sell orders, the asks, from people who would sell, but only at their price or higher. Together they show demand, the willingness to buy, and supply, the willingness to sell.

As long as everyone just waits, nothing trades. A trade happens only when someone crosses the spread:

a buyer who accepts the lowest ask, or
a seller who accepts the highest bid.

If buyers keep paying the ask, the cheapest sell orders get used up. The next ask is a little higher, and the price moves up. If sellers keep hitting the bid, the price moves down. That is all a price move is.

How far a price moves for a given amount of buying or selling depends on the market depth: how many shares are waiting at each price level. A deep book absorbs large orders with little movement. A thin book moves a lot.

At each price level, most stock exchanges fill orders by time: the order that arrived first is filled first. This is called price-time priority.

A large order walks the book

The order book of a fictional stock shows:

Asks: 300 shares at 100.02, 500 at 100.03, 400 at 100.04
Bids: 400 shares at 100.00, 300 at 99.99, 600 at 99.98

A buyer sends an order to buy 700 shares immediately. It takes all 300 at 100.02, then 400 of the 500 at 100.03.

After the trade, the last price is 100.03 and the best ask is now 100.03, with 100 shares left. The buyer's average price is about 100.026, slightly more than the 100.02 the screen showed before. One eager buyer moved the price, simply by needing more shares than the best level offered.

Common mistakes

"More buyers than sellers make the price rise." Every trade has one buyer and one seller. What moves the price is which side is more eager to cross the spread.
"The price on the screen is available in any size." Only the shares at the best level are. Larger orders walk through several levels.
"Volume shows who won." High volume shows that a lot traded, not whether buyers or sellers were the driving side.
Ignoring depth. The same order can barely move a deep market and push a thin one far.
Believing the book is fixed. Orders are added, changed and cancelled all the time. What you see is a snapshot, not a promise.

The takeaway

A price moves when one side is more eager and takes out the orders waiting on the other side. The order book shows how much it takes.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the price levels a large market buy has taken out.

Tap the chart.

A market buy fills against the cheapest sell orders first and keeps going up the book until it is complete.
2A buy order for 700 shares fills 300 at 100.02 and 400 at 100.03. What is the average price?

(300 × 100.02 + 400 × 100.03) ÷ 700 ≈ 100.026. The order paid more than the best price on the screen.
3What makes the price of a share rise?

When buyers keep paying the ask, the cheapest sell orders disappear and the price moves up to the next level.
4Two buy orders wait at the same price. Which one is filled first on most stock exchanges?

Most stock exchanges use price-time priority: the best price first, and at the same price the earliest order.

of 4 correct.