Question About Interaction Between Buy & Sell Limit Orders

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omgbirdman
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Question About Interaction Between Buy & Sell Limit Orders

Post by omgbirdman » Wed Jul 11, 2018 2:21 pm

This is a purely hypothetical scenario, for that reason it may not be actionable, but let's hope the moderators disagree.
Let's say we are dealing with a stock that has extremely low trading volume. Person A places a limit order to sell 1 share of stock X at $100.
Person B places a limit order to buy 1 share of stock X at $150. (Yes - this spread is highly unrealistic.)

These two orders are compatible and thus should be filled with one another, right? But how are they filled? Does the stock get exchanged at $100? $150? Somewhere in between?

Thanks for any input.

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Phineas J. Whoopee
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Re: Question About Interaction Between Buy & Sell Limit Orders

Post by Phineas J. Whoopee » Wed Jul 11, 2018 4:33 pm

omgbirdman wrote:
Wed Jul 11, 2018 2:21 pm
This is a purely hypothetical scenario, for that reason it may not be actionable, but let's hope the moderators disagree.
Let's say we are dealing with a stock that has extremely low trading volume. Person A places a limit order to sell 1 share of stock X at $100.
Person B places a limit order to buy 1 share of stock X at $150. (Yes - this spread is highly unrealistic.)

These two orders are compatible and thus should be filled with one another, right? But how are they filled? Does the stock get exchanged at $100? $150? Somewhere in between?

Thanks for any input.
No. A trade only happens when the buyer and seller agree on a price.

The middle of this post of mine goes through market mechanics. It's in a thread about the Efficient Market Hypothesis, but mechanics are the same whether or not the EMH is true.

PJW

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Pajamas
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Re: Question About Interaction Between Buy & Sell Limit Orders

Post by Pajamas » Wed Jul 11, 2018 4:50 pm

Basically that's a crossed market. The key is that there are other bids and asks even if they originate with the market maker. One or the other would be executed at market prices if either one could be executed at market prices.

However, a discrepancy of that magnitude would be considered an error and there are safeguards against that sort of mistake. Most or all retail brokers will require manual review of any order that someone attempts to enter that is so far from market prices. Then there are market rules and actions by market makers to prevent that type of situation but I don't know the practical details of how they actually handle something like that.

https://www.investopedia.com/terms/c/crossedmarket.asp

https://www.investopedia.com/study-guid ... d-markets/

So I guess what I'm saying is that your situation is hypothetical only and would not be allowed to occur in reality due to multiple safeguards.

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Phineas J. Whoopee
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Re: Question About Interaction Between Buy & Sell Limit Orders

Post by Phineas J. Whoopee » Wed Jul 11, 2018 5:18 pm

What we call the market price is the most recent price at which a buyer and a seller agreed and traded. It's usually what mark-to-market accounting marks to. As I explain in my linked post most potential buyers, and most potential sellers, disagree over prices, and that's only the ones who are actively in the market. Many more are not placing orders at all, limit or otherwise.
PJW

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grabiner
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Re: Question About Interaction Between Buy & Sell Limit Orders

Post by grabiner » Wed Jul 11, 2018 9:05 pm

What usually happens when orders cross is that the trade happens at the price of the first order placed.

This makes it practical to place a limit order to buy above the current ask. If I have placed an order to sell 500 shares at $20 which is the best offer, and you want to buy 1000 shares, you can place a single order to buy 1000 shares at $20.10; you will buy my 500 at $20, and another 500 if there is an offer to sell them at $20.10 or lower.
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Iridium
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Re: Question About Interaction Between Buy & Sell Limit Orders

Post by Iridium » Wed Jul 11, 2018 9:26 pm

The second order would be referred to as a 'marketable limit order', because it is a limit order, but can be fulfilled immediately. Therefore, for pretty much all intents and purposes, the order is treated like a market order. As the best offer at the time of the second order is $100, it would execute at that price. Which sticks for the first order, but that is the trade-off: the limit orders collect the spread, but never get prices improvement, not take advantage of favorable price swings. The claim that the first order collected the spread may seem incorrect, but remember that at the time of the first order, the best bid must have been under $100. So the first order still did better than if it had been a market order.

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