FoundationsIntermediate· 7 min read

What actually happens when you press buy

The one thing to remember

The exchange does not set the price. It matches buyers and sellers, and the price is whatever they agree.

The question

Understand the mechanism you are participating in.

Figure

How What actually happens when you press buy works, in one picture

The same argument as the text, as a chain. Each step is what makes the next one possible.

Figure

The fee you never see

You buy at the ask and sell at the bid, so you are down the spread the instant you trade. In an illiquid stock it dwarfs any commission you thought you were avoiding.

1
There is a queue on each side, and it is public
The order book lists everyone willing to buy, ranked by price, and everyone willing to sell, ranked by price. The highest bid and the lowest ask sit at the top facing each other. The gap between them is the spread.
2
A market order takes whatever is at the top
It says: fill me now, at whatever price is available. In a liquid stock that is fine. In a thin one, your order can eat several levels of the book and fill at a price that will genuinely shock you.
A limit order joins the queue instead of jumping it. You give up certainty of execution to gain certainty of price. In anything illiquid that is the adult choice.
3
The open and the close are different animals
Exchanges usually open and close with an auction: orders accumulate and clear at a single price. Volumes are enormous and prices can move sharply. The first and last few minutes of the day are the worst time for a casual market order.
4
And much of the volume never touches the public book
Large institutional orders are frequently executed away from the visible exchange, in venues designed to avoid moving the price. The book you can see is real but it is not the whole market.

Try it

Lump sum versus drip feedInteractive

Long-run drift7%

Volatility18%

All in on day one

£32,199

Spread over 10 years

£21,682

Winner

Lump sum

Reseed a few times. Lump sum wins most paths, because markets rise more often than they fall. Drip feeding wins the ugly ones, which is what you are really buying.

You have got it when

You can explain why the same order costs more in a small company than a large one.

What actually happens when you press buy

How What actually happens when you press buy works, in one picture

The fee you never see

There is a queue on each side, and it is public

A market order takes whatever is at the top

The open and the close are different animals

And much of the volume never touches the public book

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