How Markets Work: Bids, Asks, Spread and Liquidity

What you will learn

• Who is on the other side of a trade, and why every trade needs both a buyer and a seller.
• What the bid, the ask and the spread are, and how to read them on a quote.
• What liquidity and volatility mean, and why they change from hour to hour.

What is a market?

If you want to buy something right now, who decides the price you pay?

For exchange trading, the venue’s matching engine applies its rules to compatible buy and sell orders. Price-time/FIFO is one allocation family: among orders with the relevant same-price priority, earlier orders fill first. It is not the rule for every exchange/product: pro-rata and hybrid rules can allocate same-price quantity differently. Exchange-listed stocks can also execute off-exchange; listing does not mean every trade passes through one exchange book. See Reading the DOM Honestly: Spoofing, Icebergs and Hidden Size for the existing fuller matching/hidden-liquidity explanation.

No one sets the price from above. Price is simply the level at which the most recent trade happened. If buyers become more eager, they accept higher prices and the last trade moves up. If sellers become more eager, they accept lower prices and it moves down. Everything else in these lessons, from candles to volume profiles, is a way of describing that process.

Who takes part?

Why would two people agree on a price but disagree about where it goes next?

Participants have very different reasons for trading, and that is why trades happen at all.

• Hedgers use markets to offset a business risk. A farmer or a fund manager may sell futures to reduce exposure to a price move they cannot afford.
• Investors buy or sell with a view measured in months or years.
• Short-term traders try to act on moves measured in minutes, hours or days.
• Market makers and liquidity providers post buy and sell prices at the same time and earn, or lose, from the difference and from exchange incentives.
• Institutions such as pension funds and asset managers move large amounts, often spread over many orders.

A buyer may be opening a new position, while the seller may be closing an old one, hedging something else, or simply rebalancing. The same trade can mean different things to each side.

Futures, such as those a hedger might sell, are leveraged products. Leverage can cause losses larger than the amount invested.

What are the bid, the ask and the spread?

When a quote shows two prices, which one would you get?

A quote usually shows two prices:

• The bid is the highest price someone is currently waiting to pay.
• The ask (also called the offer) is the lowest price someone is currently waiting to sell at.
• The spread is the gap between them.

Suppose a quote reads bid 100.00, ask 100.02. Someone who wants to buy immediately pays 100.02, the ask. Someone who wants to sell immediately receives 100.00, the bid. If both happened at once, the buyer and seller would be 0.02 apart before the price moved at all. That gap is a real cost to anyone who trades immediately; see trading sessions and costs.

Behind the best bid and ask sit more orders at other prices. The full list is the order book. Order flow tools that show it in detail are covered much later, in order flow basics.

What is the difference between waiting and crossing the spread?

Is it better to wait for your price or to take the price that is there? What does each choice cost?

Every trade joins two kinds of order:

• A passive order waits in the book at a chosen price, such as a bid at 100.00. It may or may not be filled.
• An aggressive order trades immediately against whatever is waiting, paying the ask or hitting the bid.

Waiting can avoid taking the displayed spread but does not assure a fill. A marketable order seeks prompt execution against available opposite-side interest; it does not reserve the displayed quote or guarantee that the full size fills at that price. A marketable limit still has its price boundary. Liquidity, changing quotes, trading state and venue/product protections matter. Neither approach is inherently better. See Order Types Explained: Market, Limit, Stop and Bracket.

Order book and spread diagram

Fictional displayed book; 100.75−100.50=0.25. The picture shows a quote, not an allocation rule or guaranteed execution price.

What is liquidity?

What makes it easy, or hard, to trade a large amount without moving the price?

Liquidity describes how easily you can trade a meaningful amount close to the current price. Markets are usually described as liquid when:

• the spread is narrow,
• there is plenty of size waiting at and near the best bid and ask, and
• trading is frequent, so prices update smoothly.

Liquidity is not fixed. The same market can be deep during its busiest hours and thin overnight, on holidays, or in the seconds around a major scheduled report. In thin conditions, a modest order can move the price several steps, and the spread can widen. Scheduled news is one common cause; see economic events and headlines.

What is volatility?

If two markets both ended the day unchanged, could one still have been far riskier to trade?

Volatility describes how much and how fast prices move. A market that swings widely within a session is more volatile than one that drifts in a narrow band, even if both finish where they started.

Volatility and liquidity are related but different. A market can be liquid and volatile at once, for example just after a major release, or quiet and thin, for example late at night. Traders often watch both, because together they shape how far price may move and how much it may cost to trade. Measures such as average true range, covered in technical indicators, put a number on recent volatility; they describe the past, not the future.

What this does not tell you about the order book

• The quote you see is a snapshot; orders can change or disappear before you act.
• A narrow spread at one moment does not mean the market will stay liquid.
• Knowing who participates does not tell you who is buying or selling right now, or why.
• None of this describes which way price will move next.

Watch the lesson explained

Check yourself

Reflect on these; there is no score.

1. A quote reads bid 50.10, ask 50.14. What is the spread, and who pays it? Hint: the gap between the two prices, paid by whoever trades immediately.
2. Why might a hedger and a short-term trader happily take opposite sides of the same trade? Hint: different goals and time horizons.
3. Describe a time of day when a market you follow might be less liquid. What would you expect to see in the quote? Hint: spread and visible size.
4. Can a market be volatile but liquid? Give an example of when that might happen. Hint: just after scheduled news.
5. Under a DECLARED simple FIFO toy book, two ordinary sell orders at the same price entered in order A 3 contracts then B 5 contracts. A marketable buy can match 4 at that price with no changes/implied orders. Who fills? Would that result prove all products use FIFO?

Last reviewed November 8, 2026. Spotted a mistake? Report an error.