Market Mechanics – Part 2

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How Market Price jumps

What happens if we get a big market sell order, say 7 lots? Again it will be added to the orders stack at a price that gets filled immediately.

prices6

The order will be filled at 1.0925. The 7 lot sell order will be matched with the first 7 buy limit orders (ie one at 1.0928, three at 1.0927, two at 1.0926, and one at 1.0925). Remember that the buy limit orders are required to be filled at their level or better, so the buyers will be happy to be filled at 1.0925 rather than higher prices. So the market price changed by 3 pips from 1.0928 to 1.0925.

This kind of big price jump happens rarely, perhaps around the time of an important economic news announcement, such as the NFP announcements in 2008. Due to great uncertainty there were not many limit orders in the order stack but there were many stop orders straddling the market price. In the initial seconds after the announcement there was no clear consensus among traders, and the price violently gapped up and down in seconds before settling in one direction.

Usually your broker would not want such a movement in their quoted prices, otherwise arbitrageurs would take advantage of the difference between your broker’s quotes and another broker’s quoted prices. What they do is “lay-off” any un-matched client market orders with other brokers / banks so that your broker does not have any net position in the market, and his prices do not become too different from other broker’s quoted prices.

 

How Price Level is Orchestrated

At other times, the market price can be manipulated / orchestrated to move in this manner. The professional traders at the banks and funds know, or are able to determine, at what prices many traders have put their stop orders. They are able to covertly or overtly signal their intentions to the other professionals. They will scale-in and trade volumes large enough to move the price to these stop levels, which then allows them to exit their volume positions at profit. The professionals don’t have to do all the work; they only have to start the move with sufficient volume and then other traders see the initial momentum and jump in. Once the stops have been taken out in one direction, often the professionals will then reverse direction and aim for the stops in the other direction. Have a look at price movement around the London open and you can sometimes see this kind of “wash and rinse” price action.

 

How this can be used by the retail trader

In summary, prices change according to the flow of orders. Big price changes, as seen in long candles, require consistent volume in one direction over a sustained period of time. Retail traders trade a variety of styles, using various methods and criteria, with various objectives, over various timeframes. This variety means that there usually won’t be a clear, concerted direction. However, the professional traders are able to act in a concerted manner with sufficient volume to be able to move the market prices to certain levels that they want. Retail traders are too small to have any effect on price, instead they must learn to anticipate and follow the price movement in order to trade profitably. This is how we trade; by watching how price behaves as it reaches these certain levels.