[MUSIC] In this video, you will see what happens if a marketable limit order is unable to execute entirely, because of its limit price restriction. You will also see how a large market order executes against the order book and moves prices. This will help you understand the idea of price impact. Let's continue with our order book example from last time. At the end of the last video, the order book had S1 a sale order at a price of 40 for 150 shares and B1 buy at a price price 39.95 for 175 shares. Let's move the order book forward by sometime by adding a few more orders on both sides of the market. S1 and B1 continue to be on the order book. We now also have S4, a sell order for 500 shares of 40.02 as well as another sell order for 1,000 shares of 40.05 and S6, another sell order for 1,500 shares at 40.10. [SOUND] On the buy side, we have B3, an order for 600 shares at 39.99 and B4, an order for 900 shares at 39.96. The best ask price continues to be 40.00 while the best bid price is 39.99. Consequently, the bid, ask spread is $0.01. Note in reality, we will not see the individual orders and their respective sizes at each price. We will only see the aggregate depth across all orders at a given price. In other words, the depths at each of the prices we observe in the order book may be contributed by multiple orders or a single order. That is something we will not know precisely. For example, the depth of 1,000 shares at 40.05 maybe because of three different sale orders. Each with a limit price of 40.05 and one order being for 300 shares, another for 500 shares and a third for 200 shares. In this example, for simplicity, I'm assuming that there is one order at each price that contributes to the entire depth at that price. Now, a buy order at B5 arrives for 400 shares at 40. Will this order execute against any of the sell orders? Let's see what happens. This trader is willing to pay as much as $40 for each share. Is someone willing to sell shares at that price are lower? The answer is yes, as well as willing to sell 150 shares at $40. So, B5 will execute against S1 and we will see a trade for 150 shares at $40. Even though B5 wants to buy 400 shares, S1 is willing to sell only 150 shares at $40 and so the trade will be for only 150 shares. Now that S1 is completely filled, what happens to the remaining 250 shares that B5 wants to buy? The limit price is still 40 and it won't pay more than that for each share. Is anyone else in the market willing to sell at 40 or less? No, S4 is not willing to sell at a price lower than 40.02 and S5 is not willing to sell that a price lower than 40.05. So, what happens to the balance 250 shares of B5? It will become a standing limit order at 40 for 250 shares. That is the balance will send an order book awaiting execution. On the cell side, the lowest price at which someone is willing to sell is S4's 40.02, which is now the best asked price. On the buy side, the highest price at which someone is willing to buy shares is now B5's 40, which becomes the new best bid price. The bid asked spread is now two cents. The bid at the best ask price is 500 shares and that at the best bid price is 250 shares. Next, a market order B6 to buy 200 shares arrives in the market. This order has no price restrictions and will execute immediately against existing sale orders in the order book. S4 is for 500 shares. S5 is for 1,000 shares and S6 is for 1,500 shares, which add up to 3,000 shares. So that is enough number of shares on offer to completely fill B6. We will see a day for 500 chairs at 40.02, which is S4 executing against B6. Another one for 1,000 shares at 40.05, which is S5 executing against B6. And the third one for 500 shares at 40.10, which is S6 executing against B6. Here, we can see the price uncertainty of market orders while execution itself was guaranteed. Even though the best ask price was 40.02, the market order executed at prices higher than that also. After these trades, the best bud price for 250 shares remains unchanged. However, the best ask price is now 40.01 for 1,000 shares and the bid ask spread is $0.10. This market buy order has moved the best ask price by $0.8, which is typically referred to as the price in back of an order. Since there are no price grades for market orders, market orders could end up moving prices substantially, especially when they are large. We summarize the book at this point. There is only 1 seller at S6 that is 40.10 for 1,000 shares. On the buy side, we still have B5 at 40 for 250 shares. B3 at 39.99 for 600 shares. B4 at 39.96 for 900 shares and B1 for 39.50 at 175 shares. At this point, a new sell order S7 enters the market at 40.05 for 500 shares. This brings the best ask price to 40.05 and the bid ask spread drops to $0.5. In the last couple of videos, we have seen how the order book changes dynamically as orders await execution while other orders execute immediately. Orders that sit in the book awaiting execution are usually considered to be providing liquidity in the market while those that execute immediately demand or consume liquidity. Next time, we will discuss the idea of limit price placement and order aggressiveness. [MUSIC]
