What is an order book, and how do market and limit orders work?

Bids, asks and the spread

The bid is the highest price a buyer will pay right now. The ask is the lowest price a seller will accept.⁴ The bid is almost always lower than the ask, and the gap between them is called the spread.⁴

Chainlink's documentation explains that bid and ask prices sit in an exchange's order book, and stand for real orders that buyers and sellers have sent in.¹ Kraken, as one example of a crypto exchange, describes its platform as a central limit order book with a matching engine that pairs buyers with sellers.²

The mid price

The mid price is halfway between the best bid and the best ask.¹ It is a useful reference point, but Chainlink notes it is not a price at which trades should be carried out. Real trades must match an open bid or ask.¹

Chainlink adds that a narrower spread usually means a more liquid market. A wider spread can mean less liquidity or more volatility.¹

Who gets filled first

Exchanges set their own matching rules. Kraken's rules, for example, match the best price first. If several orders share the same price, the earliest one goes first.² This is often called price-time priority.²

Market orders

A market order buys or sells at the best price available.³ It is usually carried out straight away, but the price is not guaranteed.³

FINRA says a market order gives you the most certainty that your trade will happen.⁵ The downside is that you might not get the price you saw, especially when prices move fast.⁵ The SEC adds that the last traded price is not necessarily the price a market order will get.³

Limit orders

A limit order buys or sells only at a set price or better.³ A buy limit order can only trade at the limit price or lower. A sell limit order can only trade at the limit price or higher.³

The catch: a limit order is not guaranteed to trade. It only fills if the market reaches your price.³ FINRA says a limit order can sit unfilled if there are not enough buyers or sellers at your price or better.⁶

Stop orders

A stop order waits until the price reaches a level you choose, called the stop price. Then it becomes a market order.³ So the price you get can be well away from the stop price, depending on the orders available at that moment.³

Makers and takers

Some exchanges, Kraken among them, charge different fees depending on what your order does. On Kraken, an order that matches straight away against the book pays a "taker" fee, because it takes liquidity away. Market orders do this.²

An order that waits on the book, adding liquidity, pays a "maker" fee instead.² To keep the maths simple, this module leaves fees out.