I can give you an article on this topic.
What happens to the order book when a market order is received?
Imagine a Bitcoin exchange set up to offer market orders. Let’s say there are X buy orders at the market price and Y sell orders at the market price (not limit orders). Now let’s say we are talking about the case when a customer places a market order on the stock exchange.
What happens next?
- Matching: The exchange algorithm automatically matches market orders to create new trades that satisfy both sides of the order book.
- Price Determination
: Since there are no limit orders, the price at which these trades are matched is determined solely by market demand and supply.
How does it work?
In this scenario:
- The buyer places a market order with an amount in Bitcoins (eg 1 BTC).
- The exchange algorithm automatically matches this order to create a new trade:
- A buy order with the same amount of BTC (say 1 BTC) and a market price of $30,000.
- A sell order with the same amount of BTC (say 1 BTC) and a market price of $20,000.
Price Determination
The exchange algorithm determines the new price at which these trades will be matched. In this example:
- The buy order is matched to create a trade where you buy 1 BTC at the midpoint between $30,000 and $20,000 (say $25,500).
- The sell order will also be matched to create a new trade where you sell 1 BTC at a price higher than what you paid ($35,000).
What if there were no limit orders on either the buy or sell side?
If there were no limit orders on either the buy or sell side, prices would be set by the most active traders in the market. In this case:
*The trade could not be completed at $25,500 because multiple traders are bidding up and down for this price.
*The market could become more volatile as traders take advantage of the imbalance.
Conclusion
In short, when a market order enters an exchange’s order book, it is automatically matched against other orders to create new trades. The prices at which these trades are matched depend solely on market demand and supply, without taking into account limit orders or other factors that may affect prices.