Market structure: the book, the order types and who pays whom

Everything a market maker does happens inside a matching engine with specific rules, and those rules are not decoration: price–time priority decides whether your quote gets filled, the fee schedule decides whether the fill was worth having, and the auction mechanics decide where a third of the day’s volume trades.

Definition 1.1

The limit order book

Price–time priority — Resting orders queue by price first and then by arrival time. A better price always jumps the queue; at the same price, whoever got there first is filled first. That second clause is why queue position is an asset — being early at a price level is worth real money, and losing it by amending an order is a genuine cost.

Term	Definition	When it is the right one
Best bid / best offer	Highest buy, lowest sell	What you can actually trade against
Mid	Average of the two	A rough fair value when the book is balanced
Microprice	Mid weighted by the opposite side’s size	A better fair value when the book is lopsided
Last traded	Price of the most recent print	Backward-looking; can be stale in seconds
NBBO	Best bid and offer across all venues	The US regulatory reference for a fill

Table 1.2 · The prices people mean. The microprice is the one worth understanding: with 1,000 on the bid and 100 on the offer, buyers are queued up and the true value sits nearer the offer than the mid. Quoting off the mid in that book is how you get run over.

Type	Behaviour	Used when
Limit	Rests at a price until filled or cancelled	You are providing liquidity and want the spread
Market	Takes whatever is there	You need the fill now and accept the price
IOC	Fills what it can immediately, cancels the rest	Sweeping without leaving a resting order behind
FOK	All of it immediately, or nothing	The trade only makes sense in full size
Iceberg	Shows a fraction of the true size	Working a large order without advertising it
Pegged	Tracks a reference price automatically	Staying at the touch without constant amendments

Table 1.3 · Order types and what they are for.

Proposition 1.4

Maker–taker, and why it changes your quoting

Most equity venues pay a rebate to the resting order and charge the aggressor — typically a rebate around $0.20$ per hundred shares against a fee near $0.30$ . A maker therefore earns the spread *plus* the rebate, while a taker pays the spread *plus* a fee, and the gap between the two is often larger than the tick.

Holds when

On a one-cent tick in a liquid name, the rebate can be a fifth of the spread. It is not a rounding error.
Some venues run the schedule inverted, paying takers, which changes which side of the book you want to be on.
This is why an order router chooses venues on net cost rather than on displayed price alone.

Example 1.5

You buy 1,000 shares at $\$20.00$ and sell 1,000 at $\$20.01$ , both as resting limit orders. The rebate is $\$0.0020$ a share. What did you make?

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Worked solution

Formula $\text{P\&L} = \text{spread captured} + \text{rebates}$
Substitute $= 1000 \times 0.01 + 2 \times 1000 \times 0.0020$
Solve $\text{spread} = \$10.00$
$\text{rebates} = \$4.00$
Answer $\$14.00$

Sanity check. The rebate is $40\%$ on top of the spread. Had both legs crossed instead, at a $\$0.0030$ fee, you would have paid $\$6$ in fees and captured nothing — a $\$20$ swing on a trade whose gross edge was $\$10$ .

Market structure: the book, the order types and who pays whom

After this lesson you should be able to

The limit order book

Maker–taker, and why it changes your quoting

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