Limit Order Books, Spreads, Midprice, and Microprice

Summary

The document introduces the limit order book as the collection of outstanding buy and sell limit orders. Market orders seek immediate execution and consume available liquidity, while limit orders wait at specified prices and provide liquidity. The best bid and ask define the quoted spread, which represents the immediate round-trip cost at the top of the book before other trading costs. The article relates narrower spreads to greater liquidity and wider spreads to thinner markets.

It distinguishes the midprice, the simple average of best bid and ask, from the microprice, which weights those prices by the posted sizes at each level. When the best-level volumes are unbalanced, the microprice shifts toward the side with the smaller queue. The discussion is conceptual and gives no empirical study or execution model; it assumes the best quotes are available and does not account for fees, deeper-book impact, or changing orders. It motivates further study of optimal execution and market microstructure.

Key ideas

• Market orders seek immediate fills and remove liquidity, while limit orders wait at chosen prices and supply liquidity.
• The best bid and ask determine the quoted spread, a component of the cost of immediate trading.
• The midprice averages the best quotes without considering displayed order sizes.
• The microprice weights the best quotes by their posted volumes and can reflect queue imbalance.
• The discussion describes top-of-book concepts but does not model fees, deeper liquidity, or execution outcomes.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.