Order-Driven Market

What it is

An order-driven market is a trading environment in which buyers and sellers publicly display the prices and quantities at which they are willing to trade a security. These orders populate an order book that a matching engine uses to execute trades. This contrasts with quote-driven markets, where designated market makers or dealers post bid and ask quotes from their own inventory.

How it works

• Participants submit two primary order types:
• Market orders — execute immediately at the best available price; consume liquidity.
• Limit orders — specify a price and wait to be matched; provide liquidity.
• The trading system continuously matches buy and sell orders from the order book, executing trades when prices cross.
• The full (or partial) order book may be visible to market participants, depending on the exchange and data access.

Order ranking and execution rules

Orders are typically matched according to:
1. Price priority — orders offering the best price are matched first (highest buy, lowest sell).
2. Time (or secondary) priority — among orders at the same price, earlier orders are filled before later ones.
– Partial fills occur when an order’s size exceeds the available opposite-side volume; remaining volume stays on the book and can be matched with subsequent orders.
– Some systems prioritize displayed (visible) quantities over hidden or iceberg orders at the same price.

Transparency vs. liquidity

• Transparency: Order-driven markets are generally more transparent because the order book shows current bids, offers, and depth.
• Liquidity: They can be less liquid than quote-driven markets where market makers commit to transacting at posted prices. Liquidity in order-driven systems depends on active participation and the number of resting limit orders.

Effects of informed trading

• Informed traders can improve measured liquidity (narrower bid-ask spreads and greater market resiliency) in order-driven markets because they submit both market and limit orders.
• Limit orders tend to have a smaller price impact than market orders—empirical estimates suggest limit orders can reduce price impact by a substantial factor compared with market orders.

Where they’re used

Many modern stock exchanges operate as hybrids, combining order-driven matching with market-making activity. Examples include major equity markets that display order books while also using designated liquidity providers.

Key takeaways

• An order-driven market matches publicly posted buy and sell orders via an order book.
• Market orders consume liquidity; limit orders supply it.
• These markets are typically more transparent but may rely on participant activity for liquidity.
• Orders are matched by price priority, then by time or other secondary precedence rules.