What a financial market is

At this instant, somewhere, one participant is willing to pay a certain amount for a quantity of euros and another will not part with the same quantity for anything less than a slightly higher amount. Neither has to trade. Both are free to walk away, and most of the time both do. When the two figures meet, money and euros change hands, and that agreed number is reported as the price. A moment later it happens again, at a number that may be identical or may not.

That is worth stating plainly, because a quote board makes a market look like something else. Prices sit in neat rows, they update on their own, and they appear to be issued by an authority somewhere. Nothing issues them. Every number on that board is the residue of an agreement between two parties who each judged the exchange worth making, and the next number will be the residue of the next agreement.

A quote is two prices, not one 

An instrument does not have a price. At every moment it has two, and they are never the same number. The highest price any buyer is currently prepared to pay is the bid. The lowest price any seller is currently prepared to accept is the offer, also called the ask. Anyone transacting without waiting buys at the offer, because that is the cheapest price a seller has actually put on the table, and sells at the bid for the mirror reason.

The distance between the two is called the spread, and each figure is attached to a quantity. A bid is never just a price, it is a price for a stated amount, and once that amount is taken the bid is gone. Behind the best bid sit further bids at lower prices, behind the best offer sit further offers at higher ones, each with its own size. That standing arrangement on both sides is the order book, and the two figures on the screen are only the top of it.

Why a price moves 

A price changes when the balance of interest at the top of that book changes, and only two mechanisms can change it. Either resting orders are consumed by someone transacting against them, or the participants who placed them withdraw, add to or reprice them. Every move reported on any timescale reduces to those two events repeated.

Take the first. Buying interest arrives in a size larger than the quantity resting at the best offer. It takes all of that quantity and continues into the next offer, which by definition is priced higher, so the cheapest offer still standing afterwards is higher than the one standing before. Nobody decided the instrument was worth more. The cheapest willing seller was removed and the next one wanted more. Selling interest does the same downward, removing the highest willing buyers and leaving lower ones behind.

Two details there are worth a second reading. The order that moved the price was not large in absolute terms, only large relative to what was resting, which is the only sense in which size means anything. And neither order was filled at the price displayed when it was sent, because part of each filled a level further away. That difference is not a fault. It is what happens when an order is bigger than the quantity standing at the best price.

Liquidity is depth, not busyness 

Liquidity describes how much resting interest stands near the current price on both sides. A market is deep when substantial quantity sits at each level close to the top of the book, and thin when little does. That is not the same as how busy it looks: an instrument can print a great many small transactions while holding almost nothing at any one level, and another can sit quietly with very large quantities behind both sides of the quote.

Depth determines how far an order moves the price and therefore what it ends up costing. The identical order that walked through two levels above would have filled entirely at the best price in a deeper book, and travelled further in a thinner one. Traders call the gap between the displayed price and the average obtained slippage. Depth is also why one instrument behaves differently at different hours: the participants who provide that resting interest are not present in equal numbers around the clock, so the book thins and refills on a schedule of its own.

Where the negotiation happens 

Markets are organised in two broad ways, and the difference decides what a price even means. On an exchange, every participant sends orders into one central book run by a single venue under published rules. Because there is one book there is one best bid and one best offer, and the transactions printed there constitute an official record: an opening price, a closing price, a published volume. A clearing house normally steps between the two sides once a transaction is agreed. Listed shares, exchange traded futures and listed funds work this way.

An over-the-counter market has no central book. Participants deal bilaterally, each agreement made directly between two named parties, and dealers quote prices to those they deal with rather than into one shared queue. Foreign exchange is the largest market in the world and is organised this way. The consequences are concrete. Several slightly different prices for the same currency pair exist at once at different institutions, none of them wrong. There is no official closing price, which is why two data sources can disagree in the last decimal place. And because no venue opens or shuts, trading runs continuously from Monday morning in Asia to the New York close on Friday.

• Where an order rests: in one central book on an exchange, or with an individual counterparty over the counter.
• Who stands between the parties: a clearing house on an exchange, nobody over the counter, which is why the standing of the party on the other side matters there.
• Whether one official price exists: yes on an exchange, no over the counter, where each source publishes its own.

The five markets this curriculum covers 

Everything taught in the lessons that follow sits in one of five asset classes, and every later lesson assumes these names are already familiar.

• Foreign exchange, the relative price of one currency against another, quoted in pairs and traded over the counter.
• Indices, a calculated measure of a group of listed shares rather than a thing anyone can own.
• Commodities and metals, physical goods such as energy products and precious metals, priced through standardised contracts.
• Shares, units of ownership in an individual listed company.
• Exchange traded funds, listed funds that hold a basket of assets and trade on an exchange like a single share.

Each of those can be reached in more than one way. Buying the thing itself is one route. A contract whose value references the price of the thing, without any of it changing hands, is another. The market a contract references is called its underlying, and the two stay separate: the contract borrows the price, and the underlying market carries on exactly as before. What that contract is, and what it does not confer, is the subject of the next lesson.

Where practitioners disagree 

There is an old argument about what a price represents. One tradition, associated with the efficient markets literature, treats it as the collected judgement of everyone participating, already reflecting the information available, so a change is a response to something nobody knew a moment earlier. Another, associated with market microstructure research, treats it as an artefact of the order book described above: it moves because interest arrived in a size the resting orders could not absorb, whether or not anything was learned.

The disagreement persists because the two accounts are measured over different intervals. Over months, prices and published information track each other closely enough to make the first hard to argue with. Over seconds, prices move constantly while no information arrives at all, which the second describes better. Neither tradition claims to predict the next price.