Lesson 2 of 9
What the price is a price of
A quote is an offer to trade a stated size, not a fact about the company. Bids, asks and depth, and why the screen price is only the top of the book.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A quoted price is an offer to trade a stated quantity at that moment, and says nothing about what the next thousand shares would cost.
- The book has depth: prices behind the best bid and the best ask, each with its own size, and a large order walks through them.
- Two shares with the same quoted price can have very different real costs, because the depth behind the quote is not the same.
The price on a screen is usually the last trade, or the midpoint between the best bid and the best ask. Neither is a price you can necessarily get.
What exists is a book: a list of orders to buy, ranked from the highest price down, and a list of orders to sell, ranked from the lowest price up. The top of each list is the quote. Everything below it is the part nobody shows you.
The top of the book is not the whole book
- Best ask, $40.05300shares
- Next ask, $40.08900shares
- Third ask, $40.152,500shares
Bid, ask and the size beside them
The bid is the highest price somebody is currently willing to pay. The ask, or offer, is the lowest price somebody is currently willing to accept. A trade happens when one side crosses to meet the other.
Each is quoted with a size. A bid of $39.95 for 200 shares is a commitment to buy 200 shares, not 20,000. The commitment disappears the moment it is filled or cancelled, and quotes are cancelled constantly.
So the honest reading of a quote is a sentence with three parts: this price, for this quantity, right now. Drop any of the three and the number stops meaning what it appears to mean.
Depth, and what a large order does
Buying more than the size at the best ask means taking the next price up, then the next. The average price you pay is a weighted average of the levels you consumed, and it is worse than the quote you saw.
This is why an order that is small for one company is large for another. A thousand shares is nothing in a company that trades millions a day. In a company that trades twelve thousand shares a day, the same order is most of the session's volume and will move the price against itself.
That 0.13 percent is a cost the confirmation will not itemise. It is the difference between the price you were looking at and the price you got, and on a round trip in a thin book it is paid on the way out as well.
Why the book is thinner than it looks
A quoted size can be withdrawn before your order arrives. Displayed depth is also only part of the real depth: some orders are hidden, some sit on venues whose books are not published, and some liquidity only appears when an order asks for it.
The consequence for an investor is simple. Treat the book as an indication of what is available, not a promise. In a company that trades rarely, treat it as a weak indication.
What this means for research
A quoted price is an input to a valuation, not the output. The business behind it did not change when the quote moved, and the quote changes thousands of times a day in a large company and once a week in a small one.
The one practical rule that follows: before buying anything that trades thinly, look at the daily volume rather than the price. It tells you whether you can get out at a price near the one you can get in at, which is a different question from whether the company is any good.
Check yourself
A stock is quoted at $40.05 with 300 shares offered. What does that commit anyone to?
- Selling any quantity at $40.05
- Selling up to 300 shares at $40.05, until the quote is filled or cancelled
- Holding that price for the rest of the session
Show the answer
Answer: B.
A quote is a price for a size, at a moment. It can be filled or withdrawn immediately, and it says nothing about the price of the next share.Two companies trade at the same quoted price. One trades four million shares a day, the other twelve thousand. What differs for a buyer of 2,000 shares?
- Nothing, since the quoted price is the same
- The second order is a large share of the day's volume and will likely fill at worse prices
- The second is cheaper because fewer people want it
Show the answer
Answer: B.
Depth, not price, decides what an order costs. The same order size is trivial in one book and dominant in the other.Why can displayed depth overstate what is really available?
- Exchanges publish stale data on purpose
- Quotes can be cancelled before an order arrives, and some liquidity is never displayed
- Depth is always exactly accurate
Show the answer
Answer: B.
Displayed orders can be withdrawn in an instant, and hidden or off-exchange liquidity sits outside the published book in both directions.Sources
- Regulation NMS, on the display and protection of quotations across US equity markets.
- Rule 605 of Regulation NMS, on published execution quality statistics, including size categories and price improvement.
- SEC investor education material on bid, ask and market orders.
What this leaves out
- The book, the depth table and the fill arithmetic are illustrative, with invented round prices and sizes so the arithmetic can be checked by hand.
- US equities trade across many venues at once, so there is no single book. The consolidated best bid and offer is an aggregate, and depth behind it is fragmented.
- Liquidity varies by time of day and collapses around news. A book read at one moment does not describe the next.
- Nothing here is advice about any security.