Market Structure¶

Difficulty beginner

Overview¶

Market structure defines how buyers and sellers interact to determine prices. Understanding structure is essential for knowing when, where, and how to trade efficiently.

Market Types¶

1. Exchange-Traded Markets¶

Centralized venues with standardized rules and transparent pricing.

Examples: NYSE, NASDAQ, CME, ICE, LSE, CBOE

Characteristics: - Central limit order book (CLOB) - Price-time priority matching - Transparent order book (visible depth) - Regulated and surveilled - Standardized contracts

2. Over-the-Counter (OTC) Markets¶

Decentralized, bilateral trading between counterparties.

Examples: Forex, bonds, most derivatives (before Dodd-Frank), swaps

Characteristics: - Dealer networks - Negotiated pricing - Less transparent - Counterparty risk - Customizable contracts

3. Dark Pools¶

Private exchanges not displaying orders publicly.

Characteristics: - Hidden liquidity - Reduced market impact - Typically for large institutional orders - Less regulatory oversight - Price improvement potential

Order Book Mechanics¶

Central Limit Order Book (CLOB)¶

ASK (Sell Orders)
Price    Size
$150.10  500
$150.05  200
$150.03  1000  ← Best Ask
─────────────────────── Spread
$150.02  800   ← Best Bid
$150.00  300
$149.98  1500
BID (Buy Orders)

Matching Rules: 1. Price Priority — Best price executes first 2. Time Priority — At same price, first order executes first 3. Display Priority — Displayed orders execute before hidden orders at same price/time

Order Types in the Book¶

Order Type	Visibility	Execution
Limit	Displayed	At limit price or better
Market	N/A	Best available price
Hidden/Reserve	Hidden portion	At limit price
Iceberg	Partial display	At limit price, refills

Trading Sessions¶

US Equities Session Structure¶

Pre-Market          Regular Session         After-Hours
4:00 AM ───── 9:30 AM ────────── 4:00 PM ───── 8:00 PM
    │              │                   │            │
    │ Low liquidity│ Full liquidity     │ Low liquidity
    │ Wide spreads │ Tight spreads      │ Wide spreads
    │ High vol     │ Normal vol         │ High vol

Volume Distribution (Typical Day)¶

Volume
  │
  │███                                    ███
  │███                                    ███
  │███                                    ███
  │█████          ████████████████        █████
  │███████████████████████████████████████████
  │─────────────────────────────────────────────
  │  Open    Midday    Close
  └───────────────────────────── Time

Open (9:30-10:00 AM) — 20-25% of daily volume
Midday (11:00 AM-2:00 PM) — Lower volume, choppy
Close (3:00-4:00 PM) — 20-25% of daily volume (institutional rebalancing)

Price Discovery¶

How Prices Move¶

Order Flow Imbalance — More buy orders than sell orders (or vice versa) pushes price
Information Flow — News, earnings, macro data changes valuation
Liquidity Events — Large orders consume available liquidity at current price
Market Maker Adjustments — Dealers adjust quotes based on inventory and risk

Auction Mechanisms¶

Continuous Auction — Orders matched continuously throughout the day (most markets)

Call Auction — Orders accumulated, single price determined at specific time (opening/closing crosses)

Opening Cross Example:

1. Collect all orders during pre-market
2. Find price that maximizes volume traded
3. Execute all eligible orders at that price
4. Publish opening price

Market Segments¶

Primary vs. Secondary Markets¶

	Primary	Secondary
Purpose	New securities issued	Existing securities traded
Participants	Issuer, underwriters, investors	Investors, traders, market makers
Price	Set by underwriters	Determined by supply/demand
Examples	IPO, bond issuance	Stock exchange trading

Cash vs. Derivatives Markets¶

	Cash (Spot)	Derivatives
What's Traded	The asset itself	Contracts on the asset
Settlement	Immediate (T+1/T+2)	Future date
Leverage	Limited (margin)	High
Examples	Stocks, bonds, FX spot	Options, futures, swaps

Market Data¶

Quote Types¶

NBBO (National Best Bid and Offer) — The highest bid and lowest ask across all US exchanges

NBBO: Bid $150.02 @ 800  |  Ask $150.03 @ 1000

Last Sale — Price of the most recent executed trade

Trade-Through — Execution at a price worse than the NBBO (generally prohibited by Reg NMS)

Data Levels¶

Level	Content	Use Case
Level 1	Best bid/ask, last sale	Retail trading
Level 2	Full order book depth	Professional trading
Level 3	Full depth + order attribution	Market makers

Data Vendors¶

Real-Time: Bloomberg, Refinitiv, Polygon, IEX Cloud
Delayed: Yahoo Finance, most free APIs (15-min delay)
Historical: CRSP, TickData, FirstRate Data

Market Regulation (US)¶

Key Regulations¶

Regulation	Purpose
Reg NMS	National market system, best execution
Reg SHO	Short sale restrictions
Reg AT	Algorithmic trading oversight
MiFID II (EU)	Market transparency, investor protection
Dodd-Frank	OTC derivatives regulation

Exchange Rules¶

Circuit Breakers — Halt trading on extreme moves
Level 1: 7% drop → 15-min halt
Level 2: 13% drop → 15-min halt
Level 3: 20% drop → Rest of day
Limit Up-Limit Down — Prevent trades outside price bands
Short Sale Rules — Uptick rule alternatives, locate requirements

Liquidity¶

Dimensions of Liquidity¶

Dimension	Measure	Impact
Tightness	Bid-ask spread	Transaction cost
Depth	Volume at each price level	Size executable without impact
Resiliency	Speed of recovery after large trade	Stability
Immediacy	Time to execute	Opportunity cost

Liquidity Providers¶

Market Makers — Obligated to quote continuously
High-Frequency Traders — Provide short-term liquidity
Institutional Investors — Large orders (can be liquidity consumers)
Retail Traders — Fragmented, small orders

Market Cycles¶

Bull Market          Distribution          Bear Market          Accumulation
   │                      │                    │                      │
   │  Rising prices       │  Smart money sells  │  Falling prices      │  Smart money buys
   │  High confidence     │  Volume distribution│  Low confidence      │  Volume accumulation
   │  Easy profits        │  Reversal signals   │  Pain, capitulation  │  Building base
   │                      │                     │                      │
   └──────────────────────┴─────────────────────┴──────────────────────┘
                         Market Cycle

Cross-Market Linkages¶

Correlations¶

Relationship	Typical Correlation	Reason
Stocks ↔ Bonds (normal)	Negative	Flight to safety
Stocks ↔ Bonds (crisis)	Positive	Liquidity selling
USD ↔ Commodities	Negative	Dollar-denominated pricing
AUD/JPY ↔ Equities	Positive	Risk proxy
Gold ↔ Real Rates	Negative	Opportunity cost
VIX ↔ S&P 500	Strong Negative	Fear gauge

Key Concepts Summary¶

Order Book — Heart of price discovery; understand bid/ask dynamics
Sessions — Trade when liquidity aligns with your strategy
Liquidity — Determines execution quality and cost
Regulation — Defines the rules of the game
Data — Quality of data determines quality of decisions

Next Steps¶

Market Participants — Understand who you're trading against
Order Types — Learn how to execute efficiently
Bid-Ask Spread — Understand transaction costs