What Is an Order Driven Market?

An order-driven market is a financial market where all buyers and sellers display the prices at which they wish to buy or sell a particular security, as well as the amounts of the security desired to be bought or sold. This kind of trading environment is the opposite of a quote-driven market, which only displays bids and asks of designated market makers and specialists for the specific security that is being traded.

Key Takeaways

  • In an order-driven market, trades are based on buyers and sellers' requirements, with their desired bid and ask prices and the number of shares they want to trade put on display.
  • This is the opposite of a quote-driven market, in which trades are determined by market makers—dealers and specialists looking to fill orders from their inventory or match them with other orders.
  • Order-driven markets provide two basic types of orders: market orders and limit orders.
  • Order-driven markets are seen as less liquid, but more transparent than quote-driven markets.

Understanding an Order Driven Market

Order-driven markets consist of a constant flow of buy and sell orders from market participants. There are no designated liquidity providers, and the two basic types of orders are market orders and limit orders. By comparison, in a quote-driven market, designated market makers provide bids and offers which other market participants may trade on.

The biggest advantage of participating in an order-driven market is transparency since the entire order book is displayed for investors who wish to access this information. Most exchanges charge fees for such information. On the other hand, an order-driven market may not have the same degree of liquidity as a quote-driven market, since the specialists and market makers in the latter have to transact business at their posted bid and ask prices.

Stock Exchanges like the New York Stock Exchange and the Nasdaq are seen as hybrid markets—a combination of both order-driven and quote-driven markets.

How Informed Trading Affects Order Driven Markets

In order-driven environments, where traders can choose between market orders, which require liquidity, and limit orders, which provide liquidity, informed trading activities can actually provide a boost to liquidity. A higher share of informed traders improves liquidity as proxied by the bid-ask spread and market resiliency. However, informed traders have no effect on the price impact of orders. Compared to market orders, limit orders have a smaller price impact by a factor of about four. 

How Order Driven Environments Rank Buy and Sell Orders

Order driven trading systems rank buy and sell orders according to price, matching the highest-ranking orders (if possible) at the minimum order amount. If there is a remaining volume of shares to be bought or sold in a given order, trading systems will match the order with the next highest-ranked sell or buy order. The first rule in the order precedence hierarchy is price priority, followed by secondary precedence rules, which determine how to rank orders of the same price. The first order to arrive at the best price usually has priority over other orders, though sometimes trading systems trade displayed quantities before hidden quantities of the same price.