Order book trading is an established method for executing financial transactions on an exchange, where all active buy and sell orders for a specific asset are compiled into a central, transparent list known as an order book. This structure openly displays available liquidity at various price points.
Mechanism
Limit orders, placed by buyers (bids) and sellers (asks) at designated prices, populate the order book, reflecting market depth. When a market order is submitted, it executes immediately against the best available opposing limit orders. The order book dynamically updates to reflect new submissions, cancellations, and completed trades, continually establishing the current market price.
Methodology
Order book trading facilitates efficient price discovery through a continuous double auction mechanism, allowing participants to analyze market supply and demand. Traders employ various strategies, including market making, algorithmic arbitrage, and directional speculation, leveraging the real-time information provided by the order book to optimize execution and contribute to orderly price formation.
A clearinghouse mitigates risk by replacing bilateral obligations with itself, managing the centralized risk through a tiered waterfall of financial safeguards.
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