T&S - Bid and Ask, determining what is what


Morning guys,

So, I´ve been watching the charts a few months now, mostly Futures, mostly Gold and Oil, thoroughly enjoying it.

Theres something I want to understand more on.

Assume fast intra-day trading here, watching the price and time/sales.

What I do know isn´t much, except for the basics, that the bid is the buy price, the ask is the sell price, for price to go up it is bid up by those buyers reaching up to the ask (where the sellers are) and for price to go down the ask is lowered by sellers reaching down to the buyers at the bid.

Question 1 is on the spread which is in between the bid and ask and I assume goes to the exchange?

Question 2. We buy on the bid and sell on the ask, this is clear. Is it true that the "Pros" buy on the bid and sell on the ask? That gives a great advantage if it is true.

Further to this questions, my thoughts delve further to when the bid is being raised prices raise, but from watching time and sales I can´t really get my head around it. There is a buyer for every seller and a seller for every buyer, so when buyers are bidding 99.80 the sellers at the ask will be offering at 99.81 - so clearly a 1 cent spread.

What I can´t figure out is which way the force works........ If the "bid is being hit" then sellers keeping selling to those buyers at 99.80, and buyers keep buying it, this should drive the price down with the sellers, or drive the price up with the buyers? Contrary to that if people are buying up the 99.80 then it should send the price up.. lol So which is the force in action ?

What exactly does the bid being hit mean?

Hope I am making sense. I am just trying to get this straight in my head, it seems simple but the realism of it doesn´t seem to be, even less so when I watch time and sales and assume 1 trade = 1 trade, so there´s always a buyer for every seller and vv.
The key is to differentiate Market and limit orders, and what that means for those placing limit orders (I will call these Market Makers) and those placing market orders ( call these speculators).

At any instant the market is made up of advertised limit orders as follows:

............. Ask2 A2
............. Ask1 A1
............. Ask0 A0

B0 Bid0
B1 Bid1
B2 Bid2

Call the people advertising these prices the market makers (MMs). This means that some MM will sell (using limit order) up to A0 contracts at price Ask0, another MM (or possibly the same one) will sell A1 contracts at Ask1, etc. Similarly some MM will buy B0 contracts at price Bid0, another MM B1 at Bid1, etc. Also Bid0 and Ask0 are the best bid and ask, and Bid0 < Ask0 (always - if they were equal the orders would be immediately matched and traded).

So, the only ones who buy at the bid and sell at the ask are the MMs (ie anyone advertising a LIMIT ORDER). Anyone coming in with a MARKET ORDER will buy at the Ask price (ie buy at higher prices) and sell at Bid prices (ie sell at lower prices).

So, the MM (LIMIT ORDERS) buys and sells at better prices than a speculator (who uses MARKET ORDERS).
The aim of the MM is to both buy and sell simultaneously (or in as short a time as possible) and earn the spread whilst keeping his inventory (ie his net position) as close to zero as possible.
The MM puts himself at risk by advertising limit orders, and capture of the spread is his compensation for this risk.

The speculator using Market Orders has the luxury of transacting immediately at a time of his choice, and for this he pays the spread.

The spread is not earned by the exchange.

Ideally the MM wants to simultaneously, or asap buy and sell to speculators and and capture lots of spreads. .

Hitting the bids means there are lots of sell market orders - speculators are selling a lot (trading at the Bid prices, and as these advertised bid limit orders are exhausted at successively lower prices, the best bid moves downwards).

Anyone placing limit orders could be called a market maker, although a retail based market maker will pay a commission which must be factored in to any spread captured; however some market makers (ie exchange members) will get benefits (eg direct trading with no commissions) in exchange for an exchange fee and/or providing a certain amount of liquidity.

All the above relates to direct market trading. You should be aware that on most spread betting/CFD
platforms you will buy at the ask and sell at the bid even when using limit orders (but this is another issue).