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How Market Prices Move

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Most traders are aware that market prices move because of buying and selling (i.e. trading), but not many traders actually understand how buying and selling moves the market prices. This is one of the most confusing aspects of trading (especially for new traders), but it is also one of the most important.

The explanation of market price movement is composed of two parts. The first part explains how buying volume and selling volume move the market price, and is quite easy to understand. The second part explains how individual trades (as in individual transactions) are classified as either buying or selling volume, and is the part that causes the most confusion for new traders.

Part 1 - Buying and Selling Volume (the easy part)

Every trade (as in every individual transaction) is either a buying trade or a selling trade. Buying trades help move the market price upwards, and selling trades help move the market price downwards. When there are more buying trades occuring in a market, the market price will continue moving upwards. When they are more selling trades occuring in a market, the market price will continue moving downwards. When there is a switch from more buying to more selling (or vice versa), the market price movement will change direction. That's it for the easy part.

Part 2 - Bid and Ask Volume (the complicated part)

As described in part 1, every trade (as in every individual transaction) needs to be classified as either a buying trade (i.e. buying volume) or a selling trade (i.e. selling volume). However, every trade consists of both a buyer and a seller (the traders), and therefore both a buying and a selling transaction (the trades). If every trade consists of an equal amount of buying and selling, how can a trade be classified as either buying or selling? This is the reason for the confusion that many new traders encounter when learning about market price movement.

The answer is that every trade is classified as a buying trade or a selling trade based upon how the trade affects the order book, and therefore the current market price.

The order book is composed of bid prices, ask prices, and the last price (i.e. the current market price). The bid prices are the prices at which traders have placed limit orders to buy. The ask prices are the prices at which traders have placed limit orders to sell. The last price is the most recently traded price (i.e. the most recently filled order).

When a trader places a market order to buy, a trade will occur at the current ask price, because the buy order is matched with the lowest available sell order. This causes the last price to change to the ask price, as this is now the most recently traded price. As the ask price is always higher than the bid price, the last price can only stay still or move up, and therefore this is classified as a buying trade (i.e. buying volume).

Conversely, when a trader places a market order to sell, a trade will occur at the current bid price, because the sell order is matched with the highest available buy order. This causes the last price to change to the bid price, as this is now the most recently traded price. As the bid price is always lower than the ask price, the last price can only stay still or move down, and therefore this is classified as a selling trade (i.e. selling volume).

The interaction of the order book and the market prices is much more complex than this, but the above explanation is the basis of all market price movement.

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