Liquidity, market structure and efficient markets
Prices don’t just appear. They come from millions of orders meeting in a structure built by exchanges, market makers and regulators. How that structure works affects every trade.
Who is on the other side
- Market makers continuously quote bids and asks, earning the spread in exchange for taking on short-term risk.
- Institutions (pension funds, asset managers, hedge funds) trade the largest size and split big orders up to avoid moving the price.
- Retail investors trade smaller size, usually through brokers that route orders to market makers or exchanges.
In the US, many retail orders go to wholesalers who pay brokers for them (payment for order flow). The FCA doesn’t allow this in the UK.
Liquidity
Liquidity is how easily you can trade size without moving the price. It shows up as tight spreads and deep order books. Large caps like Apple or Shell are extremely liquid. Small caps can see a modest order move the price several percent.
Liquidity is not constant. It drains in sell-offs, around news and at the open. Plenty of liquidity in calm markets can vanish exactly when it is needed.
Lit markets and dark pools
Exchanges are “lit”: orders are visible. Dark pools are private venues where institutions can trade large blocks without revealing intent. A large share of US volume now trades off-exchange.
Efficient markets
Eugene Fama’s efficient market hypothesis says prices reflect available information, in three strengths:
- Weak: past prices can’t predict future ones.
- Semi-strong: all public information is already priced in.
- Strong: even private information is priced in.
The evidence is mixed. Most active funds fail to beat their index after fees over long periods, which supports efficiency. But bubbles, crashes and persistent anomalies (momentum, for example) suggest markets are efficient most of the time, not all of the time.
Key takeaway
Markets are hard to beat, not impossible. An edge usually comes from better analysis, a longer time horizon, or doing what others can’t or won’t, and it’s worth knowing which one you are relying on.
Educational content only, not financial advice. Investing involves risk and you can lose money.