What is adding liquidity and removing liquidity? Why do I need to know about it when I trade?
When you place a trade, your order is either a buy or sell (doesn’t matter time or order type restrictions). If your order increase the order quantity (at any price) of an exchange (immediately), you are adding liquidity. If you order decreases the order quantity (immediately), you are removing liquidity. Here is how it works:
The market is trading at 18.01x18.04 for INTC. Let’s pause the market for a moment. J
If you join the best bid at 18.01, you are providing liquidity. Why? Because you just increased the order quantity at that price.
If you placed bid anywhere in between 18.01 and 18.04(not including 18.04), you are providing liquidity. Because you have added orders that closed the bid/ask spread and this order is not matched (no one is offering at 18.02 or 18.03 yet). So you are adding order quantity into the exchange’s order book.
Same thing for the offer, just reverse the logic.
The idea here is that exchange want more people to come and trade. Exchanges are typically referred to as markets – think of it (most of us Asians are familiar with this) as an open market bazaar. The bazaar wants more buyers _and_ sellers, so they can build up their reputation as the place to get your goods. Exchanges wants more buyers and sellers to come and places their goods (stocks/options/warrants/bonds, etc, etc) and money. They are willing to charge you less if you come in and make the exchange look busier. If everyone goes to NYSE and just bought or sold at the market price, there will be nobody left at the exchange (well, you will never get into this case due to MM, LMM, Specialists, DMM, etc, but you get the idea).
Basic idea is you pay less to trade if you increase order quantity on the exchange’s order book. You pay more to trade if you decrease the order quantity on the exchange’s order book. How much? Very little, but if you are a big time trader, it adds up to 6, 7, 8 figures!
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