It hit me that most people don’t really understand what’s happening inside the candlesticks;
how gaps are created, why price jumps the way it does, and why it eventually comes back to certain levels.
Alright, let me break this down for you: 👇🧵
How Liquidity Works in the Order Book:
The order book is a "digital ledger" containing buy (bid) and sell (ask) orders placed by traders. These orders are organized by price levels. When price moves, it matches market orders (aggressive trades) against the limit orders sitting in the book. If a large buy order hits, it "eats through" the asks (sell orders) at each price level until it runs out of liquidity, causing the price to jump.
What Happens During a Fast Move:
Liquidity Voids:
If the momentum is strong (like a pump), there are fewer limit orders at certain price levels, or they get consumed faster than new ones can replace them. This leaves "gaps" where little to no trading happens. These gaps are what we call price inefficiencies.
Spread Impact:
When liquidity is thin, the spread between bids and asks widens. This creates a vacuum effect where price moves faster and skips over intermediate levels.
How the Market Fills the Gap
Market Makers’ Role:
Market makers are algorithms or traders that provide liquidity by placing both buy and sell orders. When price moves too far, too fast, market makers step in to stabilize the order book by placing new orders in those gaps.
Arbitrageurs’ Role:
Arbitrage traders look for discrepancies in price across exchanges or assets. They exploit these inefficiencies, buying or selling at the gap levels, which brings more volume and liquidity to those areas.
Self-Correcting Order Flow:
The market has a self-balancing mechanism where traders, algorithms, and institutions naturally refill the order book. Gaps attract activity because they represent an imbalance, more buyers or sellers are drawn to those levels as they try to profit from the inefficiency.
Back-End Infrastructure Mechanics:
Matching Engines:
Every exchange runs on a matching engine, which pairs buy and sell orders. During fast moves, the engine prioritizes market orders (trades executed at the best available price) over limit orders. When market orders dominate, gaps appear because the engine has no orders to match in those zones.
Order Queue Dynamics:
As price "calms down", new orders enter the queue, slowly rebuilding liquidity in the skipped areas. This causes price to naturally drift back and "fill" the inefficiency.
So on the backend, it’s the matching engines, the order book dynamics, and the role of market makers/arbitrageurs that explain why price inefficiencies happen and how they get filled.
It’s all about liquidity imbalance and the system’s natural drive to restore equilibrium.