Triggering a conditional sell order on the bid price

Question

I recently set up a trailing stop sell order for an illiquid security that was triggered by the bid price going above a certain threshold. My rationale to trigger on the bid price was an attempt to minimize the effects of the magnitude of the bid-ask spread. When later on I saw that the security price had briefly gone above the limit I had set, the only question in my mind was at which price my sell order was executed. However, to my suprise I saw that my order not only had not been filled, but, even more puzzlingly, had not even been triggered.

I believe this unexpected outcome underlines an essential misunderstanding that I have of the concept of bid and ask prices, but all the further reading I have done on the subject has not helped me to fully understand exactly what happened . In my mind, I have always assumed that for a transaction to happen, the bid must equal the ask. More precisely, my assumption has always been that when a transaction happens at time t, at that precise instant of time necessarily
bid price(t)=ask price(t)=mark price (t)=last price(t).
However short the time interval during which this equality holds (possibly just fractions of a millisecond), the fact that these four prices become instantaneously equal when a transaction takes place should trigger a conditional order with a limit below the transaction price, no matter on which of the four prices the trigger is set.

I would really appreciate any help in understanding where the flaw in my assumptions is.

Answer 1

I finally understood what happened and why my ingrained belief that if a transaction happens at time t, then necessarily bid price(t)=ask price(t)=mark price (t)=last price(t) was wrong. I have not found it written anywhere, but it makes now perfect sense to me. The jist is that there is an implicit link between bid/ask prices and order types that I have never seen explicitly clarified. The bid and ask prices that are quoted for a security are only determined by the existing LIMIT orders on the buy and sell sides. Instead, market orders do not alter either the bid or the ask price, because by definition they buy at the existing ask or sell at the existing bid.

Let me clarify this concept using the example that originated my question.
I had set a trigger: if bid price of XYZ > $0.316, sell XYZ at $0.32. One day XYZ opened at $0.352 and after that first trade it went below $0.3. My question was: why was my order not even triggered? My broker told me it was not triggered because at opening the bid was only $0.266, while the ask was $0.352.
For the longest time, this made no sense to me because of the belief mentioned above: if a transaction had happened at $0.352, someone at a certain point in time must have necessarily been willing to pay that price.

Let see what might happen for that not to be the case. Saying that at opening the bid (the highest price someone is willing to pay) was $0.266 and the ask (the lowest price someone is willing to accept) was $0.352 simply means that at opening all the buy limit orders had limit <= 0.266 and all the sell limit orders had limit >= 0.352. Had the situation remained like this, no transaction would have happened because the bid-ask spread was huge (around 30% of the stock value). Enter now a poor misguided soul (or simply a noob) who decided to add XYX to her portfolio and did so through a buy market order: a market order does not specify a bid price, because the buyer is an easygoing person, does not like to haggle and just accepts to pay whatever the ask price is. That's why my order never got triggered: there was no one who was consciously bidding above $0.266. It just happened that someone suddenly arrived and put herself at the mercy of the sellers, and ended up paying a ~15% mark-up for the stock that no one was even close to be willing to pay.
Morale: Never submit a market order for an illiquid security, especially at opening, when treacherous buyers and sellers cast their nets wide hoping to catch inexperienced preys.

Answer 2

In my mind, I have always assumed that for a transaction to happen, the bid must equal the ask.

A locked market is when the bid and ask are the same. This is due to timing differences for quotes coming from different exchanges. It's an infrequent occurrence.

In order for a transaction to occur, someone must cross the spread. IOW, A buyer must agree to pay the ask or a sell must agree to sell at the bid.

I saw that the security price had briefly gone above the limit I had set, the only question in my mind was at which price my sell order was executed. However, to my surprise I saw that my order not only had not been filled, but, even more puzzlingly, had not even been triggered.

If you set a limit order to sell and you're the highest bid then you're part of the NBBO quote. A buyer who crosses the spread pays the ask and that price could be above your sell price and you'd get no fill on your order ("the security price had briefly gone above the limit I had set").

Answer 3

I think you are forgetting the spread and market makers. When we sell, we are not selling to another trader but to the "market maker". We get the bid price, the MM immediately sells it to someone buying on the ask and the MM makes a profit of the spread. It is worth remembering that if you are long on a position and have a LMT order to sell at $10 you may see a few candles that have reached your price but your order may not execute until a candle reaches a high above your LMT price. This can be more obvious if you review a trade on 5sec chart instead of 1min. You finally get filled when a candles reaches $10.01 or 10.02? These highs are more likely people buying from the market maker rather than someone being able to sell at the high. In summary I do not believe a trade only occurs when BID = ASK. This would only occur if Market Makers did not exist. Market Makers also may choose to only take fractions of a cent per share rather than the full spread depending on volume and price movement and the Algorithm.