Order Depth
There is a finite number of lots that you are able to buy or sell at any given bid or offered price. This is known as order depth. For example, if there are five lots of LME 3M copper bid at $9500/mt, this means that the largest size you could sell at that price, at that exact time would be five lots. If you had an order for 10 lots that you needed to fill at market (at the best current price), you would receive 5 lots at $9500/mt, and then five lots at the next best bid. Let's say that next best bid was $9499, and the depth was again 5 lots, your 10 lot order would be filled with a combination of 5 lots at $9500, and 5 lots at $9499, for a final price of $9499.50 for all 10 lots.
This is important to understand because counterparties will often be watching the screen price, and expect to be filled for any amount of volume at that bid or offered price, regardless of the order depth available. To avoid confusion, you need to be able to explain to them why they aren't necessarily receiving that exact price they see on-screen.
A counterparty might also expect to be filled on a level order they had been working, as soon as the last traded price hits their level. However, let's say they had been working to sell 40 lots of Copper at that same $9500/MT. $9500/MT hits, but only 5 lots are executed at that level before the price moves back down. The most you could possibly have been filled on is 5 lots, but you may not have been filled on any of your order depending on where you were in the queue - there may be 100 lots waiting to be filled at that level and they are filled on a first-placed first-filled basis. It is much better to proactively explain to counterparties that place these types of orders exactly how they work, so they are not disappointed if this situation occurs.
Some counterparties will also place what is known as iceberg orders. Let's say you want to buy 40 lots of aluminum at $2,340 and the price is currently $2,345. If you were to show the market all 40 lots at $2,340, this might act as catalyst to other market participants to place their orders just above yours. You might get a lot of orders come in at $2,340.50 or $2,341. Should this happen, it would make it harder for the market to drop to your target level. An iceberg trade allows you to place the order for all 40 lots at $2,340, but only show a pre-set number of lots, say 5 at a time. Only 5 of your lots would appear on the depth chart but once they had been filled, the next 5 lots would automatically reappear. This would keep happening until all 40 of your lots had been filled. The downside to using iceberg trades is that after each segment of your order is filled, the next order goes to the back of the queue. In this example, there might be 20 lots waiting to be filled at $2,340 - your 5 and 15 others from other companies. Once your first five lots are filled, you would have to wait for the next 15 lots to be filled at that price before your next five were filled. If you had placed all 40 lots at once, all 40 lots have the same place in the depth queue. It is a calculated risk whether to use iceberg trades or not, but you will often see them being used around psychological barriers such as big figures or round numbers where the market knows a lot of interest lies.
