Active order

Every order that lands in an exchange's order book does one of two things: it either waits for someone else to trade against it, or it trades immediately against an order that is already waiting.

An order that trades immediately is an active order. The workbook's definition: "Active orders are orders to buy or sell at the prevailing market price. These orders immediately get matched with existing orders in the order book." A market order is, by its nature, an active order — it accepts whatever price is currently on offer, so it is filled at once.

Its opposite is a passive order — one that sits unmatched because its price is away from the market, adding a new level to the order book rather than taking one out. A limit order priced away from the market is a passive order.

Take a live order book for a stock XYZ Co, with the best bid and offer at:

The best bid is 131.95 and the best offer is 132.05 — the bid-ask spread for the stock at this instant. Any new order that accepts one of those two prices trades immediately and is an active order; any order priced away from them joins the book and is a passive order.

Why the distinction matters for liquidity. Passive orders add liquidity: each one is a standing commitment to buy or sell at a stated price, and it creates a new level in the book, deepening it. Active orders drain liquidity: they are "reactive" — they respond to, and remove, an order that was already resting there. The workbook's own words: "Passive orders add to the liquidity in the market... Active orders thus drain liquidity from the market because they get immediately matched with existing orders." The farther a passive order's price sits from the prevailing market price, the more passive it is described as being.

An order not matched at all stays in the system, unmatched, until the end of the trading day or until it is cancelled or modified — which is possible only before it executes.

The last traded price of ABC Ltd is Rs 105.10.

An institutional investor who wants certainty of execution — say, to exit a position before a results announcement — places a market order. It is active: it matches immediately against whatever passive orders are sitting in the book, draining that liquidity, and the investor accepts the prevailing price rather than naming one.

A retail investor who is in no hurry and wants a better price than the current market instead places a limit buy at Rs 102.45. It is passive: it adds a new level to the book at that price and waits — possibly for hours, possibly for the rest of the trading day — until an active seller is willing to trade at it.

Chapter 4 (Secondary Markets), the "Active and passive orders" section following the discussion of the order book and order matching, sets out this distinction directly. Expect a definitional question — which kind of order matches immediately (active) and which adds to the order book (passive) — and a scenario question classifying a described order, of the kind worked through above, as active or passive.

• Active orders drain liquidity; passive orders add it. This is stated the opposite way round from what intuition suggests — "active" sounds like it should build the market, but it is the passive, waiting order that does that.
• A market order is always active because it accepts the prevailing price and matches at once; a limit order is passive only if its price is away from the market — a limit order priced exactly at the best bid or offer would match immediately and behave as an active order.
• "Passive" is a matter of degree. The workbook says the farther an order's price sits from the prevailing market price, the more passive it is — it is not a strict binary in practice, only in the buy/sell-at-market-price definition.
• Orders can be modified or cancelled only before execution. Once matched, the trade is done.
• Do not confuse active/passive order classification with active vs passive fund management — an unrelated pair of terms that happen to share an adjective.