TL;DR
- An order book is an electronic list of buy and sell orders for an asset organized by price level.
- Order books provide a great insight into market supply and demand.
- Market depth is the platform's capacity to accommodate relatively big market orders without affecting the asset price.
- Order books can reveal whether the momentum is in favor of the bulls or bears, as well as the prevailing support and resistance levels.
- Do not only use information from an order to make trading decisions.
An order book is an electronic list of buy and sell orders for a specific asset or financial instrument organized by price level.
In an order book, the market depth is represented by the number of assets being sold and bid on at various prices. Order books provide a great insight into the market’s supply and demand, through the information listed in an order book, which provides transparency for both buyers and sellers.
Order books can differ visually between exchanges, but their function remains the same.
What is Market Depth?
Market Depth is the market’s ability to adsorb large market orders without significantly impacting the price of the said asset. This takes into account the liquidity and the volume of the asset. The more buy and sell orders within the asset’s trading pair, the deeper the market depth.
How to read an Order Book?
An order book has a few data points that will give you insights about the market.
Bid Price
The Bid Price is the price at which someone is willing to purchase the asset. Bid Prices are usually lower because buyers will want to purchase the assets lower than the market price.
If you were to put in a Bid that is higher than the Ask Price, the exchange will automatically execute the order by matching the Ask Price.
Some crypto exchanges have safeguards in place to prevent "overbidding." If the trader puts in a bid price that is way too high, the exchange will prompt a message to warn the trader about the price disparity.
For example, Coins Pro will automatically reject an order if it exceeds the limits of the current asks and bids placed on the platform. This is an in-built security feature that protects users from potential market manipulation.
Ask Price
The Ask Price is the price at which the seller is willing to sell the said asset. Ask Prices are usually higher because sellers want to sell their assets at above market price. A bid-ask spread is a difference between the asking and selling prices.
Some traders place their ask price higher than the prevailing asset price to anticipate an impending price increase. For example, BTC could be trading at $10,000, but a trader can place a sell order at $15,000. When a bid price matches the lowest ask price, the market order is automatically filled.
Quantity/Amount
Quantity (or size) and amount are relevant to each other. The quantity or amount per order simply shows the number of units at the price listed.
For example, a trader wants to buy a quantity of only 1 BTC at a bid price of 1,000,000 PHP. 1 BTC is the quantity/amount and 1,000,000 PHP is the Bid Price.
Total
In the order book, there’s another column that shows Total. This is the total amount of orders of the asset. For example, in BTC/PHP pair, there is P10,940 of orders to sell 0.0102547 BTC at a price of 1,066,828.4 PHP.
The total can be easily calculated by taking the Ask/Bid Price multiplied by the number of assets.
How Does an Order Book Work?
Every cryptocurrency exchange uses order books to track buyer and seller demand. Their presentation may vary slightly depending on the exchange. However, their function is almost if not the same.
Order books are dynamic; they are updated continuously throughout the day. Only market open and market close orders are maintained separately. The two books are referred to as "opening" and "closing" order books.
At the start of each trading day, the opening price and orders are combined into a single opening price. When the market closes, a single closing price is calculated by adding together the closing book and the continuous book.
The function of Order Books in Trading
Order books can reveal whether the momentum is in favor of the bulls or the bears. If the buy order volume is much larger than the sell order volume, especially at the optimal bid/ask price level, this indicates stronger momentum from the buy side and a potential increase in price.
Conversely, more sellers indicate that bears have more control of the market. Since the order book is dynamic and might experience sudden spikes in activity, constant attention is required in order to detect even the slightest price trend.
A candlestick chart can provide useful insights into the market's present behavior and historical trends. The order book provides traders with crucial information for making educated trades. By looking at the order book, traders can track which asset is actively being traded, revealing whether the market activity is being driven by regular investors or institutions. In addition, the order book reveals order imbalances, which reveal short-term price movements.
For example, if there is a significant disparity in the number of buy and sell orders, the asset price may rise due to an increase in buying pressure. Potential support and resistance levels are also identified using the order book. Many big buy orders placed at the same price may point to strong support levels, while many sell orders placed around the same price may point to an area of resistance.
A "Buy Wall" occurs when there is a concentration of buy orders at a certain price level that don't meet the asking price of sellers. Buy Walls usually forms an area of support because sellers are not willing to sell their assets for lower prices which keeps it at a support region where the price will not fall below that.
When there is a high amount of sell orders at a certain price level, the resulting pattern is called a “Sell Wall”. A sell Wall creates a resistance point because buyers are not willing the purchase the asset at that price which means low chances of price appreciation.
The order book can provide us with a lot of trading information and market sentiment. However, it’s best to use information from an order book as well as other trading indicators to get a better picture of the market scenario, allowing you to make informed trading decisions instead of just relying on one indicator alone.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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