Ultimate Guide to Order Books and Market Depth

Orders are how you, as a trader, could interact with an exchange. But how do you know when to place an order? Are there enough buyers or sellers? Or are there too many sellers? Order books and market depth can help answer these questions. Both help traders and financial analysts find all this information at a glance. This blog will explain the two interlinked concepts and how they can help you.

What is market depth? And how is it connected to order books?

Market depth is a measure of the market’s ability to absorb rather large market orders without letting it significantly impact the security’s price. If the market for a stock is “deep,” and the orders are spread out evenly around the current market price, there will be a sufficient volume of pending orders on both the bid and ask sides. So any large order cannot significantly move the price.

The concept takes on board bids, offers, and open orders for an asset. The market depth can be ascertained by looking at level 2 price quotes. These may be found in the relevant order book, essentially a list of pending buy or sell orders at various price levels.

What is an order book?

Order books are a digital list of buy and sell orders on an exchange. Every asset traded on an exchange will have a separate order book. So there will be order books for each stock, bond, and crypto.

These books are organized by price level. And they list the number of coins that could be traded at every price point.
Due to the information order books provide on price, availability, depth of trade, and who initiates transactions, they help facilitate market transparency.

How does an order book work?

The orders listed in an order book can be both manual or electronic. The setup may vary a little depending on the source.

The primary function of every exchange is to match compatible buyers with sellers at every price point, and an order book helps with that. Buyers post bids on the exchange for specific coins, while sellers post asks. Trades on both ends are executed when a match is found. Order books are dynamic and track these evolving bids and asks in real-time.

How to read an order book: Parts of the order book

A typical order book consists of three main components: buy orders, sell orders, and trading history.

Bids vs. Asks

Buy orders are bids. They state the price and quantity the buyer wishes to purchase. On the other hand, sell orders, or asks, specify the price at which sellers are willing to part with their coins. So, a bid is the buy price, while an ask is the selling price.

Buy orders follow descending order, which means the highest bid is at the top of the order book. Sell orders are in ascending order, so the lowest sell price is at the top.

A trade is executed when the highest buy price matches the lowest sell.

You’ll find the highest bid at the top of the order book. That is, the largest amount someone’s willing to pay for the security/coin at that time. You will also find the lowest ask prices at the top.

Trading history and other parts

Order books also typically contain order histories that help determine the overall direction of market prices. Some books may contain market, stop-loss, limit, and trailing-stop orders.

How to read market depth charts

In addition to the order book, market depth charts are available in some cases. A market depth chart is a visualization of the order book. Therefore, like an order book, it illustrates the liquidity of a coin in the market.

Traders may favor the depth chart over an order book while looking for the bid-ask spread and support and resistance levels. Because a depth chart also depicts buy and sell “walls,” which can indicate the price at which a coin’s demand (or supply) dramatically increases. The walls represent many buy or sell orders at a given price point. The higher the wall, the deeper the market is.

Market depth charts also help determine the direction of price movements. For instance, a low market depth at specific prices could make moving prices easier for whales or large holders. Conversely, higher market depth could make prices harder to move, indicating stability in the short term.

What do traders use the order books and market depth data for?

To summarize our discussion, there are two primary uses of market depth data and order books. They are as follows.

Order book liquidity

Traders dealing with huge volumes of crypto often worry if their orders will be filled without moving the price. Because if prices rise as they buy, the averages and costs go up. Liquidity measures how easily these trades can be executed without moving prices. The more liquid an asset is, the higher its demand and supply. Market depth and order books both measure liquidity in their ways.

Support and resistance

Market depth charts also serve as support and resistance indicators for crypto. For instance, a big buy wall in the chart indicates that many people are willing to buy that coin at the specified price. When prices reach that point, they stay put as many buy orders keep prices afloat. Therefore, traders might be persuaded to sell an asset or buy more at a large-enough buy wall.
The same works for a sell wall. Since there are a lot of sellers at a particular price point in a high sell wall, it acts as a resistance to further price appreciation. Many sellers prevent prices from going higher and act as a wall, preventing the market from moving upwards.

Now that you understand order books and market depth, you’re set to begin your trading journey. So, bon voyage, amigos. Travel safely, don’t accept tips from unreliable sources, and enjoy the ride!

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