Order Book

What is an Order Book?

An order book is an electronic list of buy and sell orders for a financial instrument organized by price level. Order books are used for stocks, commodities, forex, cryptocurrencies, and other financial assets to record the interest of market participants in transacting at different price points.

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An order book provides valuable information on the supply and demand dynamics for a given instrument. It shows the number of units being bid or offered at each price point, which is known as market depth.

Order books also reveal the parties behind these buy and sell orders, although some participants can choose to remain anonymous.

Key Components of an Order Book

Order books typically contain three key sections:

  • Buy Orders: This is a list of all outstanding buy orders, which are bids indicating traders are looking to buy the instrument. It shows the quantity sought and the bid price for each order.
  • Sell Orders: A list of all outstanding sell orders, which are offers that indicate traders’ interest in selling the instrument. It displays the quantity offered and the asking price for each order.
  • Order History: A record of all buy and sell transactions that have been completed recently. These records display the price and volume at which the transaction was settled.

At the very top of the order book are the best bid and best ask prices. The best bid is the highest price a buyer is willing to pay, while the best ask is the lowest price a seller is willing to accept.

The difference between the best bid and the best ask is called the spread. A tight spread generally indicates that the level of liquidity for that financial instrument is high.

How Does an Order Book Work?

When a new order is placed, it gets added to the appropriate side of the order book depending on whether it is a buy or sell order and the limit price specified. Outstanding orders are arranged in the book from best price to worst price.

If an incoming order can be immediately matched against an existing order, a trade is executed, and both orders are removed from the book while the transaction is recorded in the order history.

For example, if there is a sell order in the book offering 500 shares of XYZ stock at $25 and a new buy order comes in with a bid for 500 shares at $25, the two orders will be matched and filled, generating a trade at $25 for 500 shares.

The order book provides transparency into the state of liquidity and the current valuation of a trading instrument. Traders can use it to identify support and resistance levels, detect momentum shifts, and look for optimal entry and exit points for trades.

However, some large orders are executed through alternative trading systems known as “dark pools” that do not publicly display order information. These pools limit a market’s goal to achieve full transparency.

Special Types of Orders

Different special order types may be used alongside regular market orders. This is an overview of the four most common orders employed by traders to execute their transactions.

Order Type Description
Limit Orders Specify a maximum buy price or minimum sell price to execute a trade. These orders ensure that the price received is equal to or better than this specified level.
Stop-Loss Orders They trigger a market order to close out a losing position once a certain price is reached to limit losses for the trader.
Trailing Stop Orders They work similarly to a stop-loss order, but the triggering price moves with the market to lock in gains while keeping losses in check at the same time.
Fill-or-Kill Orders Must be immediately filled in full or else canceled. No partial fills are allowed. It is useful for large block trades and suitable for certain specific trading strategies.

These order types have specific parameters that need to be fulfilled to be executed, and they add an extra layer of complexity to the order book.

Reading the Market’s Depth

The number of shares, contracts, or coins on both the bid and ask sides at each price point is known as the ‘depth of market’ or ‘depth of book’.

The higher the volume that is available to be traded at different price points, the greater the depth. This signals a high level of liquidity and a greater ability to execute larger orders without substantially moving the price.

Traders keep an eye on the market’s depth to get a sense of market conditions and potential support and resistance levels based on clusters of major buy or sell orders gathered around certain prices.

Thin markets and securities with low volume have much less depth and are considered more volatile.

Analyzing Order Book Data

6 Key Trader Insights from Order Book AnalysisThere are several key insights that traders can hope to gain by analyzing order book data:

  • Price Direction: Imbalances between the price that buyers and sellers are willing to pay/receive may indicate which direction prices could take in the short term.
  • Momentum Shifts: Changes in order patterns, order volume, and order size can signal a change in the market’s trend, waning momentum, or an impending reversal.
  • Liquidity Conditions: Thinner markets carry higher liquidity risk and are more susceptible to price volatility.
  • Support/Resistance: Major clusters of buy or sell orders near certain prices may indicate the market’s consensus in regard to key support and resistance levels.
  • Market Participants: Seeing the type and size of orders can reveal if retail traders or institutions are more active at a given point. Institutions tend to buy in bulk, while retail traders often trade smaller volumes.
  • Trading Activity: Spikes in order cancellations or modifications may show that traders scrambling to adjust their positions upon weighing on new developments.

In fast-moving, liquid markets, the order book information is extremely dynamic, and traders must react quickly to capitalize on any signals that emerge from this activity.

Order Book vs. Time & Sales Data

Time and sales are another market data feed that records executed trades, providing transaction price, volume, and time data.

While the order book displays real-time open orders, the time and sales logs show a record of completed transactions after they have been filled. Together, they give a comprehensive view of market activity and liquidity throughout or after a given session.

The order book is most useful for day traders aiming to enter or exit positions at opportune moments based on real-time supply and demand dynamics.

Time and sales data are more applicable for technical analysis of historical price action.

Dark Pools and Order Books

One limitation of public order books is that they do not account for dark pools, which are private networks used to complete large trades that can be executed without disclosing the orders to the broader market.

Large traders use dark pools to avoid revealing their intentions and prevent adverse price movements as they establish or close out positions. Dark pool trades bypass public order books but are recorded in time and sales.

The presence of dark trading activity means that the order book does not always provide a complete view of the liquidity situation or the forces that are driving the price action.

Large surprise moves may occur when previously hidden orders impact prices once they are executed.

The Bottom Line

An order book provides valuable real-time information on supply and demand for a given security as well as liquidity conditions.

Along with time and sales data, it can help traders make sense of market dynamics and pricing.

However, due to certain factors like the presence or actions of dark pools, order activity may not be fully transparent. Order books must be interpreted with this context in mind.

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Alejandro Arrieche

Alejandro is a financial analyst, business expert, and freelance writer who's been following the markets and writing informative news content for more than seven years, covering all the latest developments and important topics in business, marketing, crypto and stocks. Other than Business2Community, Alejandro has also written for include The Modest Wallet, Buyshares, Capital.com, and LearnBonds. His daily news coverage includes technical content about economics, finance, investments, and real estate and has helped financial businesses build their digital marketing strategy. Alejandro's favourite topics are value investing and financial analysis. Alejandro graduated from Escuela Europea de Dirección y Empresa (EUDE Business School).