Depth of Market (DOM): Understanding Real-Time Order Book Data

Depth of Market (DOM) is a window that displays the real-time market activity at different price levels in a security or currency market. DOM is also known as the order bookOrder BookAn order book is a list of orders that presents different offers from buyers and sellers for a specific security. It shows the prices and volumes. It records the pending buy and sell orders of particular securities, and thus, helps to determine which trade can be made.

Summary

• Depth of Market (DOM) is organized in a list of prices and shows the numbers of pending buy and sell orders corresponding to each price level.
• Traders can forecast whether the price will move up or down through the trend of DOM, and thus, determine the timing to buy or sell.
• DOM is impacted by the tick size of a security, allowable leverage, price movement and trading restrictions, and market transparency.

Understanding Depth of Market (DOM)

Depth of market is organized in a list of prices and shows the numbers of open buy orders and sell orders corresponding to each price level. The numbers are an indicator of liquidityLiquidityIn financial markets, liquidity refers to how quickly an investment can be sold without negatively impacting its price. The more liquid an investment is, the more quickly it can be sold (and vice versa), and the easier it is to sell it for fair value. All else being equal, more liquid assets trade at a premium and illiquid assets trade at a discount., showing the supply (buy orders) and demand (sell orders) of a security.

The DOM measures the sizes of orders that need to be completed in order to move the market to the next price level. The greater the number of buy or sell orders open at a certain price level, the deeper the market is, and more orders need to be executed to move the market price, and vice versa.

Also, DOM informs traders of the number of shares that they can buy or sell without causing price changes. If a market is highly liquid with large groups of buyers and sellers, the market is usually deep, and executing a large order will not cause significant price changes. Conversely, if the depth of a market is low, a large number of orders will move the market price more considerably.

Thus, investors should take the liquidity or DOM of a security into consideration, especially when placing large-size orders. When the market is not sufficiently deep, traders might need to break down a large order into several small pieces and execute each at a different price level. If it is a buy order, the price level will move up one at a time every time a batch of orders is executed; if it is a sell order, the price will gradually decrease. Neither of the cases is favorable to investors.

DOM is mostly used in the currency and security markets. Most exchanges and trading platforms offer such information, either free or for a fee. The list is updated to show real-time pending orders and trade sizes, which allows traders to understand the current market activities.

Application of Depth of Market

Traders can forecast the immediate price change through the market depth. For example, a stock is currently traded at $50.00.

Above the current price, there are:

• 300 pending offers at the price of $50.05
• 220 offers at $50.10
• 150 offers at $50.15

Below the current price, there are:

• 160 offers at the price of $49.95
• 90 offers at $49.90
• 50 offers at $49.85

The trend indicates that the market price of the stock is more likely to move up slightly. Thus, a trader can determine whether it is a good time to buy or sell.

Factors that Impact Depth of Market

1. Tick size

Tick size is the minimum price increment that a security can move. If the tick size is too small, there is less incentive for market makersMarket MakerMarket maker refers to a firm or an individual that engages in two-sided markets of a given security. It means that it provides bids and asks in tandem with to post orders in advance, since others are able to go ahead of them by posting orders with little difference in price.

If the tick size is too large, traders are more motivated to take priority by posting orders in advance. Thus, an appropriate tick size is important to balance the DOM.

2. Minimum margin requirements

Minimum margin requirements limit the leverage that an investor is able to take. Higher minimum margin requirements lower the market depth since parties participating in transactions cannot make large orders without that much capital.

3. Price movement restrictions

In many financial marketsFinancial MarketsFinancial markets, from the name itself, are a type of marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. Often, they are called by different names, including "Wall Street" and "capital market," but all of them still mean one and the same thing., security prices are not allowed to move completely free. There are price change limits and trading curbs set by exchanges. The future contracts for many commodities – such as corn – are subject to fixed and variable price limits. Limiting the range that the price can move within increases the market depth.

4. Trading restrictions

Some trading restrictions – such as futures and options position limits established by the U.S. Commodity Futures Trading Commission (CFTC) – cap the number of shares or contracts that an individual can earn. These restrictions can prevent individuals from unfairly controlling the market.

5. Market transparency

Although participants can access much of the market information, there is still information not available – for example, the pending bid and offer prices. The transparency of a market can cause concerns to participants and impact their willingness to post their orders.

Related Readings

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In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

• Matching OrdersMatching OrdersMatching orders refers to the process of entering identical orders of buy and sell simultaneously to encourage trading in that particular security.
• Maintenance MarginMaintenance MarginMaintenance margin is the total amount of capital that must remain in an investment account in order to hold an investment or trading position and avoid a
• Trading MechanismsTrading MechanismsTrading mechanisms refer to the different methods by which assets are traded. The two main types of trading mechanisms are quote driven and order driven trading mechanisms
• Volume of TradeVolume of TradeVolume of trade, also known as trading volume, refers to the quantity of shares or contracts that belong to a given security traded on a daily basis