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Understanding Order Books: A Guide for Traders

An 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 that people in the market are willing to buy and sell the security for.

Order books were originally used in stock exchanges but are now becoming popular in cryptocurrency trading as well (i.e., BitcoinBitcoinBitcoin is the forerunner of the cryptocurrency market. Operating on blockchain technology, Bitcoin is set to disrupt the currency market. Invented in 2008). The books are usually electronic, making them available online for traders worldwide.

An order book is a useful instrument for traders and financial analystsFinancial Analyst Job DescriptionThe financial analyst job description below gives a typical example of all the skills, education, and experience required to be hired for an analyst job at a bank, institution, or corporation. Perform financial forecasting, reporting, and operational metrics tracking, analyze financial data, create financial models because it provides instant and valuable market pricing information over the recorded security.

Components of an Order Book

The outline of an order book can vary between the recorded securities. However, it usually consists of several components, as listed below:

1. Buyer’s side and seller’s side

An order book is a market price recorder. Therefore, it includes a buyer’s side and a seller’s side – the two major participants in a market.

2. Bid and ask

Instead of using a buyer’s side and a seller’s side, some order books use the terms “bid” and “ask.” Buyers are the ones who “bid” for a certain number of shares at a specified price, and sellers “ask” for a specific price for their shares.

As a rule of thumb, the buyer’s side (bid) is on the left, and the seller’s side (ask) is on the right, colored green and red, respectively.

3. Prices

An order book records the value interest of both sides. The number in the buyer’s or seller’s columns represents the amount they are bidding or asking for and at what price.

4. Total

The total columns are the cumulative amounts of the specific security sold from different prices.

5. Visual demonstration

Normally, an order book comes with a table of numbers consisting of prices and total amounts from two sides. To better represent the relationship between buyers and sellers, most of the order books come with a visual demonstration as well. It can be in the form of a line chart or others. In this way, the reader can quickly achieve an overall understanding of market demand and supplySupply and DemandThe laws of supply and demand are microeconomic concepts that state that in efficient markets, the quantity supplied of a good and quantity.

Practical Example

Understanding Order Books: A Guide for Traders — Source

The image above showcases the buyers on the left (bid) and the sellers on the right (ask).

Example: On the buyer’s side, 778 units are being sold at a price of 7,500. On the seller’s side, 518 units are being sold at 7,600. The order book is filled with units being sold at other varying price levels as well.

We can see that the total amount is accumulated depending on different price levels. For instance, on the buyer’s side, at a price level of 6,872, the amount is 49,500. It is added by the previous bidding offer of 20,000, and the current one at 29,500 (20,000 + 29,500 = 49,500).

Order Book – Advantages

An order book shows the buy and sell prices in real-time (constantly being updated). It allows market participants to make informed decisions. Moreover, it helps market participants understand the market trends and dynamics over time.

Order Book – Uses

With the instant market update characteristic of an order book, orders can be matched automatically depending on the trader’s preference.

The most common example is the order being fulfilled based on the current market demand and supply. The order is being bought or sold according to the current market price.

Another example is when a trader employs limit order strategies. In such a case, traders can set a certain price level at which they want to buy and sell the security. When the market price moves to the set price, the order will be completed automatically.

Conclusion

An order book is a useful tool for traders. Learning how to read it can help traders tremendously in understanding the market they’re currently trading in or about to enter. Studying the order book in the long term enables traders to know whether or not the market of a security is healthy. The more information traders can learn about the market, the more informed decisions they can make about their orders.