Order Book 101
- ugne58
- Feb 5
- 5 min read
Updated: Feb 11
If you have ever traded in financial markets or are curious about trading, you’ve likely encountered the term order book. It is a fundamental tool that provides a real-time view of supply and demand for a specific asset. This article explains what an order book is, how it functions, and why it is essential for traders.
What is an Order Book?
An order book is an electronic list of buy and sell orders for a financial instrument, such as stocks, cryptocurrencies, or derivatives, organized by price levels. It helps traders understand market supply and demand by showing what buyers are willing to pay (bids) and what sellers are asking (asks). Exchanges or trading platforms maintain order books, updating them in real time as new orders are placed or executed.
The order book consists of two main components:
Bids (Buy Orders) – Prices and quantities that buyers are willing to pay for an asset.
Asks (Sell Orders) – Prices and quantities that sellers are willing to accept for an asset.
For each order, the order book displays the price and quantity at which traders are willing to transact.
How the Order Book Works
1. Structure of the Order Book
The order book is typically arranged in two columns:
Left side: Bids (buy orders), sorted from the highest to the lowest price.
Right side: Asks (sell orders), sorted from the lowest to the highest price.
Each row represents a specific price level and the quantity available at that price. For example:
Bid Quantity | Bid Price | Ask Price | Ask Quantity |
|---|---|---|---|
100 | $99.50 | $100.00 | 150 |
200 | $99.00 | $100.50 | 150 |
80 | $98.50 | $101.00 | 280 |
100 | $97.50 | $102.00 | 120 |
200 | $97.00 | $102.50 | 180 |
250 | $96.50 | $103.50 | 300 |
70 | $95.50 | $104.50 | 400 |
120 | $94.00 | $105.00 | 100 |
In this example:
The highest bid price is $99.50 for 100 units.
The lowest ask price is $100.00 for 150 units.
The gap between the highest bid and lowest ask is called the spread (in this case, $0.50). A smaller spread means the market is more liquid.
2. Order Matching and Execution
When a buy order matches a sell order, a trade is executed. For example:
If a trader places a market buy order for 50 units, it executes at the lowest ask price ($100.00).
If a trader places a market sell order for 100 units, it executes at the highest bid price ($99.50).
3. Types of Orders in the Order Book
Market Orders: These are orders to buy or sell immediately at the best available price. Market orders remove liquidity from the order book because they consume existing bids or asks.
Limit Orders: These are orders to buy or sell at a specific price or better. Limit orders add liquidity to the order book because they become part of the visible bids or asks.
Stop Orders: These are conditional orders placed to buy or sell a security once its price moves past a specific point, triggering a market or limit order. They are commonly used to limit losses and serve as an effective risk management tool.
Why is the Order Book Important?
The order book provides traders with critical information about market dynamics. Here are some of the key benefits:
Transparency: The order book shows the depth of the market by revealing the available liquidity at different price levels. Deep order books with lots of orders make it easier to buy or sell without moving the price up or down too much.
Price Discovery: It helps traders gauge supply and demand to determine a fair price for an asset. However, since orders can be placed and removed quickly, traders should be cautious - buy and sell walls can sometimes be used to manipulate market perception by creating a false sense of supply or demand.
Strategic Planning: Traders can place orders strategically by analyzing the bid-ask spread, order size, and overall market depth. Traders analyze the number of pending orders at various price levels to predict possible market movements. For example, if there are many buy orders around specific price, there is a higher probability of those levels acting as support.
Example: Trading with the Order Book
Imagine you’re trading Company X’s stock:
Scenario 1: You Place a Market Order
The current order book:
Bid Quantity | Bid Price | Ask Price | Ask Quantity |
|---|---|---|---|
200 | $50.50 | $51.00 | 100 |
300 | $50.00 | $52.00 | 150 |
250 | $49.00 | $53.50 | 200 |
150 | $48.50 | $54.00 | 100 |
180 | $48.00 | $54.50 | 450 |
350 | $47.00 | $55.00 | 250 |
You want to buy 150 shares immediately. A market buy order will:
Consume the 100 shares available at $51.00.
Consume 50 shares at $52.00 (because the remaining 50 shares cannot be filled at $51.00).
The new order book after your trade:
Bid Quantity | Bid Price | Ask Price | Ask Quantity |
|---|---|---|---|
200 | $50.50 | $52.00 | 100 |
300 | $50.00 | $53.50 | 200 |
250 | $49.00 | $54.00 | 100 |
150 | $48.50 | $54.50 | 450 |
180 | $48.00 | $55.00 | 250 |
350 | $47.00 | $56.00 | 100 |
Scenario 2: You Place a Limit Order
Let’s say you’re willing to buy 100 shares at $50.50 but not higher. You place a limit order at $50.50.
Your order becomes part of the bids, and the updated order book looks like this:
Bid Quantity | Bid Price | Ask Price | Ask Quantity |
|---|---|---|---|
300 | $50.50 | $52.00 | 100 |
300 | $50.00 | $53.50 | 200 |
250 | $49.00 | $54.00 | 100 |
150 | $48.50 | $54.50 | 450 |
180 | $48.00 | $55.00 | 250 |
350 | $47.00 | $56.00 | 100 |
Now, you’re adding liquidity to the market. Your order will remain in the book until someone agrees to sell at $50.50 or you cancel the order.
Visualizing Order Books: Depth Charts
A depth chart is a visual representation of the information in the order book. When people refer to “depth,” they mean the available supply of an asset - the total quantity that buyers and sellers are willing to trade at different price levels. Generally, a market is considered “deeper” when there are more buy and sell limit orders spread across various prices.
You can think of the depth chart as the order book but flipped on its side:
The X-axis represents the price levels of an asset, such as Bitcoin in the example below, increasing from left to right.
The Y-axis shows the total quantity of the asset available for buying or selling, increasing from bottom to top.
Like the order book, the depth chart is split into two sides:
Buy Side (Green Bid Line): Represents the total value of buy orders.
Sell Side (Red Ask Line): Represents the total value of sell orders.
The center of the chart shows the current mid-market price and the spread - the difference between the highest bid and lowest ask.
Traders analyze depth charts to identify familiar patterns and predict potential market movements. One common pattern is the appearance of steep, cliff-like formations known as walls:
Buy Walls: Indicate strong support at a certain price level, meaning a large buy order or many buyers could prevent the price from dropping further.
Sell Walls: Indicate resistance, where a large sell order or many sellers may prevent the price from rising.
These walls act as barriers to price movement, influencing how the market behaves at specific price levels.
Closing Thoughts
The order book is a vital tool for traders, providing real-time insights into market supply, demand, and price movement. Understanding bids, asks, the spread, and depth charts help traders make informed decisions and develop better strategies. By analyzing market depth and order flow, traders can anticipate price movements and navigate the markets more effectively.
