order book

Information is key, and this also rings true in the investment world. When drafting strategies and making investment decisions, it is always good to consult as many forms of data as you can find on the asset, as data is king, after all. By studying data, you’ll be able to create more intelligent and fact-backed strategies.

The order book is one vital data source every investor should be well-acquainted with. An order book is an electronic list of buy and sell orders and prices for a particular asset. Studying the order book before investing in an asset is an act that pays off, as it offers more insight into that asset and could determine market direction.

In this article, we’ll educate you on everything you need to know about an order book, including the components of an order book and even how order matching works.

What Is an Order Book?

Simply put, an order book is an electronic list of buy and sell orders for a particular financial instrument and the prices at which they were bought or sold. They’re like an open sales journal in centralized exchanges (CEX) that automatically documents buy and sell orders for a particular asset and leaves it available for the general public.

Order books are used to represent the intentions of buyers and sellers by showing a list of the outstanding orders of an asset in real time. This function gives insight into the market depth— the number of orders bought or sold. Together, an order book’s market depth and liquidity help discover new market prices. By using order books, traders can get some helpful insight that guides them in making better trading decisions and improving market transparency. Many asset classes like stocks, bonds, and cryptocurrencies use order books. While they typically contain the same information, the arrangement might differ depending on the exchange.

The basic information that a typical order book contains is:

  • Bids— buying orders
  • Asks— selling orders
  • Prices
  • Order history
  • The total amount of the asset 

The bid and ask information may be placed at the top and bottom or left and right part of the screen. Order books are dynamic— constantly changing and updated throughout the day.

Components of an Order Book

Order books are used for different asset classes, and while they might have some differences, there are still essential parts that make up a standard order book.

  • Bids (buying orders): This part contains all the buyer information, including the bid price and the amount ordered. The bids are usually recorded in green for easier identification.
  • Asks (selling orders): This part comprises seller information, including the asking price. Asks are usually recorded in red for the same reason that bids are recorded in green.
  • Order history: In this section, the transaction history is displayed. It shows the buyer and seller transactions and notes the prices, date of transaction, and number of orders.
  • Prices: Order books record buyers’ and sellers’ prices and interest value. 
  • Total asset amount: This side displays the sums of specific shares, previous records, and prices. It reveals the total amount of assets sold at specific prices.

These components compromise a typical order book. With all this information at your disposal, you can see that the order book contains valuable data vital to your trading decisions.

An order book can help you decipher whether an asset is headed in an uptrend or downtrend. It can also detect price supports as well as resistances. Above all, it could make you a market maker— when you’ve studied the trends and locked in a unique asking or bidding price for the order. The main parts of an order book are the asks and bids section, as it is through their data that these trading decisions are made. We shall explain them in a deeper context to help you further understand their importance.

Ask vs. Bid Orders

The ask and bid section of an order book provides more information about an asset than the other parts. As explained before, the ask price is the lowest price possible that a seller is willing to receive for the asset. However, the ask price is affected by the demand for the asset. If demand increases, the ask price increases, and vice versa.

Most exchanges offer their lowest ask price to bidders. Note that an asset cannot be sold lower than its lowest ask price but can be sold higher. Notwithstanding, if a seller’s ask price is above the current average market price, then chances are there will be no takers.

On the other hand, the bid price is the highest price possible that a buyer is willing to spend to acquire an asset. When there is high demand, the bids increase, and vice versa; this means that, like the ask price, the bid price is also affected by an asset’s daily trading volume. Assets can be bought below the bid price but never higher, unlike asks. Also, if the bid price is lower than the average market price, there will need to be an adjustment, or sellers won’t be interested.

In summary, the bid represents the demand for the asset, while the ask represents the supply for the asset, and investors need to get these details before investing in an asset. This importance cannot be underestimated because when you study both the bid and ask spreads, you’ll know whether the asset is about to pump or dump. Typically, if an asset has more bids than asks, it could be a sure sign of an upward trend. If, however, the opposite is the case, then it could be that the asset is about to take a plunge.

Bid-Ask Spread

In an order book, the bid and ask prices usually differ. The difference between these two is called a spread. The spread represents the profit and loss of the market makers because if a trader buys an asset at a higher ask price, receives a bid for it at a lower price than the ask, and sells it at that bid price, it is recorded as a loss. If the opposite happens, then it is a profit. Also, when the asset has a high trading volume, the spread is usually low, but when the trading volume is low, the spread is bigger.

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Order Book Manipulation

They say numbers don’t lie, but that doesn’t mean they cannot be manipulated. Some exchanges, known as dark pools, manipulate order books and don’t include or exaggerate some transactions in the public profile. Order book manipulation is a type of market manipulation usually done by manipulating order books to create controlled reactions to the market.

For example, if you see an asset’s order book containing 15 bids and 8 asks, the obvious interpretation is that it has more demand than supply, so the price is expected to go up. An unsuspecting trader will buy into this trade without waiting to see those buy orders executed. When this happens, and more traders start buying into the asset, the price of the asset will increase. What happens then is that the people that placed those high bids will cancel them before they get executed, then come back to the market and place ask orders using the new prices, thus profiting off of the price difference and leaving with high-profit margins and little risk.

How Does Order Matching Work?

Order matching means connecting and validating similar and opposite trades for an asset. Exchanges connect buyers and sellers whose prices are compatible. An order is compatible if the maximum bid price is equal to or higher than the minimum ask price. Order matching makes trading more organized and eliminates the stress of manually looking for an order request that matches your price, as the entire process is now automated.

Historically, order-matching was done face-to-face on an exchange floor in an open-outcry manner, but now, it has been automated and has different methods of singling out orders for matching. Order-matching systems need to be fast and accurate, as slow order-matching systems may cause losses and could be exploited.

High-frequency trading has improved order-matching efficiency in exchanges. Now, exchanges rank trades in mutually-beneficial ways for buyers and sellers and maximize order volume, which is vital for every exchange.

Updated on: January 8, 2024