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An order book is an electronic list that details the buy and sell orders of a specific security or any financial instrument. The list is organized by price level. Order books are used by almost every exchange for various assets like stocks, bonds, currencies, and even cryptocurrencies. These lists help improve market transparency by providing information on price, availability, depth of trade, etc.
Key Takeaways
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Order books include real-time purchase and sell orders, organised by price level.
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They assist traders in assessing market depth, liquidity, and price sentiment.
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Order books can identify support or resistance zones by marking grouped orders.
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They are frequently utilised in the stock, forex, commodity, and cryptocurrency markets to help investors make educated decisions.
Understanding Order Book
Orderbook can be both manual and electronic. However, most order books are electronic in today's digital age. In terms of information, most of the order book contains similar information. However, their design, placement, content, and structure may differ based on the platforms.
Components of an order book
There are generally the following parts to an order book -
Buyer's and Seller's sides
An order book is a price recorder and includes the Buyer's and Seller's side – the two participants of the market.
Bid and ask
Some older books use the terms "bid" and "ask" instead of "Buyer's" and "Seller's" sides. Buyers are for "bid", and sellers are for "ask". Where buyers bid for a certain number of shares at a specific price, and sellers ask for a particular price for their shares. As a general practice, the bid is on the left and the ask is on the right, both coloured green and red, respectively.
Prices
The order book records the interest of both buyers and sellers. The column on both the Buyer and seller sides represents the amount the buyers and sellers are bidding or asking for.
Total
The total columns are the cumulative amounts of the specific security sold at different prices.
Special Considerations
Order books do not ensure execution at the prices stated since orders can be cancelled or amended at any time. Additionally:
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Order books aim to promote transparency. However, not all orders are visible, particularly those placed through dark pools.
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Dark pools are secret, concealed order forums used by major institutions to keep their trading decisions from impacting market pricing.
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If major deals become known before execution, they might cause prices to decrease due to anticipated market effects.
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Dark pools assist in limiting market disturbance by notifying deals only after they are completed, protecting major investors from unfavourable price changes.
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However, the presence of dark pools implies that the apparent order book may not always accurately reflect genuine supply and demand, decreasing its usefulness for exact market research.
How Matchmaking Works in an Order Book
When you look at the order book, you will see it is dynamic, with the numbers changing in real-time. When the numbers change, the buy and sell orders are fulfilled or canceled. The process is through a process called matchmaking.
Matchmaking tends to match buy and sell orders. When a buy order for Rs 2305 for ten stocks of Reliance Industries Ltd is made, the match is made with a sell order at the same price. If the sell order was only for two stocks instead of ten, the buy order is partially fulfilled, and the remaining is outstanding as a partial open order for which another sell order is scouted.
All this buying and selling takes place quickly in a digital exchange, with orders being executed in seconds.
Also Check Out, Reliance Industries Share Price Live
How to read order book
The top of the book is the highest bid, and the lowest ask price. This points to the predominant market where the price needs to be executed.
For Example, a significant imbalance in the buy-side vs sell-side may indicate an upward or downward movement in the stock.
Also, a cluster of large buy orders at a specific price suggests a support level where an abundance of sell orders at or close to one price suggests an area of resistance.
Example of an Order Book
Consider a stock with the following order levels:
|
BID (Buy Orders) |
ASK (Sell Orders) |
|
Price (₹) | Qty |
Price (₹) | Qty |
|
100.00 | 500 |
101.00 | 300 |
|
99.00 | 700 |
102.00 | 800 |
|
98.00 | 1,000 |
103.00 | 900 |
This tells us:
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Traders are prepared to purchase more aggressively (in bigger numbers) at lower prices, signalling lesser demand.
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The lowest ask price is ₹101, requiring a bidder to pay at least ₹101 to receive shares instantly.
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A dense concentration of ask orders at ₹102-103 indicates probable resistance.
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High activity on the bid side at ₹98-99 might imply support.
This structure assists traders in planning entry and exit points, as well as detecting probable price movements.
Advantages of the Order book
An order book, as mentioned previously, shows the price of a security in real-time and participants' interest in terms of buying and selling. This allows participants to make informed decisions. It helps investors/traders understand the market trend and dynamics over time.
Uses of the order book
With order book-matchmaking characteristics, orders are matched automatically. The most common example here is fulfilling an order based on demand and supply.
Another example is where a trader or investor applies any limit strategy. In such scenarios, traders can set a specific level at which they want to buy or sell a security. Whenever the current price of the asset moves to the set price, the orders placed are completed automatically.
Interpreting spread, market depth and liquidity
The bid-ask spread is the difference between the highest price for buying and the lowest selling price. The number is generally seen above the order book and updated dynamically as orders are canceled or filled. The spread is used as an indicator for the demand and supply of the asset. Additionally, bid spread also relates to the market's liquidity that evolves from market makers to price takers. Thus, the tighter the spread, the more liquid the market is. It isn't easy to exchange assets at stable prices in a market with low liquidity.
Conclusion
An order book acts as a live list of buy and sell orders that reveals the true supply and demand for a stock. By checking this data, traders can easily spot price trends and identify where the price might stop or turn around. However, you should remember that the list isn't perfect because some secret trades, called dark pools, remain hidden from view.
Even with these hidden trades, learning to read an order book helps you understand the market's mood and find better entry points. Ultimately, using this tool alongside other research methods is the best way to make confident trading decisions.
Also Read, Market Order Vs Limit Order
