Order Book Meaning Examples Trading Strategies

Order Book Meaning

The electronic book contains different prices for various bids for an underlying assetUnderlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more, indicating buyer and seller interest at that price. It also provides valuable information on market participants, investor sentiment, market depth, order imbalance, spreadsSpreadsSpread is the price, interest rate, or yield differentials of stocks, bonds, futures contracts, options, and currency pairs of related quantities.read more, and the potential order execution. An exchange can offer more than one order book for stocks, depending on the financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more.

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Explanation Of Order Book

An order book is a helpful trading instrument for investors trying to maximize their profits. It typically contains the history of buy (bid) and sells (ask) offers. Besides open trades, the book contains various other orders like market, stop-loss, limit, and trailing stop. It also provides traders with market depth. The latter refers to a market’s ability to withstand the trading of many orders without causing a significant change in the price of securities. Traders can determine the best moment to purchase or sell it knowing the average security price.

Key Takeaways

An order book electronically lists buy and sell orders for a specific stock, bond, derivatives, currency pair, futures, or cryptocurrency by volume and price.It provides data on market participants, investor sentiment, market depth, order imbalance, spreads, and the possibility of order execution.The book updates in real-time, allowing traders to identify market trends, popular securities and make informed investment decisions. They can formulate different strategies using the trading pattern, timing, algorithms and charts, and automatic order matching.Besides bid and ask offers, the continuous book contains open order history and market, stop-loss, limit, and trailing stop orders.

The continuous book shows the total volume of orders for a specific asset at all price levels. It also informs about retail investorsRetail InvestorsA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making.read more or institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples.read more involved in the trade. In addition, it provides other valuable data like bid-ask spreadBid-ask SpreadThe asking price is the lowest price at which a prospective seller will sell the security. The bid price, on the other hand, is the highest price a prospective buyer is willing to pay for a security, and the bid-ask spread is the difference between them.read more, order imbalance, and investor interest, driving market trends.

It runs electronically and updates in real-time throughout the trading day, hence also called the continuous book. Instant updates enable traders to analyze trading patterns for security and trade confidently. However, they have to pay a fee to the exchange to get the information. Earlier, there was an order book for stocks only, but now cryptocurrencyCryptocurrencyCryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service.read more marketplaces have also started using it.

Advantages Of Order Book

The introduction of the order book trading instrument intends to promote transparency on stock exchangesStock ExchangesStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more. It not only reveals traders who initiate trades, but it also indicates prices that each buyer and seller are ready to accept. It, thus, makes market manipulation more difficult.

An example of market manipulation is the deliberate dumping of too many shares on the market to decrease the company’s value. Moreover, investors can conceal their identity while trading by investing in dark poolsDark PoolsDark pools are a type of Alternative Trading System (ATS) that allows investors to trade large blocks of shares without public attention.read more. Traders can spot it simply with the continuous book and question the validity and motives of such a trade. The United States Securities and Exchange Commission (SEC) can investigate it. If it discovers delinquency, the SEC has the authority to halt a deal to avoid upsetting the market in that security.

Traders can also use this tool to spot potential support (a large number of purchase ordersPurchase OrdersA Purchase Order (PO) serves as a legal document between buyer and seller, wherein, the buyer sends this contract that details the goods and services, date of delivery, payment terms as per the contract etc.read more at a specific price) and resistance (a large number of sell orders at or near a particular price) levels.

Example

An order book example is that of NASDAQ TotalView. It claims to be the most comprehensive book available in the U.S. and possibly worldwide. TotalView is a critical source of information for day and experienced traders and financial analystsFinancial AnalystsA financial analyst analyses a project or a company with the primary objective to advise the management/clients about viable investment decisions. They do a thorough financial analysis and make suitable objective projections to arrive at their conclusions.read more. It provides real-time data for securities available on NASDAQ, NYSE, and NYSE American.

TotalView also provides historical trading volumes and prices for different securities. The Net Order Imbalance Indicator (NOII) present in TotalView can help with the technical evaluation of these securities. Traders can opt to buy or sell securities based on this information.

Many other stock exchanges and independent companies feature books similar to the NASDAQ continuous book. They may, however, differ in terms of the sorts of securities listedSecurities ListedListed security refers to a financial instrument such as stocks, bonds, derivatives, etc., registered with and readily tradable on the stock exchanges like NASDAQ and NYSE.read more and the additional tools available to help a trader interpret the data.

Order Book Trading Strategies

A trader must use a short-term strategy based on order volumes, prices, and market trends before trading securities using a continuous book. For example, a book showing more buy orders than sell offers indicates a bullish marketBullish MarketA bull market occurs when many stock prices rise 20% from a recent low, with the price climb spanning for an extended period.read more. Traders can adopt different strategies to determine various elements of trading based on the information received from the continuous book, such as:

#1 – Security Trading Pattern

The historical data in the continuous book helps traders determine whether a stock is following a bullish or bearish market trendBearish Market TrendBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more. For example, if the price is consistently rising, one can safely assume that it will continue to increase for some time before taking a downturn. It can be a sign to buy the stock and then sell it for a profit.

#2 – Trading Timing

The continuous book provides insight into whether the price of a security is about to get unstable or change its historical pattern. It encourages traders to take action to minimize potential losses. For instance, if they acquired stock and the data suggests an increase in its price, they can sell it at the current price for a profit before the price declines.

#3 – Trading Algorithm

The abundance of data helps traders who prefer technical analysis over fundamental or sentimental analysis use trading algorithms. They can use this data to evaluate the market and determine whether it is appropriate to trade. They may, for example, utilize a stochastic indicator and then fine-tune its settings using the order book in stock market. It is helpful for short-term trading.

#4 – Automatic Order Matching

The continuous book also allows traders to match orders automatically per their preferences and market supply and demand. For example, in the case of a limit trade book, the trader can set a price level for buying or selling a security. When the price hits that threshold, an order gets automatically fulfilled.

These are just a few examples of how a continuous book might help traders develop an order book trading strategy. There are even more options, such as analyzing recent chart patterns to determine the market behavior.