Supply and demand determine an asset’s price, and traders base their choices on this relationship. In order to determine resistance and support levels as well as the possible direction of a trend, traders can estimate the amount of pending orders by looking at the order book, which is a list of buy and sell orders for a certain securities or currency ordered according to a price level.
The principles of market depth and order book will be covered in this review. You will also learn how to use the latter tool to assess the liquidity level in MT4, MT5, and cTrader platforms, as well as how big traders affect asset quotes.
Depth of Market (DOM): What is it?
The market’s capacity to handle high trading volumes without experiencing a notable shift in rates is known as depth of market. This measure shows how many requests there are to open buy and sell orders for a particular asset at various prices. You may evaluate traders’ sentiment, supply and demand levels, and liquidity with DOM.
High liquidity and a market where a high volume has little effect on the price are characteristics of a deep market. However, if it is shallow, a big transaction might create an imbalance that results in a bigger spread, a spike in volatility (a widening price range), and a change in the rate towards the trade direction. A market maker determines the daily price range and completes the biggest trades under such circumstances.
Depth of market:
- uses the accumulation of orders and volumes within a given rate range to help identify possible levels of support and resistance.
- demonstrates the actions of market makers, who have the power to move the market and affect an asset’s price in significant quantities.
- aids in determining the degree of liquidity and a shift in the spread’s width. The liquidity increases with the number of purchase and sell requests. You see price ranges with lower and higher liquidity based on the quantity and number of orders to execute a trade placed. Its decline suggests that the spread may be getting wider and that even a slight change can have a big impact on the quotes.
- shows a shift in volatility and the likely path of the trend. An increase in volatility is indicated by a rise in the frequency of orders in both directions. The trend’s direction is indicated by the volume and order predominance in the same direction. An upward or downward trend may be forming if buy or sell orders are much more common but there are no counterparties for them.
- indicates the likelihood of a critical level breakout. Based on past extremes, the trader establishes critical levels and evaluates the likelihood of a breakthrough of the resistance or support level.
- aids in figuring out the limit order volume that won’t significantly affect the rate. A high volume of pending orders will result in an imbalance if there is no liquidity.
The quantity of limit orders to buy and sell arranged by price levels and the separation between them determines the DOM.
This idea is highly relative. A total turnover of $100 million is regarded as shallow for a trader with a buy/sell volume of $1 million, such as hedge funds or institutional investors. Since no vendor will be able to fill an order worth 1% of the total turnover, it cannot be absorbed without having a major impact on the rate. On the other hand, a trader with a volume of $1,000 would consider a market with a total turnover of $100 million to be deep.
Book of orders
Let’s examine what is meant by the word “order book.” How does it function in trading, what is it, and how can one locate it on the trading platform?
Analysis of the order book
The order book, which is updated online in a matter of milliseconds, is a list of limit pending orders of buyers and sellers at a particular price.
In trading, there are two kinds of orders:
- L1, or level 1 market data. These are directives to complete a transaction on the exchange at the opposite party’s suggested price. After accepting an offer to sell an asset for $100, a buyer submits a counterbid to buy the asset. A request like that is then promptly accommodated. Only in the event that there is not enough product available is the instruction canceled. For example, you wish to buy ten lots of an asset, but there are only eight lots available for $100. In this instance, the order is either fully or partially completed.
- L2, or level 2 market data. Requests to trade above or below the present price are what these are. For instance, you may see an offer to sell an item for $100, but you choose not to take it. You wait for the rate to drop and put in a pending order to buy at $95 instead. As a result, the order book shows that.
Please be aware that while market orders are processed instantaneously, the order book only shows limit orders. The price has reached its level and the request has been fulfilled if the pending order is no longer visible in the book. Buy limit and sell limit pending orders are examples of limit orders. Instead of being shown on the outside market, Buy Stop, Sell Stop, Buy Stop Limit, and Sell Stop Limit are handled within the platform. Consequently, they are typically not shown on the list.
The creation and usage of the order book
Over-the-counter trading and the exchange’s order books are not the same:
- Every request made on the exchange market is routed through the exchange system. Real prices and volumes are therefore included in the list.
- The order book on the over-the-counter market can show quotes that were created in the broker’s system. Real quantities that impact the price are not visible to the trader. Only the broker’s internal data is visible to them.
Each level’s costs and volumes are listed in the order book. It displays the minimum transaction volume required to alter the quotes at a specific price level. The number of counter orders required to alter the price increases with the number of buy or sell transactions and their volumes at a given price.
- A market is said to be “deep” if there are numerous orders for a broker to purchase or sell an asset and a large number of response orders. Large orders are placed one at a time without having a big effect on the pricing.
- A huge number of orders or a high-volume order that goes unanswered might cause a substantial price movement if there is no liquidity. This kind of condition is called shallow.
In the market depth, you may also monitor both aggressive and passive orders. Aggressive ones can lead to a level breakout and emerge abruptly during significant price spikes. Conversely, passive orders form resistance or support and are found close to specific levels. Including important levels and trend lines in the future strategy improves the market depth’s efficiency.
Factors Affecting Market Depth
There are benefits and drawbacks to both deep and shallow markets. Your strategy and aims will determine this. Because deep markets contain a lot of liquidity, trades are completed quickly and at the best price. A limited spread is also present. However, because it delivers smaller price changes, there are fewer chances to profit from and use trading tactics. A huge limit order has the power to drastically alter the price in a shallow market. This presents a chance to profit from a trend shift, but there is also a lot of slippage and a big spread.
It is preferable to concentrate on leverage, trading hours, asset liquidity, potential limits, and fundamental considerations while creating a future plan.
Make use of leverage
Market depth can be positively or negatively impacted by leverage:
- A trader can boost liquidity by using leverage to increase the volume of requests and trades at various prices. Market depth rises as a result. The broker also provides the trader’s contribution to trading and liquidity.
- If a trader utilizes leverage to increase the volume of a position at one price, they consequently create an imbalance in favor of demand or supply. As a result, the price changes and volatility rises. Market depth thus declines.
The market depth can be indirectly influenced by a broker by altering the maximum leverage limit.
Hours of Trading
Depending on the asset type, the market may be more or less active at different periods. For instance, during the US and European sessions, the EURUSD currency pair exhibits the highest trading activity. The market is at its deepest and liquidity is at its maximum right now. Volumes drop as the market loses depth throughout the Asian session. A decline in market depth prior to weekends and holidays serves as another illustration. While trading volumes and the number of buyers and sellers decline during this time, the majority of traders consolidate their holdings.
The liquidity of assets
The capacity to sell an asset rapidly at the current price is known as asset liquidity. Its depth increases with the amount of liquidity. Assets from underdeveloped nations, for instance, are categorized as low-liquidity instruments. Their financial markets are manually regulated, largely closed, and have scant information. Because of their large spreads and comparatively modest trade volumes, they can thus be regarded as shallow.
Restricting the movement of prices
For instance, futures trading uses this technology. By establishing price ranges for an item, stock exchanges like the NASDAQ and NYSE prevent abrupt, quick price swings. A set range of pending orders must be placed by traders. The market depth rises as the price spread on the list falls.
Basic elements, force majeure
Any news or significant underlying element that has the potential to drastically alter the balance of power falls under this category. Liquidity is high, for instance. There are counter purchase orders because there are a lot of initial buy orders. The market is deep, the spread is narrow, and the volatility is minimal.
Following the announcement of some news, buy or sell orders for stocks, currencies, and other assets immediately spike. The market becomes unbalanced and loses depth. This indicates that it is unable to handle high transaction volumes without seeing a notable shift in pricing. The commission rises, volatility rises, and liquidity falls. A short squeeze is one instance of a significant drop in depth accompanied by a price movement.
However, market depth can be increased by fundamental causes. The SEC’s approval of applications for spot ETFs on Bitcoin, for instance, boosted investor capital inflows into cryptocurrencies, enhancing their depth and liquidity.
Conclusion
An additional instrument for creating the best trading plan and assessing the state of the market is the exchange’s order book. Its information aids in:
- Evaluate the market’s liquidity and ascertain its depth and spread. Make sure there are a lot of counter orders if you wish to purchase or sell an asset.
- Determine the degrees of support and opposition that could be powerful.
- View the volumetric dominance of buyers or sellers in the order flow.
The instrument has advantages and disadvantages. Numerous trading systems on the exchange use the data as a filter and as a source for initial market situation analysis. For scalping, swing trading, and intraday methods, it makes sense to employ it on short periods. Other drawbacks of the technology include the publication of merely limit orders, market makers manipulating volumes, and concealed and fraudulent requests. Therefore, in order to forecast prices, the order book should be utilized in conjunction with other technologies. Specifically, using a vertical volume histogram and technical indications.
FAQ’s
What is DOM, or depth of market?
A list of limit pending buy and sell orders is called DOM. Prices, quantities, supply and demand, liquidity, possible supply and demand zones, and spread are all displayed.
How is DOM used by traders?
The order book contains a limit order to purchase below the current price or to sell above the current price with the volume. The transaction is carried out and the order is removed from the list if there is a counter volume.
Which platforms have strong DOM functionality?
Almost all platforms offer market depth and order books. The usefulness and the completeness of the information presented are where the distinctions lie. For instance, MT5 has incorporated volume values and allows you to place orders from the order book with a single click. One of the most useful is the order book on the cTrader platform.
