What’s the Order Book and Why Is It Important?
October 29, 2020
The heart of an exchange is its order book. The order book is the list of all buy and sell orders placed on the platform for a pair.
Since they are limit orders, i.e. orders that will (perhaps) be executed in the future, this list provides data on market sentiment.
What’s an Order Book?
The order book is a summary of all limit purchase and sale orders for a cryptocurrency placed on an exchange.
There are a few things to keep in mind to understand how it works:
- No orders in the list have been filled yet. They are “pending“.
- The orders in the order book, as they are all limit orders, will only be executed when a certain price is reached. The price is set by the user. For example, you can ask the exchange to: “Buy 100€ of bitcoin only if it costs 8.000€. As long as the price is higher, keep my order pending”.
Any order can be cancelled either by the user or by the exchange itself. This second case may happen if:
- The set conditions cannot be met.
- The set time limit has expired.
Why are there only limit orders in the order book?
If limit orders are orders waiting to be filled, market orders are instant orders that complete them, so they don’t need to be listed in the order book.
Market orders are, however, visible in the Trade History table. Stop orders, on the other hand, are not present because they are orders that need a certain condition (reaching the stop price) to be placed in the order book.
Limit vs Stop
Limit Order = an already active order that is filled if a certain price is reached. The price is a condition for the filling. Stop Order = a non-active order that is triggered if a certain price is reached. The price is a condition for activation.
If the order book is a register of “future” orders, the Trade History is the register of “past” orders. The Trade History shows in chronological order all completed orders, indicating quantity, price and execution date.
The Structure of the Order Book
The items in the order book are listed in order of price and are divided into a “sell” side and a “buy” side. In the middle, between the sell side and the buy side there’s the spread and the last price.
If we want to set an order, we generally rely on the last price because it indicates the value of the cryptocurrency at that moment.
The sell side is at the top of the table and all orders are red. The number of sales orders placed at a certain price level is indicated here.
The sale prices of any cryptocurrency, not just bitcoin, are called Ask prices.
You read them from bottom to top, i.e. from the cheapest price (Best ASK).
The cheapest price is always the first in the list, placed just above the spread. Reading the prices, you will notice that they are inserted in increasing order, from the lowest price to the highest price.
Not only are orders read from bottom to top, but they are also filled in this order, one at a time.
Sales orders (ASKs) represent the demand because they constitute the price requested for the cryptocurrency. Purchase orders (BIDs) represent the supply because they constitute the price offered for the cryptocurrency.
The buy side is located in the lower section of the order book and all items are green. The number of purchase orders entered at a certain price is indicated here.
The purchase prices are called Bid prices.
You read them from top to bottom, i.e. from the highest price (Best BID).
The highest price is always the first in the list, placed just below the spread. Reading the prices, you will notice that they are placed in descending order, from the highest price to the lowest price.
Not only are orders read from top to bottom, but they are also filled in this order, one at a time.
The difference between supply and demand is the spread, or more precisely the bid-ask spread. The narrower the spread, the more efficient the cryptocurrency market we are looking at.
How to read an Order Book
Each order is described by three aspects:
- Price: is the price set for an order, i.e. the price at which exchange users are willing to sell or buy.
- Amount: the sum of the order amounts set at a certain price.
- Total: The total value of the order, which is obtained by multiplying the price of an order with the amount exchanged.
An order is rarely placed by a single user. What we see as “Amount” is the aggregate of all orders placed at a certain price.
If we take the last sales order in the image below as a reference, we see that the quantity of BTC sold at €11,033.90 is 2.51291. Those 2 BTCs usually don’t belong to a single owner, but to all those who placed a limit order at the price of 11.033,90€ where 1 BTC = 11.033,90€. They can be two, four, ten traders.
How the Order Book works
Sales orders are filled one at a time starting from the lowest, i.e. the most convenient. Purchase orders are completed starting from the highest.
The Best ASK is the lowest price at which a cryptocurrency is being sold. The Best BID is the highest price at which a cryptocurrency is being bought.
Following this logic, the entire amount of 2,51291 BTC at 11,033.90 € (order A) must first be filled before moving on to the next price of 11034.00 € (order B).
As the order B is completed, you will move on to C, going up the order book list. The same mechanism takes place for the buy side.
The last sale order and the last purchase order are always the most advantageous, respectively for those who are buying and those who are selling.
As sales orders are completed, the price increases because someone is buying. As purchase orders are completed, the price goes down because people are selling.
How to read a Depth Chart
The data within the order book generate a chart called Depth Chart, which graphically shows and summarises supply and demand, with the volume needed to move the price.
The x-axis indicates the price, while the y-axis indicates the amount. These generate the volumes that are represented in green for the total purchase orders, in red for the total sales orders.
One of the most useful and easiest pieces of information to find on the depth chart is the presence of a buy wall or sell wall.
A Buy Wall occurs when a large number of orders are placed to buy a certain cryptocurrency when it reaches a certain value. Conversely, a Sell Wall occurs when a large number of orders are placed to sell a certain cryptocurrency when it reaches a certain value.