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An Order Book: Definition, Components, How to Use it in Exchange and its Advantages

Considering most investors in the traditional finance market, a large number of them have never placed a trade directly with an exchange. This is based on the fact that most investors manage their assets through brokers and fund managers. 

Moreover, with the current crypto space, most investors trade their funds directly on exchange platforms. Currently, the most popular exchanges include Binance, Bittrex, and Coinbase Pro. From these platforms, you, as a crypto investor, can understand how these exchanges work to become proficient crypto traders. Grasping the understanding of order books is an essential skill that traders need to consider before placing their first trade. 

In this article, you will get a clear understanding of what order books are and how to use them in exchange. Here you can get some pointers on their components, how to manage trades in an exchange, and the unique merits of using this tool. 

Defining an Order Book

An Order Book is an electronic list consisting of buying and sell orders. It’s a tool that displays the buyer and seller interests that further offers a doorway into supply and demand. The list contains buy and sell orders related to a specific financial instrument usually organized by price level.  In simpler terms, the order book lists the number of assets being bid, displaying different offers from both buyers and sellers at each price point for a specific security. 

An order book shows the volume and price that traders are willing and able to buy or sell for a specific security. Keeping this in mind, the order book clearly proves its usefulness to crypto traders in providing real-time valuable market price information of security. 

Understanding an Order Book

Order books are constantly updated every single day. As such, certain orders specify execution either at the open market or closing market. They are called the opening order and closing order books. For example, the Nasdaq exchange, the open and the continuous order book are consolidated to generate the single opening price. Similarly, the closing and the continuous order book are consolidated to create a single closing price. 

At the top of the order book, the highest bid price and the lowest ask price are indicated. It illustrates the predominant price and market needed for order execution. Visual demonstration is usually through the candlestick chart that shows detailed information about the previous market state. 

Components of an Order Book

The list has various components that assist in making trades, although the outline might vary concerning security. Regardless, the order book normally consists of major components, and they include: 

  • Visual Demonstration- basically, an order book has a table of numbers representing specific shares prices and the total amounts from two sides. However, the buyer and seller relationship are better represented in the order books through visual demonstration. It is mostly in the form of line graphs, charts, or other forms. As pointed out earlier, order book outlines may differ based on the type of security. 
  • Buyer and Seller sides– the list is a display of the market. Consider this, the market consists of the buyer and the seller and therefore includes the two major market participants. Here, the buyer bids for a certain amount of shares at a specific price, and a seller asks for a specific price for the same number of shares. In other order books, this feature is displayed as the “Bid and Ask” section. Mostly, the biding site is colored green, and the ask side is colored red. 
  • Prices- generally, the order book also records the interest value for both seller and buyer. The specific numbers displayed on each side record the bids or are asked for while stating the price. 
  • Totals- here is where the total amounts of specific shares, recordings, and prices are displayed. It shows the cumulative amounts of securities sold at a specific price. 
  • Order History- the transaction history is displayed here. All the buyer and the seller transactions are recorded for referencing and indicate the prices, dates, and number of orders made.

How to Use an Order Book

Considering an order book being an essential trading instrument, a trader can use this tool in different ways. They are used by almost every exchange, including stocks, bonds, and cryptocurrencies. To begin with, you can have a clear review of the real-time market depth that assists in estimating a market order-filled price. 

Another use is in gauging the sellers’ momentum. When going through the order book, a trader can understand a seller’s order quantity and later predict the trend in the asset price. For example, considering the best bid or ask price level, when the order quantity on the seller’s side is lower than the buyer’s side, there is low momentum for the selling side. As such, this implies that the asset price is likely to rise. Similarly, when the buyer’s order quantity is lower than the seller’s side, this predicts momentum for the sell-side. 

For example, an order book could be for the BTC/USD pair and, as such, would have bought and sell orders in the exchange. They represent the bid or asking price of  Bitcoin in US Dollars. The USD will be the quote currency, and as such, the Bitcoin price would be in terms of USD in the order book. When a buyer bids a price of Bitcoin during an exchange, let’s say 3000 USD, a seller needs to agree on the exact bid price, in this case, 3000 USD. 

Example of Order Books

Order books continue to expand the pool of information offered to investors. For example, the total review by Nasdaq has the largest amount of information compared to any other order book. In addition, it displays more than 20 items the liquidity that is in line with its Level 2 market depth. 

The order books are a significant tool for any day trader and expert market professionals in making effective trading strategies. Dark pools, on the other hand, have order books that are not visible to the public. 

Advantages

One major advantage of using the order book is providing updated price values for both buyers and sellers. In addition, its real-time display of the market prices assists investors in making accurate and decisive trades depending on their preferences. 

Also, if investors are misinformed about specific security, they can easily get the first-hand experience in exchange through various platforms. Through these electric lists, they can understand the trends in the asset price being bid or asked. Here you can understand the dynamics in price trends of the crypto trading market. 

Application

Various updates are included in the order books currently. Putting this into consideration, matching buyer and seller orders is done automatically based on their preferences. In addition, the market update feature ensures accurate real-time market prices, thus ensuring the order is being bought or sold at the current price in the market.

Also, when employing limit order strategies, using order books serves a great purpose. Such instances require trades to set specific price levels marking the points they want to sell or buy the security. As a result, the order is automatically completed when the market price moves towards the set price. 

The system that matches the buyer’s and seller’s orders uses the order books in executing trade transactions in exchanges. The system is called the matching engine, and the order matching system is the backbone of all electronic exchanges. It determines the efficiency of the exchange. 

Verdict

In the crypto world, exchanges are usually transacted between the buyer and the seller. It takes two to tango, and in this case, an order book displays the relationship between sellers and buyers. Order books are essential in understanding the buyers’ and sellers’ interests concerning certain price levels in the exchange. In other words, it shows the support and resistance levels. Additionally, an imbalance in the orders, either by buyers or sellers, predicts the market direction. As such, traders can confirm support and resistance levels using these order books.

Over the years, electronic exchanges have been utilizing centralized systems in matching buyer and seller orders. Regardless, blockchain technology has introduced new ways of matching these orders using smart contracts, called the decentralized exchange (DEX). As such, traders are facilitated without controlling funds by a central entity. 

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Order books assist traders in making more informed strategic trading decisions. Through this tool, you can determine whether institutions or retail investors are driving the market trends. 

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