How Order Book Works

An order book is a digital ledger of all buy and sell orders that have been placed for a particular cryptocurrency. It is constantly being updated as new orders are placed. The order book can be used to see the current best bid and ask price for a particular cryptocurrency. It can also be used to see the price at which recent trades have been made. This article explain how order book works.

Introduction

The order book is a crucial tool for traders, as it allows them to see the current buy and sell activity for a particular asset. This helps them make more informed decisions about their trades, and ultimately increase their chances of success.

The order book is a running list of all the open orders that have been placed by traders who haven't been matched yet. For every entry in the order book, there is at least one other trader with an open order at that exact price. The top of the list in red are the open asks, or the prices that sellers are asking for, and below in green are the open bids, or prices that buyers are willing to pay.

Since these are all open orders, they give us an insight into what prices people think they can get their orders filled at.

By taking all of this information into account, traders can make wiser decisions about their trades and improve their chances of making a successful trade.

For a successful trade the sell and the buy price needs to overlap. For example, if someone places an open order on an exchange to buy Ethereum for 2,000 USD, someone else on the exchange will need to agree to sell their Ethereum at the same price of 2,000 USD.

An imbalance in buy or sell orders on an order book can show where the market might be headed. When there are lots of buy orders at a particular level, it could signal that there's support at that level. On the other hand, if there are lots of sell orders, it might be an area of resistance. But it's important to keep in mind that these aren't always reliable signals on their own.

The order book trading instrument is designed to promote transparency on exchanges. It indicates prices that each buyer and seller are willing to accept, making market manipulation more difficult.

Important Terms

Bid

The bid is the price at which the buyer is willing to purchase the asset

Ask

The Ask is the price that the seller is willing to sell the asset for

Amount

Number of tokens(asset) you plan to buy or sell

Price

The "$" (price) at which you plan to buy or see a certain token or asset

Market Order

A market order is simply an order to buy or sell an asset at its current market price. For example, if the current market price for Bitcoin is $2,000, and you place a buy order at that price, the trade will go through and you'll purchase the Bitcoin for $2,000.

Limit Order

A limit order, as opposed to a market order, is an automated order to buy or sell a financial instrument at a predetermined price. So, for example, if the current market price of Bitcoin is $2,000 but your analysis shows that it would be a better buy at $1,950, you would place a limit order at $1,950. The trade will not go through until the Bitcoin can be bought at that price.

Buy and Sell

The Buy Side

All "open buy orders" that are below the last traded price make up the buy side. When a buyer makes an offer to purchase something at a specific price, this is called a "bid." In other words, the bid represents the trader's interest in buying a certain number of units that are owned by someone else, usually at a price that is lower than what was paid for them originally.

Once a bid is matched with a corresponding sell order, the trade can be executed.

The Sell Side

The sell side of the market contains all open sell orders that are above the last traded price. This price is called the "ask." It means, "I am asking a certain price to sell X units I own"

Bid vs Ask

For every asset traded, there is a buyer and a seller, and a “bid” and “ask” price. The bid is the price at which the buyer is willing to purchase the asset, while the ask is the price that the seller is willing to sell the asset for.

There will usually be a gap between the bid and ask price called a “spread” or “bid/ask spread.” The bid/ask spread represents the difference between the bid and ask prices, and is dependent on the volume of trades being submitted. For example, if there is a large volume of orders in a asset’s order book, the spread will be narrower than if there are fewer orders.

Example

In this example we will understand how Order Book works based on price and time.

In this example we have three sellers and three buyers.

Here time t1 < t2 < t3 i.e. order placed at t1 happens first, then t2 and then the t3 order is placed.

Seller Orders

  1. Seller 1 at t1, asks for price $9 for each token and wants to sell 5 tokens
  2. Seller 2 at t2, asks for price $7 for each token and wants to sell 3 tokens
  3. Seller 3 at t3, asks for price $8 for each token and wants to sell 9 tokens

Buyer Orders

  1. Buyer 1 at t1, bids at price $6 for 8 tokens
  2. Buyer 2 at t2, bids at price $8 for 5 tokens
  3. Buyer 3 at t2, bids at price $8 for 3 tokens

Here Seller-1 asks for too high of a price i.e. $9 for each token and no one wants to buy at this high price, hence their order is not matched.

Seller-2, asks for $7 as the price per token, and Buyer-2 and Buyer-3 both are okay with buying at $8/token. Here Buyer-2 is given preference as their order was placed first.

Example

References

https://www.coindesk.com/learn/crypto-trading-101-how-to-read-an-exchange-order-book/

https://academy.shrimpy.io/post/what-is-an-exchange-order-book

https://medium.com/stabletrade/understanding-order-books-orders-b297ea51acff

https://www.cryptoglobe.com/latest/2020/02/breaking-down-how-crypto-exchanges-and-order-books-work/

Request Demo