Before placing a buy or sell order on a cryptocurrency exchange, you should always check the order book or order book.
You might be wondering, but what is an order book and why should I bother looking at it? In this article, we will see everything you need to know about this tool available on most exchanges.
What is an order book?
The order book is an electronic list of all buy and sell orders for a particular financial instrument, listed by price. It is a dynamic tool, so it is updated in real time and represents the interests of buyers and sellers at all times.
Order books are tools available in most cryptocurrency exchanges, but we can also find them in brokers who work with other assets, such as stocks or futures.
Configuration and display of data may be slightly different from exchange to exchange, as Binance’s order book is not the same as Coinbase’s or Kucoin’s. However, they generally provide similar information and the differences are minimal.
What is an order book used for?
An order book helps traders make better decisions by allowing them to gauge market sentiment as they can make estimates about the supply and demand of a cryptocurrency i.e. s ‘there are a lot of people interested in buying or selling.
The information that we can find in an order book is mainly used by traders, but it can also be useful for investors who need to evaluate their buying and selling strategies at certain levels.
How to read an order book?
To properly read an order book, you need to understand the different parts of it.
Prices and quantities
The quantity and price per order indicate the total number of units of a cryptocurrency waiting to be traded and at what price each unit will be bought or sold.
It is better to see it with an example:
This means that the person or entity who opened the order wants to buy 1,677 units of Bitcoin (BTC) at a price of 43,192.6 USDT per unit.
The total is the sum of all buy or sell orders at a certain level.
It can be seen in the example above in the right column: Amount (BTC)
Buy side and sell side
When we see a the order bookit will be noticed that there is a division which separates a the buy side and the sell side.
the buy side
The the buy side represents all open buy orders below the last traded price.
This buyer’s offer is known as the «BID». As soon as a seller arrives and accepts the purchase price, the transaction takes place.
the sell side
The sell side contains all sell orders above the last traded price.
This seller’s asking price is known as the «ASK» and the order waits for a buyer to accept the price and the transaction to occur.
The spread is a very important concept to consider, but it does not translate into an exact figure in the order book.
The spread refers to the difference between the BID and ASK prices of a cryptocurrency, i.e. between the highest buy price and the lowest sell price.
The spread is used to determine the liquidity of a particular asset, so the higher the liquidity, the lower the spread will be.
What should you look for in an order book?
Once we have reviewed the elements that make up an order book, we will see some observations that we can make.
Imbalances between buy and sell orders
An imbalance between buy and sell orders can indicate that the price of a cryptocurrency will rise or fall.
If the number of buy orders is much higher than the number of sell orders, the price is likely to rise because there is more demand to buy than to sell.
The same would apply in reverse, if there are more orders to sell than to buy, the price will likely fall.
We need to assess imbalances before placing an order on the exchange and for example our buy order will be favored if there is buying pressure (orders are in favor of our trade). On the contrary, it will be better to wait for another level if there are a lot of sell orders.
We can also use the order book to help us identify potential support and resistance levels. If there are a large number of orders at a certain price, it may indicate a support level. Conversely, if we find a large number of sell orders, it may indicate a resistance zone.
Locate buy and sell walls
Buy walls form if there are a large number of buy orders at a certain price.
If there are so many buy orders that they cannot be executed, orders placed at lower prices cannot be executed. Therefore, the buy wall acts as short-term support as the price will not fall until demand is met.
On the other hand, a sell wall is created if there are many sell orders at a certain level and they are unlikely to be executed. This wall will act as short-term resistance, preventing the price from rising until the sell orders on the wall are filled.
Estimate liquidity when placing an order
One of the factors to take into account when trading a stock market is liquidity, because if it is low, we must take it into account.
If you place a buy order directly on the market and there is little liquidity, your purchase will have to be supplemented by sell orders at different price levels. Thus, the average buying price of the cryptocurrency will be higher than the average price you thought you would get.
One way to avoid this is to use limit orders at a certain price and wait for them to fill.
The last and most difficult thing to look for when trading an exchange is determining if some type of manipulation is going on. The cryptocurrency market, being less regulated, is more prone to some type of manipulation compared to traditional markets.
There are different types of manipulations, but generally they consist of different tactics that give traders false signals to make mistakes.
Detecting manipulations through order books requires a higher degree of knowledge and specialization in reading them.