How to Read an Exchange Order Book (for Crypto)

This article will go into depth as to how to read and use an exchange order book when dealing with cryptocurrencies.

There is a lot of information you need to take if you want to participate in cryptocurrency trading. For first-timers, it is like drinking from a fire hose; in that the amount of valuable information is excessive. What’s more, you need to understand it before you can even think about making your first trade. The problem is there are not enough resources that provide informative content.

A majority of investors working in the traditional financial market seldom deal with exchanges directly. In essence, exchanges are a certain degree of separation away from investors. Many investors will instead manage their assets by way of brokers, fund managers, and other financial products.  These conventional financial services certainly do make it easier for investors to manage their investments. However, most investors never directly place a trade with an exchange. Therefore, the average person would undoubtedly lack a proper understanding of how exactly the exchanges operate.

In the world of crypto, you will find that most investors trade their funds directly on an exchange. Each investor is prone to having one or more accounts open with an array of cryptocurrency exchanges. There are many exchanges out there, but some of the more popular ones include Binance, Bittrex, Coinbase Pro, and Kraken. 

So, if you want to become a proficient crypto investor, you will need to grasp some core concepts. One of which is understanding the operation behind exchanges. Moreover, there is some terminology and concepts that are now standard for investors. Specifically, those who are managing their portfolio through the utilization of exchanges.

There is one particular exchange element that investors need to understand before they can place their first trade. That element is the ‘exchange order book’.

What is it?

‘Order book’ is a term that refers to an electronic list consisting of buying and sell orders. These are for a specific security or financial instrument whose organization draws from price level. An order book typically lists the number of shares being offered or bid on at each price point. Alternatively, at market depth. Furthermore, it identifies the market participants who are responsible for the buy and sell orders. There are, however, some that choose to maintain anonymity.

These lists are a great help for traders and also improve market transparency. This is primarily due to the fact that they provide worthwhile trading information.

Almost every exchange uses order books as a way to list the orders for different assets. Some of these assets include stocks, bonds, and currencies. And these currency types also apply to cryptocurrencies like Bitcoin. These orders can either be of the manual variety or the electronic variety. Generally speaking, they contain the same information, though the setup may be slightly different. It ultimately depends on the source. Buy and sell information can often appear on the top and bottom of the screen. Other times, it can appear on the left and right sides.

For the most part, the best way to describe an order book is it’s dynamic. This basically means that it is constantly undergoing updates in real-time throughout the duration of the day. There are some exchanges – such as Nasdaq – that usually refer to it as the “continuous book.” Maintenance of orders that specify execution only at market open or market close are done so separately. These are typically known as the “opening (order) book” and “closing (order) book” respectively.

The different parts

An order consists mainly of instructions to a broker or brokerage firm. These instructions illustrate how to purchase or sell a security on an investor’s behalf. You can break an order book down into a total of three order parts: buy orders, sell orders, and order history.

  1. ‘Buy orders’ typically contain valuable buyer information. Such information includes all the bids, the exact amount they want to purchase, and the asking price.
  2. ‘Sell orders’ often bear a striking resemblance to buy orders.
  3. Market ‘order histories’ usually display all of the transactions that were executed in the past.

If you look at the top of the book, you will see both the highest bid and lowest ask prices. These will direct you to the predominant market and price that need to have an order to undergo execution.

A candlestick chart will often accompany the book. A ‘candlestick’ is a price chart that has extensive usage in technical analysis. It displays the high, low, open, and closing prices of a security for a specific period of time. This type of chart provides useful information pertaining to both the current and past state of the market.

Trading decisions

The order book assists traders in making comparatively more informed trading decisions. They are able to see which brokerages are buying or selling stock. From this, they can determine whether the driving force of market action is by retail investors or by institutions. Additionally, the order book shows order imbalances that could potentially provide clues to a stock’s direction in the short term.

Let’s look further into this by taking a massive imbalance of buy orders versus sell orders. Something like this might be indicative of a move higher in the stock due largely in part to buying pressure. Traders can also use the order book to help pinpoint a stock’s potential support and resistance levels. A cluster of large buy orders at a specific price may indicate a level of support, while an abundance of sell orders at or near one price may suggest an area of resistance.

shopping cart with coins to help depict an order book

Active & Passive

Whenever a trader places an order to sell on the exchange, this is an ‘ask’. Whenever a trader places an order to buy, it is a ‘bid’. As soon as the exchange discovers a counterparty to order, it will immediately fill the order. In the process, it will close the bid as well as ask. When this occurs, it means that trade has had a successful execution.

There are a wide variety of order types, but the primary ones are ‘passive orders’ and ‘active orders’.

  • Passive orders, like the limit and stop order, are orders to buy or sell at a specific price. Or perhaps at an even better price. Passive orders are often put in the exchange order book and remain there until one of two things happens. Either their trader cancels it or the exchange consumes it. Many consider them to be ‘passive’ trades because they do not budge the market price.
  • Active orders (or market orders) are special requests. They mostly pertain to buying or selling at whatever the best available price in the current market is. In a highly liquid market, the execution of market orders are almost instantaneous. Generally speaking, market orders do not appear in the order book. In lieu of this, they actually show up in the trade history column. This way, it can be indicative of market activity. Many consider them to be ‘active’ trades because they move the market price. To elaborate, they move it to the level of the last order that they consume.

The two sides

It’s imperative that you be comfortable with reading order books. With this in mind, it is essential that you understand the concepts of the bid, ask amount, and price. The displaying of this information is on two sides of the order book. These go by the names of ‘buy-side’ and ‘sell-side’.

#1 – Buy-side

Buy-side is a term that is common in investment firms. It refers to advising institutions whose main concern is with buying investment services. The buy-side is representative of pretty much all open buy orders. As soon as bids match with an appropriate ask, only then can the execution of the trade happen. There may come a time when there is an abundance of buy orders (demand) at a certain price level. When this happens, what follows is the formation of a ‘buy wall’.

Buy walls have an undeniable effect on the price of an asset. This impact stems from the event of a failure to fill a large order. When this happens, it means that buy orders at a lower bid cannot be filled either. The price will not be able to drop any further seeing as how it is difficult to execute the orders below the wall. Moreover, they cannot reach execution until the large order achieves fulfillment. In turn, it will help the wall function as a short-term support level.

#2 – Sell-side

On the flip side, the sell-side consists of all open orders above the price that was last traded at. The formation of the opposite of a buy wall occurs when there is an abundance of sell orders (supply). Moreover, when it is at a specific price level; which is known as a ‘sell wall’.

Let’s assume that there is a very large sell order that is unlikely to reach fulfillment. What’s more, it is because of a lack of demand at a specific price level. In this particular case, sell orders at a higher price are unable to undergo execution. Therefore, it makes the price level of the wall a short-term resistance.

Price and Amount

It’s clear to see that the two sides display opposing information. In spite of this, the concepts of ‘amount’ (also going by the name ‘size’) and ‘price’ are pertinent to both. Put simply, the amount and price per order show the total units of the cryptocurrency looking to trade ar. On top of that, at what price each unit is valued.

How to use it

Whenever we place an order on the exchange, we are presented with two options. We can place an open order on the exchange for someone else to take if they choose to. Alternatively, we can take someone else’s open order on the exchange that is already available.

Let’s use the Coinbase Pro order book below as an example.

order book example

This particular order book presents the open orders for the BTC/USD trading pair that are available. Assuming we want to buy bitcoin, we could use this order book as a way to trade USD for bitcoin. 

As you can see in this order book, the lowest price at present that someone is willing to sell bitcoin is $9745.01 USD. At the same time, the highest price someone is willing to purchase bitcoin is $9745.00 USD. These two prices amount to a total difference of 1 cent. It’s important to note that the gap between the lowest selling price and the highest buying price is the ‘spread’. 

When we make the choice to purchase bitcoin, we can do one of two things. Either we place an open order on the buy-side (green text) or take the most attractive offer on the sell-side (red text). With the best offer on the sell-side being $9745.01 USD, we can take that offer to acquire bitcoin. 

Otherwise, we must place an open order for less than or equal to $9745.00 USD on the buy-side. These open orders will have to wait for when someone else complies in selling at the open order price. It is not set in stone if someone else will agree to sell at the open order price. Thus, we do not know how long it will take for us to receive our bitcoin.

Fees

For the most part, exchanges will charge higher fees for traders who take orders (i.e. acting as a taker). This is different from when they place open orders for others to take (i.e. acting as a maker), where the fee isn’t as high. The reason as to why exchanges charge higher fees for being a taker boils down to the removal of liquidity. Specifically, from the trading pair. This is where acting as a maker boosts the overall liquidity of a trading pair.

A trader with more patience may show more interest in reducing fees by way of placing open orders. An opportunistic trader, on the other hand, will likely want to take advantage of market opportunities. And they will probably do so by executing trades quickly, and this is regardless of the fees being higher.

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