An order book is a list of orders for a specific market, recorded by an exchange to measure market depth and interest from buyers and sellers.
Order books are often used by traders to identify market sentiment. For short-term traders in particular, order books are valuable as they show whether bulls or bears are dominant in the market.
Typically, order books are made up of three main components:
- Buy orders – shows buyer information including volume and price
- Sell orders – shows seller information including volume and price
- Order history – shows the orders that have been made in the past
Order books don’t cover every order in the market, as ‘dark pools’ also anonymously take orders. Dark pools are private exchanges that don’t show the identity, nor the intent (e.g. buy or sell) of an order. These are orders from whales – large traders in the market such as banks or corporations – who don’t want their trading activity to be publicly available.
Given the large volume of whales’ trades, if this information was widely available it would give traders a clear indication of how a market’s price might move.
What is order book trading?
Order book trading is a strategy that involves using the information from an order book to profit from the markets.
If an order book is showing a number of large buy orders not being filled, for example, it can indicate a dominance of bulls in the market as traders want to buy at a certain price but are unable to find a seller. Traders can exploit this imbalance and trade accordingly, in this case anticipating a price rise.
While order book trading can be a profitable strategy for day or short-term traders, there’s often only a small window to trade. It requires quick thinking and split-second decision making.