What is an order book?
The term order book refers to an electronic list of buy and sell orders for a specific security or financial instrument, organized by price level. An order book lists the number of shares that are the subject of an offer or an offer at each price or the depth of the market. It also identifies the market players behind the buy and sell orders, although some choose to remain anonymous. These lists help traders and also improve market transparency as they provide valuable trading information.
Key points to remember
- An order book is an electronic list of buy and sell orders for a security or other instrument, organized by price level.
- Order books are used by almost all exchanges for various assets such as stocks, bonds, currencies and even cryptocurrencies.
- These lists help improve market transparency because they provide information on price, availability, depth of trading, and who initiates transactions.
- An order book has three parts: purchase orders, sales orders and order history.
Understanding order books
Order books are used by almost all exchanges to list orders for various assets such as stocks, bonds and currencies, even cryptocurrencies like Bitcoin. These commands can be manual or electronic. Although they usually contain the same information, the configuration may be slightly different depending on the source. Purchase and sale information can appear at the top and bottom, or on the left and right sides of the screen.
The term backlog can also be used to describe an order log that a business receives from its customers.
An order book is dynamic, which means that it is constantly updated in real time throughout the day. Exchanges as the Nasdaq call it the “continuous book”. Orders that specify execution only at the opening or closing of the market are managed separately. These are known respectively as “opening book (order)” and “closing book (order)”.
For example, opening books and continuous books are consolidated on the open Nasdaq market to create a single opening price. The same thing happens when the market closes when the closing book and the continuous book are consolidated to generate a single closing price.
An order book generally consists of three parts: purchase orders, sales orders and order history.
- Purchase orders contain information about the buyer, including all offers, the amount they want to buy and the asking price.
- Sell orders are similar to buy orders.
- The history of market orders shows all trades that have taken place in the past.
The top of the book is where you will find the highest offer and the lowest price. These indicate the predominant market and the price to be executed. The book is often accompanied by a candlestick chart, which provides useful information about the current and past state of the market.
The order book helps traders to make more informed trading decisions. They can see which brokerages buy or sell stocks and determine whether the market action is led by individual investors or by institutions. The order book also shows order imbalances that can provide clues to the direction of a security in the very short term.
For example, a massive imbalance between buy and sell orders may indicate an increase in inventory due to buying pressure. Traders can also use the order book to identify potential support and resistance levels for a security. A group of large buy orders at a specific price may indicate a level of support, while an abundance of sell orders at a price or near a price may suggest a zone of resistance.
Although the order book is intended to ensure transparency for market players, certain details are not included in the list. Among these, there are the “dark pools”. These are lots of hidden orders maintained by big players who do not want their trading intentions to be known to others.
Without dark pools, exchanges would see a significant devaluation of prices. When information about a large transaction by a large institution is made public before the execution of the transaction, it normally leads to a fall in the price of the security. But if information about the transaction is released after it is completed, the impact on the market can be significantly reduced.
The presence of dark pools somewhat reduces the usefulness of the order book as there is no way of knowing whether the orders on the book are representative of the actual supply and demand of the stock.
Example of order book
Order books continue to collect an increasing amount of information for merchants for a fee. Nasdaq’s TotalView claims to provide more market information than any other book, displaying more than 20 times the liquidity of its old Level 2 market depth product.
While this additional information may not be very important to the average investor, it can be useful for day traders and experienced market professionals who rely on the order book to make trading decisions.