An order book is a tool that can be very valuable in predicting the direction in which the market will go. It can highly improve the search for best entry points and identification of spoof orders.
Reading the demand for buying and selling in the book is called order flow or reading the tape. It is a very old technique, but very powerful. Many day traders or ‘scalpers’ who open multiple short-term positions are using it. It is possible to combine it with technical analysis to determine when to enter the market and what type of orders to use.
Order flow is very common in liquid markets such as the US stocks and futures. The traders often use only the order book and skip reading the charts. It may be considered very arbitrary by individual traders as the attempts to automate trading rules in the code request high programming proficiency. Yet, institutional and high-frequency traders are more interested in supply and demand than in various indicators and graphic software.
Reading the order book on Binance
Looking at the order book you can get the information about the supply and demand in the market – DOM (the depth of the market). It shows inside Offer and inside Bid that is the lowest price demanded by a seller and the highest price a buyer is ready to pay.
Moreover, you can spot support and resistance levels. Check the volume profiles which are in the shaded green and red colours.
A trader can draw the support/resistance on the chart and then confirm it on the order book. Usually, you expect large orders to accumulate around the technical levels selected on the chart to verify your assumptions. But these levels will not necessarily persist. Be careful, for example, to rely on an oversized order that acts as support below your price, since it may, in fact, be a spoof order.
A trade is being executed when the limit order met a market order. This happens when a buyer and a seller have agreed on a price. There are always two possibilities, the buyer has accepted the seller’s price or the seller has decided to sell for a price the buyer was willing to pay. Thus, we are saying the UP or DOWN force is created.
The DOWNWARD selling force is established when the sell market orders have met the buy limit orders.
The UPWARD buying force is established when the buy market orders have met the sell limit orders.
We can compare market orders to your hand in the poker game which you are not sharing unless you have no other option. When buying demand is high, sell orders are being taken out fast because the buyers want to execute the market orders at the possibly lowest price before it will move up.
We can further distinguish four market forces, two are the UPWARD forces and the other two are DOWNWARD forces.
– Weak UP force is buy limit orders (bids)
– Strong UP force is buy market orders (buys)
– Weak DOWN force is sell limit orders (offers/asks)
– Strong DOWN force is sell market orders (sells)
The volume seen at a specific price on the book is the sum of the total orders for this price. Thus, it is quite difficult to conclude whether it is an individual trader having a big account who tries to move the market with a lot of size or a bunch of small players scalping for ticks. Recognizing these options is an ability that you can learn from order flow.
Remember, each market and each asset have to be read differently although the order book looks very much the same for all.
DOM – the depth of the market
DOM is the graphic illustration of the volume of buy and sell orders. It is displayed as a proportion of the aggregated volume of orders on both sides of the book. The volume at the price is higher when the steps on the graph are steeper.
You will observe that the depth of the market keeps changing at all times. This is because the limit orders are being hit with the market orders on both sides.
For example, if we have a 5-tick spread, the inside bid will need to move between 1-4 ticks in order to attract a market order from a seller. A minimal possible spread is 1-tick.
There is a war between market bids and market offers. When there are more market bids, the market is considered to be bullish. When there is more market offers – bearish.
Some tools in addition to reading the order book on Binance
Volume profiling is a tool offered by some external charting software. It can be used in addition to the order flow.
The top metrics are POC – the point of control and VA – value areas. Then it is possible to search for a volume that accumulates in triangular patterns rather than merely candlesticks patterns.
The volume-weighted average price on an asset (VWAP)
Volume-weighted average price, VWAP in short, is the average price at average volume during a specific period of time. It can be considered as the asset’s balance price, quite similar in volume profile to the POC, with the same distance from the mean of volume on both sides of the VWAP. When the price drops below it, it is assumed to be undervalued. And when the price rises above, it is considered overvalued.
High-frequency trading impact
The impact of HFT is not as visible in the crypto markets as is the case in the equity markets, still, it can be noticed on the order book. With practice, every trader is able to observe usual market behaviour and then to detect anomalies like when the orders are being executed significantly bigger or faster than normal.
High-frequency trading programmes are designed for the ranging markets. When the orders are particularly fast, HFT’s task is to use the bid-ask spread for a trade that is basically risk-free.
Technical analysis is of great importance. Observing the candlesticks patterns can bring you close to success. However, they are not patterns but people who move markets. That is why following the patterns is not always enough.
Wish you good luck!