Understanding the Order Book

The order book shows all pending buy and sell orders for a security. Understanding it reveals the real-time battle between buyers and sellers. [DEFINITION] Order Book: A real-time list of all pending buy (bid) and sell (ask) orders for a security, organized by price level, showing the depth of market supply and demand. ### Order Book Structure **Bid side (buyers):** - Shows all pending buy orders - Organized highest to lowest price - Represents demand **Ask side (sellers):** - Shows all pending sell orders - Organized lowest to highest price - Represents supply [KEY] The order book is the heart of price discovery—where buyers and sellers meet to determine prices through their orders. ### Reading the Order Book Example order book: **BIDS (Buyers)** | Price | Size | Orders | |-------|------|--------| | $50.00 | 10,000 | 45 | | $49.95 | 8,000 | 32 | | $49.90 | 15,000 | 67 | **ASKS (Sellers)** | Price | Size | Orders | |-------|------|--------| | $50.05 | 5,000 | 23 | | $50.10 | 12,000 | 41 | | $50.15 | 8,000 | 35 | ### Key Concepts **Spread:** Difference between best bid and ask ($50.00 to $50.05 = $0.05 spread) **Liquidity:** Total volume of orders at various prices **Depth:** How many price levels have orders; deeper = more liquid [EXAMPLE] If you want to buy 15,000 shares immediately, you'd pay: - 5,000 at $50.05 (taking best ask) - 10,000 at $50.10 (next level) - Average price: ~$50.08 ### Order Book Imbalances **More bids than asks:** - Buying pressure exceeds selling pressure - Price may rise to attract sellers **More asks than bids:** - Selling pressure exceeds buying pressure - Price may fall to attract buyers [TIP] Order book imbalances can signal short-term direction, but they change constantly. Don't trade on order book alone. ### Order Types and the Order Book **Limit orders:** Add liquidity by waiting in the order book **Market orders:** Remove liquidity by taking existing orders **When you place a limit order:** It appears in the order book until filled or cancelled **When you place a market order:** It matches against existing orders, removing them from the book ### Hidden and Iceberg Orders **Hidden orders:** Some orders don't appear in the order book - Institutional orders may be hidden - Creates unexpected supply or demand **Iceberg orders:** Only show partial size - 50,000 share order shows as 500 shares - Refills automatically as it's hit [WARNING] What you see in the order book isn't everything. Hidden orders and fast changes make the visible book just a snapshot. ### Order Book Dynamics The order book is constantly changing: - Orders are placed - Orders are cancelled - Orders are filled - Prices update **During volatile moments:** - Order book thins (fewer orders) - Spread widens - Prices move faster [EXERCISE] Looking at an order book, you see 50,000 shares bid at $49.95 but only 5,000 shares offered at $50.00. What might happen if a 10,000 share buy market order comes in? |ANSWER| The 10,000 share buy order would: 1) Take all 5,000 shares at $50.00 (best ask). 2) Move up to take 5,000 more shares at the next ask level (likely $50.05). 3) Prints at average of these two prices. 4) Best ask moves up. 5) Spread may widen temporarily. Large market orders move prices through the order book. ### Practical Use for Investors **Before placing orders:** - Check bid-ask spread - See if your order size is appropriate for liquidity - Decide market vs limit order based on book **Position sizing:** If your order is large relative to visible liquidity, consider: - Breaking into smaller orders - Using limit orders - Executing over time [SCENARIO] You want to sell 10,000 shares. The bid side shows 2,000 at $50.00, 3,000 at $49.95, and 5,000 at $49.90. What's your likely execution if you use a market order? Your 10,000 share market sell would: 2,000 at $50.00 + 3,000 at $49.95 + 5,000 at $49.90 = weighted average ~$49.93. You'd receive about $499,300 total. A limit order at $49.95 might only fill 5,000 shares immediately. The order book shows your order moves the market—you're a meaningful seller relative to available bids.