Analysing Order Books and Depth of Market Explained

Here we learn how to read an order book, analyse the order flow and depth of market to monitor a token market's overall health.

Analysing Order Books and Depth of Market Explained

While many traders like to formulate their crypto trading strategies by learning technical analysis and spending hours using the many different charting software available, plenty more will tell you to simply look at an asset's order book. In an industry that is notorious for having markets filled with fake volume & trade washing, anything that can help you locate spoof orders can be very helpful. Reading the buy and sell demand on a market's book is what is known as understanding order flow.

Steps to analyse a crypto market's order book

  1. What is order flow?
  2. What is Depth of Market?
  3. Analysing order books on Saturn
  4. Automation will help price discovery

What is order flow?

This is a technique that will help you understand if a coin or token's market is as healthy as the hype or news is telling you, which will allow you to manage your own orders accordingly - if your order flow analysis is revealing that the asset's market is not as healthy as thought then you may want to take less risk and be a little stricter on your entry points or orders you put in place as stop losses.

Technical analysis may fulfil the human desire to see patterns in what is sometimes just randomness, while letting us make educated predictions about the next token's price rally and trade on what we believe could happen. Whereas, reading the tape, as understanding order flow is referred to lets us know what actually can happen because you are only concerned with the market's current supply and demand - which is known as depth of market.

What is Depth of Market?

The main data you will be looking at when analysing if a cryptocurrency asset's market is overall quite healthy or not, is the number of open buy and sell orders for an asset at different prices. This is known as the depth of market, you could also see it as a quick indication of the liquidity for that particular coin or token. The higher the depth of market is, the higher number of buy and sell orders exist at each price for that asset. You can get a quick feel of the amount of buy or sell orders for a token market easily on Saturn, just by opening an order book:

ONEX Order Book (22/04/2019)

For example, above we can quickly see ONEX has roughly the same amount as Sell Orders and Buy Orders as they have around the same amount of pages: 4 & 5.

Why does this matter?

Reading the order book, lets you determine where a token's price might be heading in the near future as orders are filled or cancelled. Cryptocurrencies with a strong and healthy depth of market, will generally also be markets that have a stronger volume and be quite liquid markets. This is positive to know because these markets should be less volatile, as large buy or sell orders can happen without significantly affecting the token's market price. When markets are illiquid, you have a much higher chance of the spread being larger.

What is the spread is saying?

Spread is calculated as the difference between the best buy price and best sell price. When the bid-ask spread is narrow, this is known as a tight market. A tight market will be characterised by abundant liquidity and a higher trading activity. You will see buyers and sellers in active competition for discovering the market price, which will lead to much tighter spreads. Therefore, a tighter spread is another indication that a token market is healthy.

Analysing Order books On Saturn

For any traders that are already familiar with the thought process behind reading order flow, you will notice I have not really brought up things such as using it to spot the support and resistance levels (large buy or sell orders) to find better entry or exit price points in a token's market. This is because when you are trading on a decentralized exchange such as Saturn, I believe there is much less emphasis on watching the order book on an hourly or even daily basis than if you were trading on markets existing on large centralized exchanges.

My reasoning behind this is as follows:

  • Crypto markets on a DEX are generally speaking newer Altcoin markets with an overall lower volume & trade activity.
  • Most DEXs only allow the creation of limit orders, so there is less use of reading the order flow regularly to get a feel for the number of invisible market orders.
  • Finally, as everything is on chain there is a very low chance that traders are trying to influence the market by making spoof iceberg orders (very large orders that they will cancel at the last moment).

Now in the future this could definitely change, but currently, I believe monitoring a token's order book is something traders should do periodically. This provides traders with an idea of the token's overall market health. It will let you see if the market is progressing positively or negatively, and gives you a better idea if the token is a market you wish to stay in long-term or short-term.

Here is an example

Earlier we saw a screenshot of ONEX's order book, let's follow up and dig a bit deeper to analyse that market together. Below we have generated what is known as a Depth Chart - which is part of our the automated trading indicators we want to develop & release for you to improve your trading strategies.

ONEX Order book Depth Chart

It is the chart of the market makers, people putting up offers to buy or sell.

  • Buy Depth means it would take around 47 ETC worth of ONEX being sold to fill every buy order.
  • Sell Depth means it would take around 139 ETC worth of ONEX being bought to fill every sell order.

On the left you see the people who want to buy ONEX from you & on the right you see the people who want to sell ONEX to you. Generally, you would see the price displayed as the horizontal axis, which makes the lines show you how much ONEX would need to be bought or sold to reach given price levels.

  • The green line on the left is the cumulative buy orders below the current price.
  • The red line on the right is the cumulative sell orders above that price.

Where we see the line going vertical, this is what we know as buy walls or sell walls - large orders that will need to be fully satisfied before the token's price could continue going up or down.

So is ONEX a healthy market?

Overall, I would say yes. ONEX is actively being traded, which has led to a healthy competition between the best buy & sell price and created a tight spread of 0.001 ETC.

ONEX Recent Trade History

Yes, as we noted earlier in the article, ideally we want our market to have a near equal buy & sell depth. So it would definitely be a positive sign if we see ONEX's buy depth increase in the future - that being said I do not believe the current difference is anything to panic about.

For example, if we generated a depth chart for WiiggoCoin, this is the result:

WIIG Order book Depth Chart

Here we have some red flags of an unhealthy market, because there is a clear order imbalance. We can see an excess of sell orders compared to buy orders, creating a big sell pressure on WIIG's market when there appears to not really be any buyers.

So if you find yourself trading or holding tokens that have an unhealthy market, it will be a good time to check up on the project's recent developments. An unhealthy trading market does not mean that a project is doomed, far from it, but it may warrant checking up if the team has been active and is communicating what they have been up to. For example, in WIIG's case their website indicates they are still in their ICO phase so it could be deemed normal that trade activity is low.

Automation creates price discovery

The goal of the market is price discovery. As a project founder or developer, you want your token's marketplace to be actively trading and for its order book to be well-balanced. If your token's marketplace is healthy, this sends out a positive message to traders or investors, irrespective of your token's current price or which direction it is going. A healthy market allows people to predict future token prices and speculate on trends.

To conclude, this is why we have put such a focus around developing trading bots and tools to promote automation on Saturn Network. If it is easy to set up tools to automate trading, such as Pricewatch Bot and in the future market making bots then suddenly markets become much more attractive. Simply due to more liquidity being offered and an increase in trading activity. And this allows the project teams and their community, to concentrate on providing utility for their token which in turn will add value and drive the price!

I will talk more on market making bots and why price discovery is a very positive element of any market, in our next articles, so be sure to subscribe to our newsletter, follow our twitter and join our community.

Happy trading!