Order Book

What Is An Order Book?

An order book is a real-time, continuously updated list of buy and sell orders on an exchange for a specific financial asset, such as a stock, bond, ETF or currency. It is a formal ledger that conveys market depth on a stock exchange, derivatives or cryptocurrency market.

Each order shows the number of shares or dollar amount of the asset being bid or offered. Also, it documents the specific price and the trader or firm placing the order. This functionality provides a degree of transparency to open orders, although some buyers and sellers prefer to remain anonymous.

The order book enables market participants to gauge the buy and sell interest in an asset and therefore potential support and resistance price levels. This information may suggest forthcoming bullish or bearish price action relative to the current market price.

For instance, if there are many buy orders for a stock at an increasing price, that could indicate a bullish opinion on the stock. By contrast, an abundance of sell orders could indicate a lack of support and therefore a falling price. In either case, the order book addresses market liquidity in both the intermediate and short-term.

By seeing who the prospective sellers and buyers are—either smaller retail investors or large institutions—traders can further determine which way the stock's price is likely to move and therefore how to place their trade. The information is vital to market makers, whose job it is to match buyers and sellers while in the process of "making the market."

However, many investors wish to hide their identities for a multitude of reasons. Given this motivation, they often make their trades through dark pools, which does minimise to some degree the usefulness of the order book as a market intelligence tool.

Order Book Manipulation

Order books—and therefore asset prices—are also subject to manipulation that goes beyond the bounds of legality. Unfortunately, nefarious parties have historically attempted to skew order book information to sway financial markets. No financial instrument has been spared, as everything from stock prices to Bitcoin prices have been targeted.

Two of the most common forms of order book manipulation are spoofing and layering. Each attempts to "game" the market by placing various quantities of buy and sell orders in the queue, without having any plans to execute. The goal is to influence the best bid and best ask prices, thus manipulating the bid-ask spread.

Spoofing

In spoofing, for example, a rogue trader places a large phoney buy or sell order for a stock hoping to influence the price up or down. Then, multiple orders at the opposite end of the trade are placed to capitalise on the price movement while cancelling the original order.

Over the years, spoofing schemes have been found in even the most established stock market trading venues. Two of the biggest names are the New York Stock Exchange (NYSE) and NASDAQ.

One of the most famous examples of alleged spoofing occurred during early 2021 with the trade of GameStop by the Wallstreetbets subreddit. The extreme volatility experienced by GameStop stock was attributed to spoofing at or around specified price points. The end result was an investigation from the US Department of Justice (DOJ) into sell side spoofing practices from a group of high-frequency traders.^[2]

Layering

In layering, the trader places a series of small orders at different prices to create the appearance of wide buying or selling interest in a stock with no intention of actually executing the orders. They then make the opposite trade to profit on the price manipulation. The layering trading strategy is typically attributed to high-frequency trading practices.

Layering is used to create the market conditions for either a bullish or bearish trade. On the buy side, a trader may set quantities of sell orders beneath market price to negatively influence the going bid price. Theoretically, this action would drive prices down and give the trader a better long side entry. To layer a sell, buy orders are placed above price to create a superior short entry.

Legality

Both spoofing and layering have been determined in the U.S. and the U.K. to be forms of market manipulation and are therefore illegal. Authorities such as the US Securities and Exchange Commission (SEC) and UK Financial Conduct Authority (FCA) diligently watch out for such activities. One tool that these entities use to detect spoofing and layering is top of the book market data.

However, both are difficult to prove. Buy and sell orders can be cancelled by the trader for any number of legitimate reasons, either because they don't like the way the market for the stock is moving or because they simply changed their mind. That's why the information in the order book should be used as one of many criteria in choosing to buy or sell an asset at a given price.

Different Order Books Available

Depending on the level of market information they require, traders can subscribe to different order books through their broker. Many market veterans use buy and sell limit order book data side-by-side with their technical analysis. By doing so, they get a comprehensive view of the market through evaluating price action and potential order flow.

• Level 1 data includes the bid and ask price for an asset, the number of shares or contracts being offered for sale or to buy at, and the last price and number of shares or contracts at which a transaction occurred.
• Level 2 data includes more granular information, such as the highest five to 15 bid and ask prices for each asset, along with the number of shares or lot sizes of each.

Level 1 and Level 2 data are available from brokers at different prices.^[1] However, it's important to note that such data does not account for the impact of market orders. While it will indicate buy and sell limit order placement, data on the flow of orders to be filled immediately at the "best price available" remains elusive.

Summary

An order book is a real-time, continuously updated list of buy and sell orders on an exchange for a financial asset, such as a stock, bond, ETF or currency.

Traders use this information to determine the price support for the asset; for example, an abundance of buy orders could mean the asset price is about to go up, while many sell orders could have the opposite effect. In either instance, order book data is useful in identifying trading opportunities, or locating stop-loss and profit target orders in the live market.

The order book also shows who has placed the orders, although investors in dark pools can hide their identity.