Orderbook Logic. Understanding Orderbooks & How to Use…
By: Andrey Didovskiy
Tags: Trading, Crypto, Finance, Cryptocurrency, Bitcoin

Orderbook Logic

Understanding Orderbooks & How to Use Them

Trading demands having an edge. With so much information available now, crafting a strategy becomes overwhelming quickly. Thousands of signals to interpret as indicators of the market, thousands of different indicators each presenting data in their own unique ways. One of the most widespread, possibly least talked about, & controversial indicators is the Orderbook.

Orderbook data is almost always misinterpreted.

Orderbook data is very loose & should not be exclusively relied upon.

Orderbook data is very susceptible to manipulation.

Orderbooks are lists of open market interest of a certain asset on a venue/platform at any given time. Basically, they are the active Buy/Sell orders.

The information presented in an orderbook can be used to extrapolate two valuable properties of an asset’s current liquidity; 1)Slippage Severity & 2)Bid-Ask spread.

Slippage is a side-effect of selling onto the market. When large positions are exitied there will be a discrepancy in the final settlement. If BTC is $20,000 & somebody decides to sell 100 BTC for $2,000,000 but the open market will be able to cope with a certain amount of trade at different levels.

Portfolio Value

100BTC @ $20,000 = $2,000,000

Market Capacity

50BTC @ $20,000 = $1,000,000

25BTC @ $19,900 = $497,500

15BTC @ $19,800 = $297,000

10BTC @ $19,700 = $197,000

100BTC @ “…” = $1,991,500

Slippage here would result in a loss of $8,500.

The Bid-Ask Spread is the difference between the first buy order & the first sell order on the market. Taking the case of Bitcoin at $20,000 again it would be safe to assume the spread would be tight (somewhere in the 0.3% range) making the first buy order $19,940 & the first sell order $20,060.

* Side Note *

Most crypto & digital assets are very illiquid & have large discrepancies between the prices; sometimes ranging as high as 5%–8%.

Orderbooks visually depict the depth & size of open interest at a variety of price points. At any given moment and orderbook’s data is static, however each sequential instance of it paints a picture over time; helping understand the assets behavior.

The horizontal bar at the bottom shows price while the vertical bar on the right shows the size. The left half (green) of the orderbook will show buying pressure — which translates into how much selling the asset can absorb. While the right half (red) shows selling pressure — which translates into how much buying pressure can be absorbed before breaking through to higher levels. Large walls on either side typically represent strong levels of support/resistance.

This is a concept that might be best understood through a simulation.

Project ABC is currently trading at $0.44 each. There are a total supply of 100,000,000 ABC tokens & they are all circulating. Its marketcap is $44,000,000. There is a lot of uncertainty in the blue chip cryptos (BTC/ETH) but Project ABC is holding its price. Opening the Orderbook to look at the Depth Project ABC has a total of 390,000 tokens for sale (with a >300% premium) & 1,700,000 tokens ready to be bought with an up to (-80% slippage).

In an overly simplified & rudimentary manner this translates to:

390,000 @ 300% premium @ $0.44 = $514,800 buy side aggregate

1,7000,000 @ -80% slippage @ $0.44 = $149,600 sell side aggregate

Say you want to see what the disparity in buy/sell pressure within a specific price range. It is possible to zoom in & adjusting the scale at an extremely granular level.

By Looking at the above Depth of Bitcoin [~$18,333] (via Binance {on 12/12/2020 approximately 12:45AM}) We can asscertain that quantitatively in order for Bitcoin to gain +2.9% in price approximately 735 BTC must be bought (which results in a move to ~$18,846). On the other hand, we can also see that in order for Bitcoin to lose -2.9% of its price approximately 388 BTC must be sold (which results in a move to ~$17,794).

Interpreting Orderbooks

As mentioned at the beginning, Orderbooks are one of the most misinterpreted tools in an investor/traders toolkit; all because the visual manner in which the data is presented is counter-intuitive & extremely dynamic.

Whenever investigating an orderbook 3 general outcomes are possible based on the distribution of depth; Buy/Green dominant, Sell/Red dominant & Equal distribution

Buy Pressure (Big Green Walls & small red walls):

More buying pressure supporting price

Large green walls may seem positive at the outset, indicating the price is being defended at those levels & that more capital is committed to the securing of an asset rather than selling it. However, this is not always the case. Large green walls can be an indicator expressing the open market audience is not willing to participate at higher levels. They can also be expressing manipulation in the form of large players setting up artificial orders to make the asset seem “safe” & then just suddenly remove them causing the interpretation to suddenly shift and decimate the price.

Sell Pressure (Bigger Red Walls):

More selling pressure denying price

As in the case with their counterpart, Large red walls may seem negative at the outset, signaling that the price is likely going to have a difficult time moving up or that current stakeholders are eager to exit their positions. In reality however, this is not the case. Large sell walls could indicate a looming spike in demand that current traders expect to drive the prices up & are setting up their positions to take profits. Likewise, large sell walls can appear as spoofs used to deter actors from buying at higher levels (in hopes keeping price down).

Large stakeholders of a project have an incentive to keep price down for prolonged periods of time in attempts to accumulate greater influence over the network at a lower price point. Their spoof orders merely attempt to deter automated trading algorithms of market makers with false data; typically the monster orders are never filled, disappearing as soon as some pressure would be coming which result in exorbitant price spikes. This can be observed by looking at candle charts of crypto assets over longer time frames. Wicks (there are few candles in crypto that close without wicks & candle wicks in crypto are much more sever than in traditional markets due to the volatility).

Balance (Equilibrium):

Roughly equal distribution between both sides

Orderbooks are like seesaw’s, with both sides constantly fluctuating back and forth, evening out their distributions; at times neither side will be dominant & when this is the case using the orderbook as an indicator for trading/investment decision is rendered useless.