Market Depth

What is Market Depth?

Market depth provides a comprehensive view of all the outstanding orders for a security or asset across multiple price levels. It reveals the full order book rather than just the top bid and ask prices. This level 2 data displays the complete list of buy and sell orders, showing the demand (bids) and supply (asks) at each price point. Having this transparent look into the full market interest and liquidity gives traders and investors deeper insights.

Reading Market Depth Charts

Depth charts, also called DOM (Depth of Market) windows, are split into two sides – bids on the left showing buy orders and asks on the right showing sell orders. The prices are listed vertically with the corresponding volumes (order sizes) next to each price level. More orders stacked at a particular level indicate greater support or resistance at that price. Tracking the depth imbalances between bids and asks across multiple levels can signal potential turning points.

Using Market Depth for Trading

Monitoring raw order flow data allows traders to make more informed decisions on trade entries, exits, and overall positioning. Seeing a large sell order might hint at impending selling pressure, while buy-side dominance could precede a rally.

The depth essentially reveals what larger players are doing through their order placement. It provides cues on evolving market sentiment and dynamics that can shape trading strategies accordingly.

Market Depth Patterns

Over time, certain patterns tend to emerge in the order book data that experienced traders learn to identify.

Examples include persistent one-sided depth favoring buyers or sellers, sudden depth changes, or specific footprint-like order placement by institutions. Detecting depth patterns like spoofing, layering, or iceberg orders can offer trade signals or cues about prospective price moves.

Depth Data and Backtesting

While real-time level 2 data has been readily available, accessing historical order book data has traditionally been difficult. However, the availability of such historical depth feeds is increasing, allowing the analysis of past order flow and supply/demand dynamics.

This historical depth intelligence enables backtesting of depth-based trading strategies across prior market periods and events.

Short-Term vs Long-Term Usage

Some traders view depth as primarily a short-term tool for scalping and day trading, using it to time optimal entries/exits by gauging the immediacy of order flow.

Others apply depth analysis over longer timeframes to assess overall market sentiment and conviction among participants. The depth could be used to position for a multi-day breakout move or to identify price levels for initiating swing trades.

Market Depth Across Asset Classes

Depth characteristics can vary across different asset classes like stocks, futures, forex, and cryptocurrencies. Highly liquid futures markets tend to have extremely dense order books.

Stock depth is often thinner outside the top few price levels. Retail forex platforms show more modest depth, while crypto order books can be highly volatile. Understanding these unique market microstructures is vital.

Depth Trading Techniques

Various techniques centered on depth have been developed, like fading order imbalances by entering against the prevailing flow or riding the order flow by joining a developing auction.

Advanced tactics involve strategic order placement, like using iceberg orders to obscure full size, spoofing to bait flows, or layering to influence order book perception. Proper depth trading requires skill in registering and reacting to changes.

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.