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Academy > Technical Analysis > Bitcoin Order Book Trading: Everything you Need to Know >

Bitcoin Order Book Trading: Everything you Need to Know

2021-08-23 04:11:05

A robust trading ecosystem is a fundamental part of any money market as it enables investors to place bids and asks on particular assets. Before modern electronic trading, exchanges manually updated order books every time someone placed an order, which meant keeping extensive transaction records. Today’s digital order books handle billions of transactions per day, with stock exchanges like the NYSE managing the exchange of shares worth over $20 trillion.


What is an Order Book?

Essentially, order books are just a list of active bids and asks on a trading platform, but analyzing the data it holds can bring all kinds of insight to both large-scale investors and day traders. Investors are constantly looking for the best prices, but sometimes exchanges with lower prices may not have the liquidity required to sustain that price for a large order. This is known as slippage and is one of the many things analyzing order books can reveal.

Crypto Order Books

For digital assets, order books can be one of the best sources of data for analyzing cryptocurrency markets, capturing various metrics like trader sentiment, momentum, and can even be coupled with on-chain information for further insights. Additionally, they can also produce signals that traders can leverage to generate profits.

What are limit orders?

A limit order book is a real-time record of all the open orders to buy or sell a given financial instrument in a market. Limit order books also provide data on market depth, which signals a liquid asset’s supply and demand status by reporting the number of open buy or sell orders for a particular price point.

How to Read an Order Book?

Order books are used to place bids and asks for a stock at different prices, where a matching engine continually matches the orders of buyers and sellers. The more limit orders in a particular price range, the more liquid the asset is said to be.

Limit orders are when traders place bids or asks at a specified price instead of placing an order directly at the current market price. Traders place these orders when they’re targeting a specific price, or if they expect the market to move a certain way and want to catch a buy or sell order as the market moves, and this is essentially what causes the market to move up and down at all.

If the market price of an asset rises to $1,000 but no buy limit orders satisfy that offer, the market will have to wait for an aggressive seller to meet the closest bid in the limit order book. For instance, if the highest bid is placed at $950, an aggressive seller will start selling stock at $950 and pull the market down by $50 a share.

Limit Orders vs. Market Orders

From this, it’s clear that limit orders are usually placed in cases where the trader waits for them to be executed when a buyer or seller is available to satisfy it. On the other hand, market orders are executed immediately at the current market price or the next best available price, as we saw in the example above.

Let’s take a look at an actual order book.

Example of an order book

The left side of the above image shows all the open buy and sell orders. On the extreme right is the chart of all the recently executed trades. In the middle, we have a real-time view of the BTC/USD market performance in the form of a candlestick chart. For our current purposes, the left side of this data set is the most crucial section: i.e., the open orders. The figures in red denote ask prices, while those in green represent bids.

The three headings, Price, Size, and Total, represent the price of the asset at which the order was placed, the number of shares of tokens being bought or sold at that price, and the number of such orders currently open. This data is deceptively simple, and with enough capital, can be manipulated to spoof unregulated markets.

Order Book Trading Strategy

When a large amount of limit buy or sell orders are placed at the same price level, it constructs a wall that limits price movement. The price is restricted from moving further down during a buy wall since traders would want to sell for the highest price. During a sell wall, the price is halted from moving up since bids would favor buying the dip.

Special Consideration: Order Book Manipulation

These buy and sell walls are points of great market depth, but they can also be used to exploit trader behavior by generating false market sentiment. Order book manipulation is a significant concern in cryptocurrency markets, where government legislation and regulatory frameworks are still under construction. Addresses controlling large amounts of capital, also known as whales, can disrupt the natural flow of trade, creating intentional sell walls to keep the prices from rising while building a short position, and buy walls to keep prices from falling when betting long.

This requires injecting massive amounts of liquidity into the market at a single price to manipulate traders into buying and selling at the asset’s walled-off market price. After assets are exchanged at the desired price, orders are withdrawn, and the market is allowed to flow freely again. Regulated markets have ways of combating these malicious market actors, but it’s important to be wary of the whales in the world of cryptocurrencies.

Level 2 Data / Market Depth Charts Explained

On the surface, order books only present the price, total size, and the number of orders at a particular price level. However, Level 2 data or market depth provides a more comprehensive breakdown of how the market values an asset. Besides showing the highest and lowest bid and ask prices of all the market players involved, this data also shows the number of shares they are trading at that price point.

This helps traders map upcoming and dying trends in a market to sharpen their investment strategies and improve their portfolio performance. However, even this data can be misrepresented to trick investors into believing a particular market sentiment exists. Market makers and institutional investors are also adept at trading under the radar, keeping their activity out of the spotlight. This can be done by splitting an investment across various price levels, but some traders also use electronic communication networks (ECN), which are computer-based trading engines that automatically match and execute orders at the best bid and ask prices.

Using a Limit Order Book with On-Chain Data

Another benefit of limit order book analysis is how it can be used in tandem with on-chain data. For example, analysts can correlate its metrics with the funds flowing into and out from an exchange, and some interesting indicators can be highly constructive in understanding market behavior.

Usually, a gap in the bid-ask spread would increase inversely with an exchange’s liquidity, and this dynamic is even more evident on cryptocurrency exchanges. When net flows decrease, implying capital is flowing out from the exchange, the spread widens, suggesting decreasing liquidity levels. However, another way to analyze the bid-ask spread is to compare it with the exchange’s on-chain inventory.

A larger gap between the spread and the number of tokens the exchange holds can often be a sign of risk, and exchanges have been accused of wash trading and reporting inflated trade volume metrics to hide this gap. One way to counter this fallacy is to monitor reported volumes against actual on-chain volumes, where drastically different values become a likely sign of wash trading.


These are just a few of the many ways traders use order book data to make better trading decisions. Though players with large amounts of capital have ways of spoofing order books to manipulate traders, when combined with on-chain data, order book analysis provides a more well-rounded view of a particular asset’s market which simply isn’t possible with on-chain analysis alone.

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