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The basics of the orderbook

An orderbook is a term that you might have come across frequently in the trading circles. Whether you are trading forex, stocks or futures chances are that your broker all your friends would have mentioned about the orderbook. No matter what kind of a trader you are, it is important that you understand the concept of orderbook and the crucial role it plays in trading.

Generally speaking, an orderbook is applicable only for an exchange. However, you can find an order book even for the forex markets. As you might know, the foreign exchange markets are over the counter instruments. This means that when you trade currencies, trading is done over the counter rather than through an exchange. As a result, it can be difficult to find an aggregate orderbook for the currency markets.

Forex brokers nowadays, offer order book to a certain extent. This order book basically comprises of a bunch of deals that are settled with the forex broker or with their liquidity partners. Before we get into more details about the order book, let's first discuss the meaning behind this term.

What is an orderbook?

An orderbook, as the name suggests is a book that is maintained by an exchange. It records all the orders that have been placed and executed during a trading day. An orderbook basically comprises of a list of records of all the transactions that have taken place.

An order book is a very important aspect in a trading exchange. Therefore, exchanges such as the New York Stock Exchange, the NASDAQ exchange maintain an order book which shows the trading activity for the day. You can also find an orderbook even in the futures markets. This is because instruments such as stocks and futures are settled at an exchange and they're not an over the counter trading instrument like the currency markets.

01 Orderbook

Example orderbook – Source: LMAX

The picture about shows a very basic example of how an orderbook looks like. Of course, as we mentioned this is a very small aspect and we do not really see how the real orderbook looks like. In the above example, we are looking at the orderbook for gold.

An order book comprises of two main columns called the bid and ask, also known as the offer. The bid price is the price at which you are able to sell. Likewise, the ask price is the price at which you are able to buy.

This might seem a bit counter intuitive however, if you look at it from a trader’s perspective you will then understand that the bid price is the price that the market, or other traders are bidding for. In other words, this is the price that you can buy the instrument. Therefore, you can see that at the bid price you would be able to sell to others.

Similarly, the ask price is the price that other traders are asking for, order to sell the instrument to you. Therefore, this becomes your buying price.

If we look individually at each of the two columns which is the bid and ask price, you will see that it is further divided into two more columns. The first column on the left is called quantity. As the name suggests, this is the quantity, or the number of contracts dot other traders are bidding or asking at. Next to the quantity is the price. This is the price that the forex broker is either bidding or asking for.

At the very top, you will see that the price and the quantity are highlighted in bold and in bigger fonts. This basically represents the current market price or the best bid and the ask price.

When looking at an order book, there are multiple aspects to it as well. One of this is called the depth of the market. The depth of market, as the name suggests shows you the number of buyers and sellers who are lining up to buy the asset.

The depth of market is broadly classified into level one and level two data. For example, in the above screen that you see this is typically called level 1. The level one data basically shows you the current orders that are placed by others within the exchange.

The level two data is a bit more comprehensive and shows you the orders that are placed at different price levels. However, you should note that just because an order is placed doesn't mean that it will be executed. For example, you could place a pending by order and then cancel that order after a short while.

In the next part in this article, we will take a look at the importance of the orderbook and how it can help you as a trader.

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