How does an order book work?

An order book is an essential part of any trading market. Whether you trade in stocks, forex or cryptocurrencies, the order book shows which buy and sell orders are active at that moment. It functions as the beating heart of an exchange, where the intentions of thousands of traders come together in one clear system.

For many beginners, an order book can look complicated at first glance due to the rapidly changing numbers and colours. Yet understanding an order book is crucial if you really want to gain insight into how prices are formed and how the forces of supply and demand steer the market. In this article you learn what an order book is, how it works technically and how you can read it to make better trading decisions within the crypto market.

In short

• An order book shows all current, open buy and sell orders for a specific trading pair.

• The system is divided into bids (buyers) and asks (sellers).

• The current market price of a cryptocurrency is determined by where supply and demand meet.

• The spread represents the price difference between the highest bidder and the lowest seller.

• Market depth is a visual representation of the available liquidity at different price levels.

What is an order book?

An order book is a real-time digital overview of all open orders for a certain cryptocurrency on an exchange. It is a database that keeps track of at which prices and in what quantities market participants are willing to trade. Every time a trader places a new order that is not immediately executed against the market price, it is added to the order book.

The system works like a queue: as soon as a buyer and seller agree on a price, a 'match' takes place. The transaction is then executed, recorded on the blockchain (or in the exchange's database) and the relevant orders disappear from the order book. This process repeats itself thousands of times per second with popular coins such as Bitcoin or Ethereum.

Bids and asks: buyers and sellers

An order book is always divided into two clear sides that are often indicated with colours (green and red):

• Bids (buy orders): This is the 'buy side'. Here are the prices that buyers are willing to pay and the quantity of tokens they want to acquire. The highest bid price is at the top of this list.

• Asks (sell orders): This is the 'sell side', also called the 'offers'. Here are the prices for which sellers want to offer their tokens. The lowest ask price is at the bottom of this list.

Together, the bids and the asks give a complete picture of the current market dynamics. If the 'buy side' is much larger than the 'sell side', this indicates strong buying pressure, which often pushes the price up.

What is the spread?

The spread is the price difference between the very highest bid price (the best bid) and the very lowest ask price (the best ask). This 'gap' in the middle of the order book is where the action takes place. Suppose the order book shows the following:

• Highest bid: €100

• Lowest ask: €101

In this scenario, the spread is exactly €1. The size of the spread is an important indicator of the health of the market. A very small spread indicates a liquid market where many traders are active, while a large spread often points to less activity or high uncertainty.

How does an order book work?

The order book is a dynamic system that is continuously in motion. It is fed by millions of calculations per second. The price of a cryptocurrency that you see on your screen is simply the price of the very last transaction that was successfully matched out of the order book.

When a buyer decides that a seller's price is acceptable, a trade arises. There are different ways in which traders interact with the order book via order types:

• Limit orders: These are the building blocks of the order book. You set a specific price (for example: "buy 1 BTC for €60,000"). This order remains in the book until the price is reached.

• Market orders: These orders 'consume' the order book. You say: "buy 1 BTC now immediately at the best price". The exchange then takes the lowest available asks from the book until your order is completely filled.

How do you read an order book?

Being able to read an order book gives you an edge over other traders, because you can see where the 'walls' of money are located.

Analysing the buy side (bids)

The bids show where the support levels lie. If you see that at a certain price, for example €40,000, there is an enormous amount of buy orders (a so-called 'buy wall'), then you know that the price will probably not just drop below that level. Buyers here function as a safety net for the price.

Analysing the sell side (asks)

The asks show you where the resistance lies. Large blocks of sell orders at a specific price level can form a barrier to a price increase. Traders must first 'eat up' all those sell orders before the price can move further up. A thick 'sell wall' can be a sign that the market will have difficulty breaking out in the short term.

Market depth and Depth Charts

Market depth shows how many orders are spread over different price levels, further away from the current price. Exchanges often visualise this in a 'depth chart'. This is a graph with two mountains (green and red).

• High liquidity: The mountains are steep and high, which means that large orders will barely change the price.

• Low liquidity: The mountains are flat and thin, which means that a single large trade can make the price rise or fall by several percent (slippage).

Why is an order book important?

For a serious trader, the order book is indispensable because it is the only place where the real intentions of the market are visible. It helps in determining accurate entry and exit moments. Instead of buying blindly, you can look at whether there is enough liquidity to fill your position without driving the price against yourself. Moreover, it helps in assessing the stability of a coin; coins with a thin order book are much riskier due to the chance of sudden price flashes.

Order book vs market orders

It is essential to understand the difference between making a market and taking a market. Limit orders are placed in the order book and wait for execution; they are called 'makers' because they add liquidity. Market orders are executed immediately against the existing orders; they are called 'takers' because they extract liquidity from the book. On many exchanges, makers pay lower trading fees than takers, because they help keep the order book filled and healthy.

Order book and volatility

The structure and the 'thickness' of the order book determine how volatile a cryptocurrency is. In a market with a low volume, a relatively small sell order can already cause a considerable price drop, because there are not enough bids to absorb the blow. In a deep and liquid order book, such as that of Bitcoin on large exchanges, price movements are often much more stable because millions of euros of orders are ready at almost every price level.

Common misconceptions

Many traders make the mistake of thinking that the order book predicts the future. That is not the case. Large orders that you see now can be cancelled or moved by means of algorithms (bots) within a fraction of a second. This is also called 'spoofing': placing fake orders to push the market in a certain direction without having the intention of executing the order. The order book is therefore a valuable snapshot, but not a crystal ball.

Frequently asked questions

How does an order book work for cryptocurrencies specifically?

Although the principle is the same as with stocks, crypto order books work 24/7. There is no opening or closing bell. Moreover, crypto order books on decentralised exchanges (DEXs) can sometimes work differently by making use of Automated Market Makers (AMMs), although more and more DEXs also implement on-chain order books.

What is the most important goal of an order book?

The main goal is transparency and price discovery. It facilitates a fair marketplace where the price is not determined by one party, but by the collective of all buyers and sellers who place their orders in the book. It ensures that transactions can take place efficiently and at the fairest market price.

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