What Is an Order Book and How Does It Work?

Order books are real-time snapshots of market demand, but they are also called “continuous” because they are updated in real time as soon as each order is placed and filled. In this way, it is kind of like watching a tug-of-war play out in real time. An exchange’s order book is not to be confused with a company’s order book, which is a log of its customer orders.

The highest bid and lowest ask prices are shown at the top, bottom, or sides, depending on the order book. They indicate the current market price and sometimes include candlestick charts that show how prices are and have been moving.

Types of orders

There are different types of buy and sell orders that traders can place depending on their trading strategy:

Market orders are placed by traders who want to buy stocks at the current market price. These orders are usually filled almost instantly. The price that traders see when they place the order is not necessarily the price it executes for when the market is volatile, so in this way, market orders prioritize execution speed over price.

Limit orders are when traders want to buy or sell shares at a specific price of their choosing. This price can be the market price, but it can also be higher when they feel that the market price is too cheap to sell, or lower when they feel that it’s too expensive to buy. These orders prioritize price over speed, and it can take a while before the limit price is actually reached, if it ever is. Sometimes the stock keeps moving in one direction and never reverses, and other times price movements are so volatile that the limit price is skipped and the order doesn’t get placed. Although this gives traders more control over price, there is no guarantee that their order will ever be filled.

Stop orders, or stop-losses, are used by traders who know that they want to sell a security after it falls below a certain price, to limit losses or secure some gain. This is useful when traders don’t have time to sit in front of the exchange and monitor prices in real time. They choose a limit price that will trigger a market order once that price level is breached. When the market is volatile, however, the execution price can be much lower than the stop-loss limit.

Other conditional orders can be placed by traders who only want their trades to be filled under certain specific conditions. An All-or-None (AON) order means that the trader does not want any partial fills. The order must be filled completely or not at all. Fill-or-Kill (FOK) means the trader wants the order to be filled immediately and in its entirety, or it is canceled. Immediate-or-Cancel (IOC) orders are the same as FOKs but with partial fills allowed. These more complex orders give traders increased control over how and when their trades are filled.

How order books work

Order books ensure that there is a continuous flow of transactions on the exchange by matching buy and sell orders.

They show liquidity and market sentiment thanks to the spread, which is the difference between the highest bid and the lowest ask price. The smaller the gap between those two prices, the more liquidity there is.

Order books bring transparency to the market, but they don’t show everything. If a large player like a bank or hedge fund wants to place a huge order, they will do so in a “dark pool” instead of the order book so as to protect the market from falling rapidly. When big firms place big orders and make their transactions public, their reports move the market in a certain direction. Making these hidden prevents volatility that would be created in anticipation of these big orders. Because of this, traders never really know whether what they see in the order book is everything there is to see, or not.

Advanced order books

Some trading platforms offer more detailed order books that include much more data than classic ones, for a fee.

A more advanced order book will show every single price level, not just the top five or ten like a classic one. They can also show you things like “icebergs,” which are large orders disguised as many smaller ones. This is when big players will place ten orders for 1000 shares one after the other instead of one order for 10 000 shares to keep other traders from picking up on their intention.

While this extra information won’t matter much to the casual trader who buys and holds stock, it will make a difference for professionals and day traders who have to make quick decisions based on small changes in the market. It gives them extra tools to inform their decision-making.

Why are order books important?

Order books provide traders with data about current market conditions that help them make more informed trading decisions.

Traders can use order books to spot big imbalances in buy and sell orders that can be indications of short-term price movement. If there are a lot more buy orders than there are sell orders, for example, it can be a sign of short-term bullish momentum because of buying pressure pushing up the price.

Order books are also useful because they can show potential resistance and support levels. If there is a very large number of limit buy orders at or around a specific price, it can be a sign of a possible support level, which means the stock could bounce back up from there. This works the same way with sell orders. A very high volume of sell orders around a specific price can indicate a possible resistance level, meaning the stock could have trouble breaking past that price area to rise further.