What Is an Order Book?

Order Books Explained

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An order book lists all the open orders with different offers from buyers and sellers for an underlying security. It provides investors with information such as the different prices of each order, the total volume of orders at that particular price, and the spread between the best buy and sell prices.

Because order books play a key role in investing, it’s important to understand what they are and how they work.

Definition and Examples of Order Book

An order book is an electronic or written list of all the buy and sell orders investors have made for a particular security. It lists the prices buyers and sellers are willing to pay, and how many orders are submitted for the particular price. Investors use order books for technical analysis of potential investments. For example, knowing the prices and the volume of orders behind those prices can indicate which direction or trend the underlying security may move.

An order book is often included in what is known as “Level 2” market data—in-depth data on bids and asks for a particular security. Orders can be listed by order volume or price and are updated in real time.

  • Alternate name: Continuous books

Suppose you want to determine the amount of interest other investors have in a particular security. You can look at the order book to view all the open orders, including their respective prices and the volume of orders at each price.

This information gives you a good idea of the interest in that security, the sentiment of investors, and the overall market depth of how that security is trading. You can use this info to supplement your analysis and determine whether you should invest in this particular security, or take a long or short position.

How Does an Order Book Work?

Major stock market exchanges such as the NYSE or the NASDAQ use an order book to record the open orders and market interest of listed securities in real time. The order book also identifies the buyers and sellers behind each open order. However, some investors hide their identities behind their orders by investing in what’s known as a “dark pool.”

Dark pools are groups of large trades aggregated away from the order book.

Order Types

Each time an order is placed, it is listed in the order book until it is fulfilled. An investor can submit four types of orders that would report as an order within the order book. They are market orders, limit orders, stop-loss orders, and trailing stop orders.

  • Market order: An order to buy or sell a security on the exchange processed immediately at the current market price.
  • Limit order: An order that allows investors to fulfill an order only at the submitted limit price or lower (buy order), or the submitted limit price or higher (sell order).
  • Stop-loss order: Stop-loss orders are used to limit an investor’s loss by triggering an immediate buy or sell (depending on whether you hold long or short positions) when the underlying security is losing money.
  • Trailing stop order: A trailing stop order is a stop-loss order placed at a specific dollar amount or percentage above or below the most recent high/low (again, depending on whether you hold long or short positions).

An order book takes all the pricing information of these different trades and aggregates them according to price and volume for you to analyze while making investment decisions.

Bid vs. Ask

For every security traded, there is a buyer and a seller, and a “bid” and “ask” price. The price at which the buyer is willing to pay for a security is the bid, and the price at which the seller is asking for the security is the ask.

There will usually be a gap between the bid and ask price called a “spread” or “bid/ask spread.” The bid/ask spread represents the difference between the bid and the ask prices and is dependent on the volume of trades submitted. For example, if there is a large volume of open orders in a security’s order book, the bid/ask spread will be thinner, and vice versa.

Pros and Cons of Order Books

Pros
  • It helps measure the market sentiment of a particular security

  • Gives investors an indicator of whether there is a bullish or bearish trend for that security

Cons
  • Order book info may not be relevant for long-term investors

  • Order book trends can change quickly

Pros Explained

  • Helps measure market sentiment of a particular security: The ability to view how many trades are placed at a specified price is an indication of the market’s overall sentiment for the underlying security.
  • Gives investors an indicator of whether there is a bullish trend or a bearish trend: Seeing orders placed for buyers and sellers at a range of different prices with their respective volumes can indicate whether a security may have an upward or downward movement in the near future.

Cons Explained

  • Order book info may not be relevant for long-term investors: Investors who use the order book to place a trade are often short-term day traders or investors looking to determine the opportune time to enter the market.
  • Order book trends can change quickly: The order book is updated in real time, making the data you have time-sensitive. If you are basing a trade on order-book data, keep in mind that the data may only be relevant for a short time.

What It Means for Individual Investors

Understanding the order book can give you an edge on when and at what price you should enter the market for a specified investment. It can reveal both the depth of trades behind a security and pre-market information, giving you indications of the best price to enter the market.

In most cases, investors use the order book for shorter-term investments.

However, long-term investors often use it to time the market to get the best entry price. Individual investors should be wary of using the order book as a fundamental reason behind an investment, as it doesn’t give guaranteed indications of a directional movement of a security.

Key Takeaways

  • An order book is a list of all the open trades of a particular security. It lists all the open buy and sell orders, prices, and the current volume of orders for that price.
  • Order books consist of open trades, including market orders, limit orders, stop-loss orders, and trailing stop orders.
  • For each security being traded, there is a buyer and a seller. The best price a buyer is willing to pay for a security is called the “bid,” and the best price the seller is willing to accept is called the “ask.”