Table of contents:
- 1 Overview about the Order Types:
- 1.1 Limit Orders and Market Orders:
- 1.2 The order book explained
- 1.3 What’s level two data?
- 1.4 Trading industry wants to withhold information
- 1.5 Being able to read the Order Book
- 1.6 Why is the Order Book suitable for day trading?
- 1.7 Time & Sales
- 1.8 Order Book trading:
- 1.9 Questions that an order book trader can ask himself
- 1.10 Conclusion on the subject of Order Book trading, Dom and Time & Sales
What is the order book and how does it work? All buy and sell orders are collected in the order book. This then determines the equilibrium price. On this page, I will explain in detail how to use it.
Order books exist for all exchange-traded securities.
However, before one becomes familiar with the price formation and the formation of the equilibrium price, one should, first of all, know the common types of orders.
Overview about the Order Types:
1. Cheapest order (unlimited buy order, also known as buy market):
The investor agrees to accept any price for the purchase of the securities.
2. Best order (unlimited sell order, also known as a sell market):
The investor agrees to accept any price for the sale of the securities.
3. Limited buy order:
The investor specifies a price up to which he wishes to buy a maximum of the shares.
4. Limited sell order:
The investor specifies a price which he wants to achieve at least when selling.
5. Stop Loss Order:
A stop-loss order is a sell order that is best executed at the next price when the price reaches or falls below a limit set by the investor.
6. Stop buy order:
A stop buy order is a buy order that will be executed at the cheapest price at the next price when a limit set by the investor is reached or exceeded.
7. Stop sell order:
A stop-sell order is a sell order that will be executed at the best price at the next price when a limit set by the investor is reached or exceeded.
Limit Orders and Market Orders:
But if you look at the types of orders, there are basically only four forces:
- Buy Limit (Buy Limit)
- Sell Limit (Sell Limit)
- Purchase Market (Buy Market)
- Sale Market (Sell Market)
Stop-loss orders are also market orders. This is because when a certain price (stop loss) is reached, the order is executed at the next price (market).
However, these stop-loss orders cannot be seen in the order book. Only limit orders are visible in the order book.
A limit order alone cannot be executed. It requires an additional market participant to use a market order to enter or exit the market and thus execute the limit order in the market. It is therefore the market orders that are the driving force in the market.
The order book explained
The order book is also known as the DOM (Depth of the market). The following figure shows the order book for the DAX Future with the ten best bid and ask prices.
What’s level two data?
There are level 1 and level 2 data. These give an insight into the depth of the market.
With Level 1 data, you only see the first line of market depth in the order book, so to speak. You only get an insight into the best bid and ask side. In other words, you only see the spread here, so to speak. The spread is the difference between the best bid and ask side.
- The best bid side is therefore the highest buying limit.
- The best ask side, on the other hand, is therefore the lowest sell limit.
- In the order book shown above, the spread is 1 point.
The FDAX thus quotes 12,704 to 12,705.
- 12,704 is the best bid side or the highest buy limit.
- 12,705 is the best ask side or the lowest sell limit.
Level 1 data therefore contains the following data:
- Best bid and ask price with the respective volume
- The last price with the respective volume
For pure charting, the level 1 data are therefore completely sufficient.
Therefore, many retail traders will never have used Level 2 data or even heard of it. This is pretty wacky when you imagine that most people act with only a fraction of the possible information and think that they can trade profitably (especially in day trading).
With level 2 data, on the other hand, you get an insight into the complete depth of the market. One gets, so to speak, an insight into the real market.
The market depth varies from market to market, but for most markets the complete market depth corresponds to ten digits or ten lines in the order book.
This means you get insight into the ten best bid and ask pages.
Level 2 data is therefore also more expensive than pure level 1 data.
However, in order to gain a complete insight into the order book, you need level 2 data.
Level 2 data and thus the order book is an often underestimated tool.
Trading industry wants to withhold information
The trading industry, represented by the brokers, has no interest in people really being profitable in the long term. Many CFD brokers even benefit when clients lose money.
However, as a CFD trader you usually don’t get level 2 data. Therefore, a lot of work has been done to make the majority of people think that they can be successful in day trading and only with charts.
When the industry realized that people were no longer as stupid as before and that volume was important information for trading, Market Profile and Footprints charts were increasingly marketed to the broad mass of day traders. Because with this additional money can be earned from the trading industry like brokers and software providers. But that means not you have to be profitable in trading.
Being able to read the Order Book
In our opinion, it is an illusion to know what is really going on in the market if you don’t work directly with the order book including the level 2 data and the Time & Sales list.
It’s also very cost effective, but at least as effective as all the other tools on the market. We would say even better.
Why is the Order Book suitable for day trading?
Because you really have to deal with the market.
Of course this is extremely tiring, but that is trading.
If you think you can just look at a chart, put an indicator in it, and be very profitable in the long run, you’re wrong. Of course, there are exceptions, but usually, this is not the case.
Anyone can do chart analysis, but that has nothing to do with current market events.
Especially in day trading and in the smaller time levels, we think that only with charts you have no advantage.
Time & Sales
The Time & Sales list is together with the order book the best tool for day trading. Here you can see the order flow of the respective security.
The Time & Sales shows every single trade that has been executed in the respective security.
Besides the time of the trade, you can also see the price and the volume.
With the Time & Sales list alone, it becomes quite difficult to gain an advantage.
But together with the order book the whole thing looks different.
In our opinion there are two truths in trading: One is price and the other is volume.
If you are able to read the order book, the probability in trading increases significantly.
Order Book trading:
If you combine the order book and the Time & Sales list, you can use it for order book trading.
It is important, however, that you are familiar with both instruments before you combine them.
You should also know how the market really works, i.e. what types of orders there are and how they affect the market.
With this combination of DOM and Time & Sales you get a good insight into the market.
On the one hand you can see the order volume, the executed trades and the trades in the “queue” (the limit orders above and below the market).
You can see how many contracts it takes to move the price x points up or down.
Through the speed of Time & Sales and the rhythm with which orders are executed, you can see if the market is getting hectic or nervous.
If you compare Time & Sales with the order book, you can see how the bid and ask sides change. Is there an “imbalance”? Which side is currently the “stronger”?
You can also see whether new volume is coming in or how it is changing.
Questions that an order book trader can ask himself
- What is the displayed volume at a price and how many contracts are actually traded at that price?
- What is the speed with which the respective bid and ask pages are served?
- What does the spread do? How does the spread change with executions and speed?
- On which side of the spread are the orders executed?
If you are long and the orders serve the letter sides, this is a good indication of sustained strength and vice versa.
You should also know what time of day which market participants are usually in the market and how they act.
- How are the volume and rhythm usually at what time in the market?
- When does the rhythm and/or volume change?
- Which trading systems (algorithms) are running or could be running and what could they do?
There are many aspects that must be taken into account in order book trading.
But once you are able to do this and willing to make this effort, you can gain a sustainable advantage in the market (Trading Edge).
It is simply that the majority of traders are simply not able to do this, and those who would be able to do so are simply too “lazy”.
Order book trading is not just about looking in the order book and seeing where what has happened. It is also and above all to understand how, where, and what has happened and to guess how, where, and what could happen.
And you don’t see that in the chart. You don’t see there how something happened in detail where.
But that is the detail that can give you the necessary trading advantage in day trading.
- Which conclusion can the day trader draw when the next order serves the money side?
- What does it mean when the letter side is executed.
- What does it mean if the volume changes?
- What does it mean if the rhythm of the order flow changes?
On the one hand, you have to be able to understand the past and the present situation. But of course, you also have to be able to deduce what the future situation will be like in order to be prepared for all scenarios.
That is what makes trading so demanding and complex.
Conclusion on the subject of Order Book trading, Dom and Time & Sales
Reading a chart or simply looking into the order book is not complex.
However, this does not mean that you can be infallible in order book trading and not incur losses.
Of course, losses are also part of trading according to DOM and Time & Sales.
In order book trading, too, you will be wrong or overlook certain things.
There are also situations in which the order book may not even bring any advantage or where the Algos are making fun of you.
But in my opinion you can gain a sustainable advantage, which is expressed in a sustainable good performance, if you know how to use the tools presented in this article.
It is also the purest form of day trading. You can’t get any closer to the market and that’s what trading is all about for me.
Read my other articles about futures:
- CFDs vs. Micro Futures – Which one is better?
- Futures Broker Comparison – Find the best Broker and save money
- How does the Volume Profile work? – Tutorial
- How to calculate the Tick Value of Futures
- Options vs. Futures – Two Different Types Of Futures Contracts
- Orderbook – The most common Order Types for Futures Trading
- What is Future Trading – Tutorial for beginners
- What is the Footprint Chart? – Trading Tutorial
- What is the Market Profile – Tutorial