Bitcoin Order Book Trading

Bitcoin Order Book Trading

A robust trading ecosystem is a fundamental part of any money market as it allows investors to place offers and orders for specific assets. Before modern electronic trading, exchanges manually updated order books whenever someone placed an order, which meant keeping extensive records of transactions.

Today's digital order books handle billions of transactions a day, with stock exchanges like the NYSE managing the trading of shares worth more than $20 trillion.

What is an order book?

What is an Order Book

Essentially, order books are just a list of active offers and offers on a trading platform, but analyzing the data it contains can bring all kinds of insights to big investors and day traders.

Investors are constantly looking for the best prices, but sometimes the lowest priced exchanges may not have the liquidity to sustain that price for a large order.

This is known as slippage and is one of the many things that analyzing order books can reveal.

Cryptocurrency Order Books

For cryptoactives, order books can be one of the best data sources for analyzing cryptocurrency markets, capturing various metrics such as trader sentiment, momentum and can even be combined with on-chain information for greater insights.

In addition, they can also produce signals that traders can leverage to generate profits.

What are Limit Orders?

A limit order book is a real-time record of all open orders to buy or sell a particular financial instrument in a market.

Limit order books also provide market depth data, which signals the supply and demand status of a liquid asset, reporting the number of open buy or sell orders for a given price point.

How to Read an Order Book?

Order books are used to place bids and orders for stock at different prices, where a matching engine continuously matches orders from buyers and sellers. The more limit orders in a given price range, the more liquid the asset is said to be.

Limit orders are when traders place bids or orders at a specified price, rather than placing an order directly at the current market price.

Traders place these orders when they are targeting a specific price, or if they expect the market to move a certain way and want to take a buy or sell order as the market moves, and this is essentially what causes the market moves up and down.

If the market price of an asset rises to $1.000, but no limit buy orders satisfy that offer, the market will have to wait for an aggressive seller to fill the closest offer in the limit order book.

For example, if the highest bid is placed at $950, an aggressive seller will start selling shares at $950 and pull the market down by $50 a share.

Order Limit vs. Market Orders

From this, it is clear that limit orders are normally placed in cases where the trader expects them to be executed when a buyer or seller is available to fulfill them.

On the other hand, market orders are executed immediately at the current market price or the next best available price, as we saw in the example above.

Bitcoin Order Book Trading

The left side of the image above shows all open buy and sell orders. On the right is the graph of all trades carried out recently.

In between, we have a real-time view of market performance BTC / USD in the form of a candlestick chart. For our current purposes, the left side of this dataset is the most crucial section: namely, open orders. Numbers in red indicate selling prices, while numbers in green represent bids.

The three titles, price, size and total, represent the price of the asset on which the order was placed, the number of token shares being bought or sold at that price, and the number of such orders currently open.

This data is seemingly simple and, with enough capital, can be manipulated to fool unregulated markets.

Order Book Trading Strategy

Order Book Trading Strategy

When a large amount of limit buy or sell orders is placed at the same price level, it builds a wall that limits price movement.

The price is prevented from falling further during a buying wall as traders would like to sell at the highest price. During a sell wall, the price is prevented from rising, as the bids favor a buy on a fall.

Special Consideration: Order Book Handling

These buy and sell walls are points of great market depth, but they can also be used to exploit trader behavior, generating false market sentiment.

Order book manipulation is a significant concern in the cryptocurrency markets, where government legislation and regulatory frameworks are still under construction.

Addresses that control large amounts of capital, also known as whales, can disrupt the natural flow of commerce, creating intentional selling barriers to keep prices from rising when building a short position, and buying barriers to keep prices from falling into the stakes. long.

This requires injecting large amounts of liquidity into the market at a single price to manipulate traders into buying and selling at the asset's isolated market price.

After assets are exchanged at the desired price, orders are withdrawn and the market can flow again freely. Regulated markets have ways to combat these malicious market players, but it's important to be careful about whales in the world of cryptocurrencies.

Level 2 Data / Market Depth Charts Explained

On the surface, order books only show the price, the total size and the number of orders at a given price level.

However, level 2 data or market depth provides a more comprehensive analysis of how the market values ​​an asset.

In addition to showing the highest and lowest buy and sell prices of all market participants involved, this data also shows the number of shares that are trading at that price point.

This helps traders to map the final and future trends in a market to improve their investment strategies and improve their portfolio performance.

However, even this data can be skewed to mislead investors into believing that a specific market sentiment exists.

Market makers and institutional investors are also adept at trading under the radar, keeping their activity out of the spotlight.

This can be done by splitting an investment into multiple levels of prices, but some traders also use electronic communication networks (ECN), computer-based trading mechanisms that automatically combine and execute orders at the best buy and sell prices.

Using a Limited Order Book with On-Chain Data

Another benefit of limit order book analysis is how it can be used together in on-chain. For example, analysts can correlate their metrics with funds moving in and out of an exchange, and some interesting indicators can be highly constructive in understanding market behavior.

Typically, a gap in the bid-ask spread would inversely widen with exchange liquidity, and this dynamic is even more evident on cryptocurrency exchanges.

When net flows decrease, implying that capital flows from the exchange rate, the spread increases, suggesting a decrease in liquidity levels. However, another way to analyze the buy and sell spread is to compare it to the exchange's on-chain inventory.

A larger gap between the spread and the number of tokens the exchange holds can often be a sign of risk, and exchanges have been accused of trading and reporting inflated trade volume metrics to hide this gap.

One way to combat this fallacy is to monitor reported volumes against actual volumes on-chain, where drastically different values ​​become a likely sign of wash trading.

Summarizing About Order Book For Cryptocurrencies

These are just a few of the many ways traders use order book data to make better trading decisions.

Although investors with large amounts of capital have ways to spoof order books to manipulate traders, when combined with on-chain data, order book analysis provides a more complete view of the market for a particular asset, which simply it is not possible with on-chain analysis alone.

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