What Is an Order Book? Definition, How It Works, and Key Parts

What Is an Order Book?

The term order book refers to an electronic list of buy and sell orders for a specific security or financial instrument organized by price level.

An order book lists the number of shares being bid on or offered at each price point, or market depth. It also identifies the market participants behind the buy and sell orders, though some choose to remain anonymous. These lists help traders and also improve market transparency because they provide valuable trading information.

Understanding Order Books

Order books are used by almost every exchange to list the orders for different assets like stocks, bonds, and currencies — even cryptocurrencies like Bitcoin. These orders can be both manual or electronic. Although they generally contain the same information, the set up may be slightly different depending on the source. Buy and sell information may appear on the top and bottom, or on the left and right side of the screen.

An order book is dynamic, meaning it's constantly updated in real-time throughout the day. Exchanges such as Nasdaq refer to it as the "continuous book." Orders that specify execution only at market open or market close are maintained separately. These are known as the “opening (order) book” and “closing (order) book” respectively.

For instance, the opening and continuous books are consolidated at the Nasdaq market open to create a single opening price. The same happens when the market closes when the closing book and continuous book are consolidated to generate a single closing price.

Reading an Order Book

There are typically three parts to an order book: buy orders, sell orders, and order history.

• Buy orders contain buyer information including all the bids, the amount they wish to purchase.
• Sell orders resemble buy orders, but instead include all the offers (or asking prices) or where people are willing to sell.
• Market order histories show all the transactions that have taken place in the past.

The top of the book is where you'll find the highest bid and lowest ask prices. These point to the predominant market and price that need to get an order executed. The book is often accompanied by a candlestick chart, which provides useful information about the current and past state of the market.

The order book helps traders make more informed trading decisions. They can see which brokerages are buying or selling stock and determine whether market action is being driven by retail investors or by institutions. The order book also shows order imbalances that may provide clues to a stock’s direction in the very short term.

For instance, a massive imbalance of buy orders versus sell orders may indicate a move higher in the stock due to buying pressure. Traders can also use the order book to help pinpoint a stock’s potential support and resistance levels. A cluster of large buy orders at a specific price may indicate a level of support, while an abundance of sell orders at or near one price may suggest an area of resistance.

Special Considerations

Although the order book is meant to provide transparency to market participants, there are some details that aren't included in the list. Among these are “dark pools.” These are batches of hidden orders maintained by large players who do not want their trading intentions known to others.

Without dark pools, exchanges would see significant price devaluation. When information about a big transaction by a large institution is made public before the trade is executed, it normally leads to a drop in the price of the security. But if information about the transaction is reported after it takes place, the impact on the market may be significantly lowered.

The presence of dark pools reduces the utility of the order book to some extent since there is no way of knowing whether the orders shown on the book are representative of true supply and demand for the stock.

Example of an Order Book

Order books continue to collate an increasing amount of information for traders for a fee. Nasdaq’s TotalView claims to provide more market information than any other book—displaying more than 20 times the liquidity of its legacy Level 2 market depth product.

While this extra information may not be very significant to the average investor, it may be useful to day traders and experienced market professionals who rely on the order book to make trading decisions.