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School / Exchanges and Orders

Lesson 2 of 6 · 7 min

The Order Book, Liquidity and the Spread

Lesson goalAfter this lesson you can read an order book, calculate the spread and estimate what a purchase will cost you in a thin market.

The price on a chart sounds like a single number, but in the market there are two at the same time: the one at which someone is waiting for you to sell to them, and the one at which someone is waiting for you to buy from them. You see all of it in the order book.

What is in an order book

  • Bids (buy offers): the highest price at which someone is waiting for you to sell to them right now.
  • Asks (sell offers): the lowest price at which you can buy from someone immediately.
  • Spread: the difference between the lowest ask and the highest bid.
  • Depth: the quantity waiting at each price level.

What is liquidity

Liquidity means you can quickly buy or sell a substantial amount without moving the price much. A narrow spread and great depth are signs of good liquidity. On the same exchange, one pair can be very liquid while another is almost empty. Liquidity also changes: in quiet hours or after bad news, offers tend to be pulled just when you need them.

How an order “walks the book”

An order that executes immediately takes offers in sequence, from the best to the worse ones. If it is larger than the quantity at the first level, the rest is filled at a worse price.

What to look at before an order

  • How big is the spread as a percentage, not just in absolute terms?
  • How much is available in total near the current price compared with your order?
  • Can you get out as easily as you got in, even when everyone wants out?
  • Are you trading in a period full of news, when depth can change suddenly?

Remember

  • Buy and sell offers wait in the book, and the spread is the difference between the best two.
  • A liquid market has a narrow spread and great depth.
  • A large order takes several levels, so the average price is worse than the one displayed.
  • The spread is a cost you pay before the price has moved at all.
  • Large offers in the book can vanish, and volume can be inflated.

Test your knowledge

To pass, you need to answer at least two thirds of the questions correctly. You can try as many times as you like.

1. In the book you see a highest bid of 99.50 and a lowest ask of 100.50. You want to buy a small quantity right away and then sell it right away. What happens before fees?
2. You buy 5 tokens immediately. The book has 1 at 10.00, 2 at 10.20 and 5 at 10.50. What is the approximate average price?
3. A small token is rising on the chart, but its spread is 6% and there are few offers near the price. What is the most important conclusion?