Trading with market depth

Market Depth and DOM

Market Depth and DOM

Market depth is an electronic list of buy and sell orders, organized by price level and updated to reflect real-time market activity. Most of today’s trading platforms offer some type of market depth display that allows traders to see the buy and sell orders waiting to be executed—not just the best bid and ask prices, but the bids and asks on either side of the market—as well as the size of all the bids and offers.

All of this information can be useful to traders because it shows not only where price is now, but where it is likely to be in the near future. Here, we look at market depth, from the basics to how you can add market depth to your trading toolbox.

Inside prices

Market depth displays information about the prices at which traders are willing to buy and sell a particular trading symbol at a single point in time. Market depth data are also known as Level II, depth of market (DOM) and the order book since it shows pending orders for a trading instrument.

Because market depth is in real time, it changes constantly throughout the trading session. On an instrument such as the E-mini S&P 500 futures contract (ES), which trades under extremely high volume, the market depth updates many times each second. On thinly traded instruments, the bids and offers may update every few seconds, minutes or even hours.

Regardless of how frequently new bids and offers come to the market, market depth shows the different prices and the number of orders lined up at each price to buy or sell.

Market depth data can be viewed on a separate Level II window or on a price ladder and shows the buyers (bid) and the sellers (ask). (Note: U.S. regulations require that bid prices always appear on the left and ask prices appear on the right.)

A price ladder or DOM display shows each price level in the middle column, with the number of buyers at each price level on the left, and the number of sellers at each price level on the right, as shown in “Climbing the market” (right). 

Another way to view market depth is to overlay it on a price chart, as shown in “Charting depth” (right). These are the same data that would appear on a Level II window or DOM, just presented in a different, more visual manner. In this example, the levels of market depth are displayed over the right-hand side of a price chart, next to the various prices.

The green bars represent the buy orders; these are called the bid prices. The size of each green bar reflects the relative number of shares, contracts or lots that buyers would like to purchase. The vertical location of these bid bars correlates to the specific price at which traders are interested in buying. The top green price bar is known as the inside bid and represents the highest price at which there are interested buyers. This can be thought of as the wholesale price for the symbol.

The red bars indicate market participants who want to sell; these are known as the ask prices for the symbol. The size of each red bar reflects the number of shares, contracts or lots that traders would like to sell, and the vertical location corresponds to the specific price at which traders are currently interested in selling. The lowest red bar is known as the inside ask and represents the lowest price at which there are interested sellers, or the current retail price for the symbol.

This market depth display also displays numerically the size of the bids and asks at each price level. For example, there are 1,515 contracts for sale at the price of 1880.00. It also shows the cumulative activity: the total number of buyers (shown as a total and as a percentage beneath the bid bars) and sellers (shown above the ask bars). 

Regardless of how market depth is viewed, it provides information about the inside bid and ask — the price at which you could buy or sell right now with a market order—as well as multiple levels of bid and ask prices waiting in the queue. 

To simplify how market depth works, it might be helpful to see how the display changes when a trader places an order. “Order up,” right, shows two DOM displays. The one on the left shows an inside bid of 1634.50 with a size of 153. Imagine a trader places an order to buy 10 contracts at this level. The size at 1634.50 immediately increases to 163 (see the DOM on the right), reflecting the order to buy 10 contracts. In this manner, the market depth changes continually throughout the trading session as buyers and sellers place their orders in the market, and the orders are either filled, modified or canceled.

Using the data 

Once we understand the basics of the market depth display, we can look at some potential uses for this information. Traders look at market depth to view the various prices and volumes of orders that are lined up in the market at any given time. Symbols that trade with good depth (that is, with many levels on both the bid and ask side with significant volume at each level) are relatively liquid, meaning that large orders will not affect price as much, and traders will have an easier time getting into and out of trades.

The opposite holds true for symbols that trade with narrow depth (that is, symbols with fewer market depth levels or limited volume at each level). Large orders can affect prices significantly in these markets, and traders may have a more difficult time getting their orders filled.

Market depth is a quick way to check the activity in a particular trading symbol, and traders can find out if there is currently enough depth and volume to complement their trading style.

The shape of the market depth bars can give us clues about the condition of the market. In a balanced market, for example, the ask and bid sizes increase uniformly throughout the first four or five levels, above and below the inside market, forming a triangle shape, as shown in “Ordered market” (right). Note that there are about the same number of sellers as buyers.

Other times, market depth can highlight an unbalanced market. “Downward bias” (right), for example, shows a situation where 58% of the orders are to sell and 42% are to buy. This type of selling pressure can cause price to fall.

Market depth is useful for identifying future support and resistance levels. Traders can quickly determine if there are more sell orders in the market than buy orders—or the opposite. If there are more sell orders, for example, price tends to weaken because of the increased selling pressure. At times when there are more buy orders, however, price tends to gain strength due to the buying support.

Sometimes certain price levels are more attractive than others. These are prices that have been accepted by market participants — for whatever reason. If a particular market depth level is significantly larger than those surrounding it, an “outlier” can form. These outliers can point to areas where significant buying or selling will likely take place in the near future as pending orders are filled, which can slow down the price movement. When a particular bid level becomes larger than the surrounding bars, for example, it can point out a powerful short-term support price. Conversely, if an ask level stands out, it can signal a meaningful short-term resistance level. These areas of high concentration can be viewed as significant pivots; areas that will propel a market in either direction once the level is defended or taken out. 

The first chart in “Price bubbles” (right) shows an ask level at 1875.00 that is notably larger than the surrounding price levels. Indeed, price had already tested this level several times over the course of the previous 20 or so price bars. If price reaches this outlier market depth level where many sellers are waiting, price movement may pause as all the orders are filled, and price could get pushed down in response to the increased selling.

The second chart in “Price bubbles” shows an example where an outlier is on the bid side. Here, almost 2,300 buyers are bidding 1680.00. If price pulls back to this level, it is likely to act as strong short-term support because price will pause to fill all the orders, which in turn can drive price back up.

Both support and resistance can be tested numerous times before the level is broken and price continues either below a support level or above a resistance level. It’s a bit like a tennis match where one player is support and the other is resistance. The ball (which represents price in this example) can bounce back and forth between the two players until one athlete eventually weakens and the tennis ball flies past them off the court. 

When price does break through a support or resistance level, it is common for that level to be revisited, albeit with a different role. Once price pushes through a support level, that level can turn into an area of resistance when price returns. Likewise, if price advances through a resistance level, it can turn into a support level the next time price approaches that level. Market depth can help traders spot these developing areas of support and resistance.

Trading Technologies Market Ladder and DOM
*Trading Technologies Market Ladder and DOM

Market insiders


Market depth shows the number of orders at each price level for a particular trading symbol at any given time. Because it is a real-time tool, it updates constantly throughout the trading session to reflect the current orders in the queue, sometimes changing numerous times each second.

Traders can benefit from incorporating market depth analysis in their trading because it can give clues about current market conditions, and can help traders spot future areas of short-term support and resistance. Knowing where these levels are likely to occur in the near future can help traders determine precise trade entries and exits. 

While a study of market depth can provide traders clues to market conditions, you need to be aware that you may not be getting a complete picture. Many market participants—particularly those who execute large size—have always attempted to hide that size so as not to alert other market participants. Back in the floor trading days, brokers would be directed to only show (bid or ask) for a certain amount of contracts and keep buying or selling until they have completed the entire desired position. In the age of electronic trading, traders use devises like an iceberg order, which bids or offers for a specific size and then automatically enters additional orders at a specific price once that first order is filled. There are also algorithmic traders that put on and take off orders in milliseconds probing the market looking for weaknesses and opportunities. This does not mean that a study of market depth cannot help spot support and resistance, just that you need to be aware that there are some orders that are not being reflected in the queue.
 

Jean Folger is the co-founder of, and system researcher with, PowerZone Trading, LLC. Jean can be reached at www.powerzonetrading.com.

About the Author

Jean Folger is the co-founder of and system researcher with PowerZone Trading, LLC.