By Hazem Alhalabi
By Tamta Suladze
5/5(4)

Reading the Market Depth Chart - How Does it Help in Decision Making?

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How To Read Market Depth Chart

Trading in the financial markets entails carefully analysing price actions, market inputs, movements and more data. Traders use every possible tool and chart to narrow their research and find the best trading opportunities. 

Reading charts is vital to a trader’s day, combining various investment strategies with technical indicators and trying to predict potential price movements or assess market efficiency.

Understanding the market depth chart enables traders to evaluate the market and its efficiency in executing buy/sell orders, especially with assets with changing volume and liquidity levels. Let’s get into the details of the market depth chart and how you can use it.

Key Takeaways

  1. The market depth chart is a graphical representation of the order book, depicting the pending buying and selling orders on a specific asset.

  2. The depth chart is split between buy and sell walls, which represent the demand and supply changes and patterns.

  3. Understanding the market depth charts is crucial to making trading decisions and understanding liquidity and market sentiments.

What is Market Depth?

Analysing market depth is a crucial part of analysing financial markets, which is done before making trading decisions, especially for executing significantly large buy or sell orders.

Previously, brokers on trading floors would shout and raise their hands to execute market orders, manually processing their buying and selling transactions through telephones. 

However, since everything has become digitalised, buying and selling orders are being listed on electronic trading platforms. Today, traders and brokers can take a look at the order book to analyse the market depth and evaluate liquidity patterns and changes. 

Analysing market depth level is crucial, especially in markets with high liquidity levels, such as Forex, commodities and stocks, where a slight change in the liquidity pattern can impact the asset price.

By looking at the market depth numbers, a market is “deep” when there are many buying and selling orders placed and pending fulfilment. 

However, it is vital to note that a fair balance must be maintained between the buying and selling activities, which affect the supply and demand dynamics and, therefore, the market prices.

what is market depth

Market Depth Chart Explained

The market depth chart is a graphical representation of the order book, showing the price trends and patterns that change as pending orders and liquidity fluctuate. 

The chart shows the demand and supply levels, marked on two axes, X and Y. The X-axis represents the market prices, while the Y-axis represents the amount of pending orders.

The chart enables the trader to understand the price changes and fluctuations in the demand and supply patterns. Thus, traders can evaluate the efficiency of investing in the given security.

The chart is split between two sides, left and right, representing the demand and supply of different price levels. In the best scenarios, both sides of the chart would be balanced or almost symmetrical.

Any uneven tendencies will be depicted as the graph skews to either side, representing a market shortage or excessive liquidity.

what is market depth chart

Importance of Market Depth Price Chart

This analysis is used to predict current and potential market directions and discover support and resistance levels, which assist investors in creating their trading strategies.

If the depth chart is tilted to the left, it means that the asset is illiquid, and the price will potentially increase because demand is higher than supply. On the other hand, if the chart is tilted to the right, it means the asset is sufficiently liquid, and prices are more likely to stabilise or decline because supply is more than demand.

Traders can use this information to place suitable market orders. For example, if the chart is skewed to the left, it means there are more buying orders than selling, resulting in a lack of liquidity. Thus, the product is becoming illiquid and is more likely to increase. 

Therefore, a trader can place a buy order to capitalise on the likelihood of a price surge before selling at a higher price and reaping the gains.

Elements of Market Depth Chart

This chart type is very straightforward, clearly depicting what the trader is looking for. However, understanding its elements and dynamics is important. Here’s what you can find in the depth chart.

  • Buy wall: depicted on the left side of the vertical axis. The buy wall represents the cumulative value of buy orders placed on the given security at different price levels. The buy line is highlighted in green and has a declining trend from the left to the right.

  • Sell wall: depicted on the right side of the vertical axis. This sell wall represents the cumulative value of the sell order placed on the given asset at different prices. The sell line is highlighted in red and has a declining trend from the right to the left.

  • Vertical Y-axis: This axis represents the price level at which the pending buy/sell orders have been placed.

  • Horizontal X-axis: This axis represents the volume of the pending buy/sell orders that have been placed.

  • Mid-market price: The mid-market price is the middle price point between buying and selling or the average between the highest bidding price and the lowest asking price.

Market Depth Chart Indicator

The market depth indicator works by hovering over the chart, which reflects the number of assets that can be bought or sold at a given price point at that specific time. This indicator also shows the cost of executing the market order and the implications on the market value.

Fast Fact

The market depth represents level 2 data (previously Nasdaq Quotation Dissemination Service), which is a subscription-based model allowing companies to access the bidding and asking market prices.

How to Read a BTC Market Depth Chart

Reading the Bitcoin depth chart is important since the crypto market is highly speculative and volatile, and investors’ decisions and overall sentiment highly impact the market orders. Here’s how the BTC buy and sell walls work.

Buy Wall

The height of the buy wall changes according to the number of unfulfilled purchased orders for Bitcoin at a selected price. When the buy line is significant, it indicates that buyers believe that the BTC price will not fall below a certain level. 

Traders are more likely to buy more of the cryptocurrency when they see a bullish market depth chart, encouraging them to increase their purchases and push the current market price even higher.

market depth buy wall

Sell Wall

Similar to the buy wall. The high sell wall rises according to the number of unfulfilled selling orders for Bitcoin at a certain price. A low sell wall indicates that most crypto traders are holding on to their assets and are not selling now because they anticipate the Bitcoin price will increase.

A large sell wall prevents the market price from dramatically increasing and helps stabilise the prices. 

market depth sell wall

Market Depth vs Order Book

The order book and the market depth chart meanings are almost the same. Both provide insights into the pending market orders. However, they differ in how they represent data and their implications on the traders’ decisions.

  • Data representation: Depth charts graphically represent order book data, providing an overview of demand and supply patterns. On the other hand, order books offer a detailed view of every pending buy/sell activity at various price points. 

  • Accessibility: The depth charts are available at most trading platforms, and any user can apply the price chart, while order books are only accessible to a selected type of traders, such as liquidity-providing firms and market makers.

  • Use cases: The market depth chart usually works for short-term investment decision-making by looking at price patterns and changes. The order book is more detailed, enabling traders to understand the market dynamics profoundly and look at different supply and demand patterns over time.

Conclusion

The market depth chart is a visual representation of the order book, depicting the changes in supply and demand patterns and assisting traders in understanding market dynamics and anticipated liquidity shortage or surplus. 

The depth chart shows the number of buying and selling orders placed by market participants at different price levels, helping traders in decision-making by analysing possible bullish or bearish market movements. 

Analysing the depth chart is crucial regardless of the studied asset class. However, it is mainly applied to markets with high liquidity, such as the commodity and currency markets. 

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