Understanding Order Books

Market, Limit, Stop loss. What’s the difference?


Courtesy of https://monzo.com/blog/2016/01/08/how-does-the-wholesale-foreign-exchange-market-work/


What is an order book?

An order book is a list, typically electronic, of buy (bid) and sell (offer) orders, including the number of shares to be bought or sold. The order book is organized by price level. This helps keep track of the level of interest for a tradable instrument and shows the market depth.

The order book helps traders become more informed about the trades they make by allowing them to analyze current buy and sell activity. Using an order book to make informed decisions about trades enables investors to increase their likelihood of making a successful trade.

Market Order

A market order is an order that is placed to buy or sell a financial instrument at the current going rate of the market. For example, let's say that the current market price for a share of Apple (AAPL) is $300, if you place a buy order at the current market price then the trade will execute and buy the share for $300.

Limit Order

A limit order, on the other hand, is an order that is placed to buy or sell a financial instrument at a specific price. The process of buying and selling is then automated by the trading platform/exchange. For example, let’s say that the current market price for a share of Apple (AAPL) is $300, but according to your analysis, it would be a better buy at $298.50. You would then place a limit order at $298.50 and the trade will not execute until the share(s) can be bought at that price.

It essentially says that I am willing to buy or sell at this price, no higher, no lower.

Stop Loss Order

A stop-loss order is similar to a limit order, in that, once the price of your stock drops and hits a specified price, the platform that you are trading on automatically sells the shares for you. Or put another way, it closes out (liquidates) the position that you held. It literally “stops losses.”

Trailing Stop

With a trailing stop, the price that your share(s) are sold at is determined by a specified amount below the market price, usually a percentage. If the price increases, the stop follows the market price by this specified amount. But if the price drops, this lower specified amount will stay the same. This mechanism allows one to lock in higher-profits and limit the amount of loss.

For example, say that you buy a share of Google (GOOGL) for $1,000 and set a trailing-stop up at 10%. The trailing stop will sell your position if the price reaches $900, but if the price reaches $1,100, the new trailing stop will be $990 (10% below the $1,100).

Conclusion

Understanding how order books work is an important feature in determining the amount of interest in any given tradable instrument. Looking at an order book gives you a broad picture of the market-depth. Understanding the various types of orders and how they function is also an important part of being a responsible and successful trader.

Even though these techniques originated in the stock market, they are just as applicable to cryptocurrencies.


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