Backtest MasterClass – Part 5

Understanding the Order Book

While we learned about stop losses and take profit in the last backtest masterclass, we now move to understand the order book and its dynamics.

There’s no doubt that new traders can get easily confused when first getting introduced to the crypto markets. Between the candlestick charts, depth charts, volume, moving averages, etc. all cluttering the screen, things can be a bit confusing. But what about all those numbers on the side? You probably already know and see all the recent trades going on in the market, but you’ve likely also seen a stack of numbers, prices, and quantities with little movement just sitting there. What is that?

It takes two to tango in the world of crypto trading, where a dynamic relationship between buyers and sellers is always on display in something called an order book. In this post, we’ll show you how to read this powerful tool that will help you understand a token’s supply, demand and gain insights into the moves you can make in order to have a fair exchange or even turn a profit. We’ll be covering the following topics:

  1. What is an Order Book?
  2. Components of an Order Book
  3. Order Matchmaking
  4. Understanding the Order Book
  5. Order Patterns
  6. Dark Pool

What is an Order Book?

Order Book is a tool that visualizes a real-time list of outstanding orders for a particular asset, order books represent the interests of buyers and sellers, offering a window into supply and demand. But while all order books serve the same purpose, their appearance can differ slightly among exchanges. That said, they are all built with the same features and functions.

Mudrex Masterclass — Order Book
Order Book Cluster of different Exchanges

It looks like 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 tokens being bid on or offered at each price point or market depth. A matching engine uses the book to determine which orders can be fulfilled i.e. what trades can be made. These lists help traders and also improve market transparency because they provide valuable trading information. An order book is dynamic, meaning it’s constantly updated in real-time throughout the day.

Components of an Order Book

The outline of an order book can vary between the recorded securities. However, it usually consists of several components, as listed below: 

1. Buyer’s side and Seller’s side: An order book is a market price recorder. Therefore, it includes a buyer’s side and a seller’s side – the two major participants in a market. 

2. Bid and Ask: Instead of using a buyer’s side and a seller’s side, some order books use the terms “bid” and “ask.” Buyers are the ones who “bid” for a certain number of tokens at a specified price, and sellers “ask” for a specific price for their tokens. As a rule of thumb, the buyer’s side (bid) is on the left, and the seller’s side (ask) is on the right, coloured green and red, respectively. 

3. Prices: An order book records the value interest of both sides. The number in the buyer’s or seller’s columns represents the amount they are bidding or asking for, and at what price. 

4. Total: The total columns are the cumulative amounts of the specific security sold from different prices.

5. Visual demonstration: Normally, an order book comes with a table of numbers consisting of prices and total amounts from two sides. To better represent the relationship between buyers and sellers, most of the order books come with a visual demonstration as well. It can be in the form of a line chart or others. In this way, the reader can quickly achieve an overall understanding of market demand and supply. 

Practical Example 

Mudrex Masterclass — Order Book
Order Book Example

The image above showcases the buyers on the left (bid) and the sellers on the right (ask).

Example: On the buyer’s side, 778 units are being sold at a price of 7,500. On the seller’s side, 518 units are being sold at 7,600. The order book is filled with units being sold at other varying price levels as well. We can see that the total amount is accumulated depending on different price levels. For instance, on the buyer’s side, at a price level of 6,872, the amount is 49,500. It is added by the previous bidding offer of 20,000, and the current one at 29,500 (20,000 + 29,500 = 49,500).

We see Binance has a similar setup. The top portion of the order book shows who is selling BTC, what price they’re selling at, and how much there is on the market at that price point. On the bottom portion of the order book, we see who is willing to buy BTC in the markets at a specific price and how much the market is willing to buy at that price in total.

The following are the price types that you can spot in an order book:

  1. Bid Price: The highest posted price someone is willing to buy an asset.
  2. Bid Size: The number of tokens that people are trying to buy at the bid price.
  3. Ask Price: The lowest posted price someone is willing to sell an asset. Also called the “offer price.”
  4. Ask Size: The number of tokens being sold at the ask price.
  5. Last Price: The price at which the last transaction occurred.
  6. Last Size: The number of tokens involved in the last transaction.

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.

Order Matchmaking

Even after learning what each component of an order book means, reading one can still be overwhelming. The numbers change at an incredibly fast pace and, if you don’t know what’s happening behind the scenes, you might still be confused as to your next move.

When you see the numbers on an order book change, it means orders are being filled or cancelled in the backend. Those changes are reflected in the order book in real-time. That process is called matchmaking, and it refers to the automatic placement of your offer to its counterpart.

Here’s an example. Say you want to sell 1 BTC for 9000 USD. The order will appear on the sellers’ side of the order book. Now, if someone on the buyers’ book wants to buy 1 BTC for 9000 USD, the matchmaking mechanism will grab your order and complete it with the buyer’s order. After that, both orders will disappear from the order book. This mechanism works through a First-In-First-Out principle — the first orders placed are the first orders matched.

Understanding the Order Book

Being able to see the last price a token was exchanged for, the number of tokens waiting to be bought/sold at a specific price, and the spread between the buyers’ and sellers’ sides, allows you to make an informed decision. With this, you can make your own analysis, predict the next movements on a token’s price and — most importantly — place your orders at the right time so that you can maximize the value of your trade.

  1. Buying/Selling Pressure: Some traders like to look at how many tokens are being bid versus how many are being offered, which may indicate which side is more eager or more powerful, and may predict the short-term direction of the market price. This tactic is combined with watching the recent transactions. If most of the transactions are occurring at the bid price, it means the price could go down in the short term, whereas if most of the transactions are occurring at the offer, the price could go up. For instance, a massive imbalance of buy orders versus sell orders may indicate a move higher in the stock due to buying pressure. 
  1. Support/Resistance Levels: 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. For example, if we see a massive buy wall (lots of buy orders) for BTC at $9,000, then we can tell that we’re likely to see a significant amount of support at that level, even without consulting the charts and past performance. Likewise, the same can be done for resistance levels. If we see a large sell wall at a specific price, then we can get an idea of where the next resistance level is likely to be and how significant it will be if the market busts through it.
  1. Spread: Spread is calculated as the difference between the best buy price and best sell price. When the bid-ask spread is narrow, this is known as a tight market. A tight market will be characterised by abundant liquidity and higher trading activity. You will see buyers and sellers in active competition for discovering the market price, which will lead to much tighter spreads. Therefore, a tighter spread is another indication that a token market is healthy. You could also see it as a quick indication of the liquidity for that particular coin or token. The higher the depth of the market is, the higher number of buy and sell orders exist at each price for that asset. 
  1. High Frequency Trading: Although the high-frequency trading (HFT) of hedge funds and investment banks isn’t prominent in the crypto markets like it is in the equity market, the impact of algorithms can be seen on the order book flow. With enough time a trader can become familiar with how a particular market usually trades and spot anomalies on the book – for example, if orders are being filled more rapidly or are much larger than usual. 
    With extremely fast orders what HFT tries to achieve is to take advantage of the bid-ask spread for essentially a risk-free trade. For example, in the bitcoin market, if bid orders are being hit at $6,400 (by sellers) in quick succession, the probability is that the price will keep going down to $6,350 (providing there is more ask depth than bid depth). What an HFT programme will do is fire a sell order within microseconds of that $6,400 bid order being hit, just as it’s being withdrawn from the market. This puts them in an immediate breakeven position and essentially a risk-free trade.
    When HFT migrates to crypto it will change the game for day traders and order flow interpretation will require faster anticipation of which direction the market will go in the next 20 trades. High-frequency trading programmes are tuned for ranging markets but if a market breaks out in a particular direction HFTs accentuate the trend through a cascade effect which sets off other HFT programmes to buy or sell into that trend.

Order Patterns

Order patterns are perhaps the most complicated aspect of order book reading, as they illuminate much of the manipulation that occurs in altcoin markets. Whilst we won’t go into the more advanced stuff here, it is significant to highlight the four types of order pattern: clean orders, bot orders, walls and, for lack of a better term, non-clean orders or messy orders.

  1. Clean Orders: A clean order is simply an order that is unusually perfect, mathematically. These are often orders consisting of multiples of 5s or 10s that occur at regular intervals in the order book. 
  2. Non-Clean Orders: Much like clean orders, non-clean orders are about determining symmetry and patterns in the order book. However, they are more difficult to notice, as, unlike their clean counterparts, they consist of seemingly random numerical values. Non-clean orders are simply a more discrete way for market manipulators to mark out significant levels for future reference.
  3. Bot Orders: A bot order is one that defies human ability in its execution. Often, algorithms are in place to bid up a buy order or push down a sell order. This is easily noticeable and you have likely experienced it yourself. Recall a time when you’d place a buy order at the top of the order book, only for it to be displaced within milliseconds by another buy order; this is a bot order.
  4. Walls: Most are familiar with walls. A wall is an unusually large order in the order book. However, most tend to react in the most irrational manner when it comes to these orders. Large buy orders being pushed and pulled near current prices are often viewed by the masses as the perfect time to enter, lest one miss out on what must be an imminent bullish move. Large sell orders are viewed as the perfect time to exit, lest we lose all our money when the market crashes and burns. This is order book manipulation at its finest. Buy walls are an attempt at causing irrational market participants to buy up the order book, and vice-versa for sell walls. This allows for better pricing to be had for the puppet-master for both accumulation and distribution purposes.

Note these various orders down as and when you come across them – and you will come across them – and you’ll begin to piece together a trail of footsteps that must be left by those manipulating price and can help you make trading strategies that can outmanoeuvre these market manipulations.

Dark Pools

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 or institutional investors 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.


Although technical analysis is sometimes enough to trade off, it is important to keep in mind that people, not patterns, move the markets and spotting a pattern is just one step in the process of identifying a trade. There is always a two-way bet going on any pattern and watching order flow can show the probability in which direction it will break. In a market notorious for trade washing, getting a feel for spoof orders will only come with time and familiarity watching the book.

Check out the rest of the articles if you haven’t already!

  • Part 1: Understanding the Backtest Report
  • Part 2: Getting better at Sharpe Ratio
  • Part 3: Understanding Maximum Drawdown
  • Part 4: Stop-Loss and Take-Profit
  • Part 5: Understanding the Order Book

For more masterclasses, crypto news, investment strategies and many other resources visit the Mudrex blog.

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