Market Depth

What Is Market Depth?

Market depth alludes to a market's ability to ingest generally large market orders without essentially impacting the price of the security. Market depth considers the overall level and breadth of open orders, bids, and offers, and generally alludes to trading inside an individual security. Normally, the more buy and sell orders that exist, the greater the depth of the market — given that those orders are scattered reasonably evenly around the current market price of that security.

Understanding Market Depth

Market depth, or depth of market (DOM), is closely connected with liquidity and volume inside a security, yet doesn't infer that each stock appearance a high trade volume has great market depth. Market depth can be assessed by taking a gander at the order book of a security, which comprises of a rundown of pending orders to buy or sell at different price levels. On some random day, there might be an imbalance of orders sufficiently large to make high volatility, even for stocks with the highest daily volumes.

The decimalization of ticks on the major U.S. exchanges has been said to increase overall market depth, as confirmed by the diminished significance of market makers, a position required in the past to prevent order imbalances.

Market depth is a derivative of the multitude of orders that populate a security's order book at some random point in time. The amount will be traded for a limit order with a given price — in the event that it isn't limited by size — or the least good price that will be gotten by a market order with a given size — or a limit order that is limited by size and not price.

Albeit a change in price may, thus, draw in subsequent orders, this is excluded from market depth since it is an unexplored world. For instance, on the off chance that the market for a stock is "profound," there will be an adequate volume of pending orders on both the bid and ask side, preventing a large order from essentially moving the price.

Depth of market likewise alludes to the number of shares of a specific stock which can be bought without causing price appreciation. On the off chance that the stock is very liquid and has a large number of buyers and sellers, purchasing a bulk of shares regularly won't bring about recognizable stock price developments.

How Traders Use Market Depth Data

Market depth data assists traders with determining where the price of a specific security could head. For instance, a trader might utilize market depth data to comprehend the bid-ask spread for a security, alongside the volume accumulating above the two figures.

Securities with strong market depth will as a rule have strong volume and be very liquid, allowing traders to place large orders without fundamentally influencing the market price. In the mean time, securities with poor depth could be moved on the off chance that a buy or sell order is sufficiently large.

Market depth data for the most part exists as an electronic rundown of buy and sell orders known as the order book. These are organized by price level and refreshed in real-time to reflect current activity. In the past, this data used to be accessible for a fee, yet these days most trading platforms offer some form of market depth display for free. This allows all gatherings trading in a security to see a full rundown of buy and sell orders pending execution, alongside their sizes — rather than basically the best ones.

Real-time market depth data allows traders to profit from short-term price volatility. For instance, if a company goes public and starts trading interestingly, traders can hold on for strong buying demand, signaling the price of the recently public firm could proceed with a vertical direction.

Illustration of Market Depth

Consider the order book information in the picture below, which displays the current bid-ask spread on the left, alongside the market depth on the right. This type of quote is otherwise called level 2 market data.

The current quote in the security, MEOW shares, is $13.62 - $13.68, with 3,000 shares on the bid and 500 shares on the offer. The right panel shows the depth of bids on the left. In the event that each of the 3,000 shares were sold at $13.62, the next best bid would be $13.45, yet just for 16 shares.

Would it be a good idea for you have an order to sell 10,000 MEOW shares at the market, you would sell every one of the accessible bids down to $13.35, where there is a standing order to buy 43,500 shares. Selling 10,000 shares would hence drop the market down almost 30 pennies, or around 2%. This shows a low level of market depth.

Highlights

• Market depth alludes to the market liquidity for a security in view of the number of standing orders to buy (bids) and sell (offers) at different price levels.
• Notwithstanding price levels, market depth considers the order size, or volume, at each price level.
• The greater the market depth, the more outlandish that large trades will significantly impact a security's price.
• Market depth can be discovered by taking a gander at level 2 price quotes that can be found in a security's order book.