What Is Market Depth?
Market depth is a volume indicator that indicates the effects of large orders on the stock price. It considers the overall breadth and level of offers, bids, and open orders. Market depth will be higher if the buy and sell orders are higher. However, even dispersion of those orders around the current market price of the security is essential.
Key Takeaways
Market depth defines market liquidity based on the number of orders to sell and buy.
Market depth considers volume and order size for each price level.
Greater market depth indicates that large trades will have less effect on the security price.
Market depth can be determined by observing the level 2 price quotes in a security's order book.
Understanding Market Depth
Market depth is close to volume and liquidity. But, it doesn't always mean that any stock with a large transaction volume has good market depth. The order book of securities, a list of pending orders, can be used to determine market depth. Even for stocks with the most prominent daily volumes, there may occasionally be an imbalance of orders that is significant enough to produce considerable volatility.
Market depth indicates all the orders of a security's order book at a given time. It refers to the amount that will be used to trade the limit order within a given price if limited by price. It can also be defined as the least favorable price for a market order within a given size if determined by size.
Change in price doesn't affect the market depth. However, it could attract subsequent orders. For instance, a "deep" market for a stock indicates a sufficient volume of pending orders on the ask and bid price. It will not allow a large order to move the price.
How do Traders Use Market-Depth Information?
Market depth information aids traders in forecasting the price movement of a particular security. For instance, a trader may use market-depth information to comprehend a security's bid-ask spread and the volume building above those numbers.
Substantial market depth permits traders to place big orders without changing the market price. Strong market depth securities typically have strong volume and are pretty liquid. Meanwhile, if a buy or sell order is big enough, equities with poor market depth might be moved.
Market depth data is a list of sell and buy orders. This electronic list is known as the order book. All the orders in the order book are organized by price level. One can update the list based on the current activity in real-time.
Trading professionals can benefit from short-term price volatility thanks to real-time market depth data. For instance, traders can wait for significant buying demand if a company starts trading after becoming public. It will ultimately lead to a continuous rise in the price of a newly public firm.