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hello traders and welcome back to
another in-depth with chris episode and
today's discussion we're going to be
diving into the deep dark corners of the
dom otherwise known as market depth
you've probably heard about the dom or
market depth trading at some point in
your trading journey or your educational
exploration journey and as such we're
going to cover exactly what that subject
is so at the end of all of this you'll
know what it is how to read it and
perhaps have a better idea if it's
something that's worth spending your
time on other than that let's dive into
the subject and get going
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market depth is one of the several
indicators that we have available to us
as traders that we use to gauge market
activity it helps better visualize the
relationship between the buyers and the
sellers in the market so let's start off
with the exact buy the book definition
so i don't muddle anything up with my
own market depth is also referred to as
depth of market that's what we say dom
for and it measures the supply and
demand balance based on the number of
open buy and sell orders that's
important for a particular asset once
again it measures the open buy and sell
orders nothing more nothing less a depth
of market might look something like this
graph that we have down here where on
the left hand side we we have a quantity
and on the right hand side we have a
price and this is how the by category is
subdivided and the cell category is
exactly the same but the other way
around on the sell side we have price on
the left and quantity on the right
the top row is in in the buy segment
that is is going to refer to the highest
price that the buyer is willing to pay
similarly the top row on the sell side
of the chart is going to be the lowest
price in which sellers are available
these trades are executed when a buyers
and sellers demands match
the information can be presented in a
multitude of ways and another chart will
actually look something like this now
this is a little bit less common but
this is also illustrating the same
information we have our bid our ask and
we also have the depth of our market
being visualized by both a bar chart as
well as a generalized graph a fill-in
graph market depth compares the activity
of the buyers and sellers and helps
understand the interest of investors in
that particular asset the greater the
number of orders the deeper and more
liquid the market is many of these
orders may not get filled since there
might not be a match between what buyers
are willing to pay and what sellers are
willing to accept
dom can be one of the most
straightforward tools to use in the
trading environment because how directly
evident it is when there are buyers
offering to purchase at a higher price
one can expect the price to increase on
the other hand if there is increased
selling interest the price will most
likely drop the dom is important because
it signals the potential price behavior
based on the active orders that are
currently sitting for liquid assets a
single order won't impact the price much
however it might significantly affect
the price of a less frequently traded
asset so depending on what we trade will
help us better understand how powerful
the reads are that we're getting from
the dom market depth is also crucial in
validating price movements predicted by
technical indicators so for example an
ascending triangle may generate a buy
signal to a technical trader if the dom
backs this up through higher buy volumes
the trader can be more confident and go
ahead and proceed further this is one of
the main reasons why dom levels are also
monitored along with trading volumes
market depth can be influenced by
several factors the first of which is
the tick size the tick size is the
minimum amount by which the price of an
asset can move the tick size is
especially small in the case of foreign
exchange a smaller tick size increases
the market depth of the particular asset
smaller tick sizes ensure that price
movements aren't very drastic therefore
the trader needs to generate a higher
trade volume to realize a substantial
profit generally in these situations
next we have margin requirements higher
margin requirements mean that a trader
has more of his capital locked up for a
particular trade this in turn leads to a
lower depth since it limits the
disposable funds relaxing the margin
requirements can improve market depth
but it is also riskier since it
facilitates the use of more leverage
next we have the restrictions on price
movement most exchanges curb price
movements such limits can have a
detrimental effect on the dom for
example circuit breakers are imposed on
stocks that limit trading if the price
increases or drops by a certain
percentage the threshold limits can vary
for each stock companies with lower
level circuit breakers may not support
high trading volumes and next we have
trading restrictions which should be
easy to understand based on what we just
said many stocks may not have a
derivative you know futures or options
behind them and because of this they may
have restrictions that are in place by
the exchanges such restrictions also
impact the market depth trading can be
temporarily halted for companies under
investigation for example and then
finally we have market transparency most
investors prefer to invest in a
transparent market with readily
available reliable information markets
with informational asymmetry or lack of
transparency can promote illegal trading
activities for example insider trading
and using material non-public
information to trade can result in a
loss of confidence among investors in
that particular market which in turn can
lead to an outflow of funds and decrease
the market depth
to better understand how dom trading
works let's look at this graph of apple
stock the event in this situation is
going to be marked off down here by this
e with my very terribly drawn arrow
and this is the date that the company's
earnings were released investors were
drawn to the stock after the
announcement as trading volumes boom
surged the actual trading volume was
higher on the day when the price surged
compared to the trading volumes during
the last few trading sessions that's
what we can see by the sharp incline a
trader could have observed the dom
charts on this day to understand how
buyers flocked to buy apple shares
following the announcement since it is a
blue chip company the possibility of
manipulation through false trades would
also be less likely a trader could have
placed a profitable trade by observing
the patterns in dom charts and referring
to the latest events that were taking
place at the time and riding the wave
the advantages of dom trading are
relatively easy to see the first is that
it's easy to interpret the inputs for
dom are price and volume no mathematical
equations or sophisticated calculations
are required to understand the market
depth making it one of the most
straightforward trading tools available
to us the next thing that we have going
for it is the real time information many
technical indicators lag which means
they depend on past prices which can
cost you trading opportunities the dom
gives you real-time information and then
finally we have no additional charts are
required this does come with a caveat
one doesn't need
extra charts in order to trade the dom
or generally any type of extra
subscription
but we always encourage using multiple
channels of information to validate
however it is that we're feeling
as far as disadvantages go the dom is
subject to manipulation you'll hear some
traders refer to this as iceberg orders
that are eventually washed away and what
this really represents are traders that
have placed a large number of limit
orders that are yet to fill or not
likely to fill to almost cause a pseudo
confidence in the market then they plan
on removing them once price actually
gets close then we have no information
on executed trades and that is just the
darn truth with the dom it does not tell
us how many are actually executed in
those orders that we're looking at it
tells us how many orders are waiting to
be filled but not information about
what's actually been executed and then
finally we have no additional charts
required we can also view this as a
disadvantage based on what we were
talking about on the positive side as
well because there are no charts
acquired you could view it as a
disadvantage because you're limiting
your overall informational channels if
you're only trading with the dom but
once again this one's neither here nor
there so to sum things up market depth
charts or dom charts provide simplicity
and efficiency in paying attention to
the current ebb and flow of orders going
in and out of the market it allows you
to gain a potentially clear
understanding of where price is headed
based on that waiting order system where
you can see how many people want to buy
at a specific price it's up to you to
practice with market depth charts or dom
charts and see if they're right for your
personal trading style but other than
that the more you know the better off
you are good luck out there happy
trading i'll see you all very soon
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you