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What Is an Order Book? How It's Built and Why It Matters

In financial markets, the order book is one of the most fundamental concepts. It's where buying and selling interest meets - and where price discovery begins. If you've ever placed a trade on a stock, future, or crypto exchange, your order likely became part of an order book, even if only for a moment.

But what exactly is an order book, how is it constructed, and why is it essential to market microstructure? Let's break it down.

What Is an Order Book?

An order book is a real-time list of buy and sell orders for a particular financial instrument - like a stock, currency pair, or futures contract - organized by price level. It's the mechanism through which modern electronic markets match supply and demand.

An order book has two sides:

  • Bids: Buy orders, sorted from highest price to lowest.
  • Asks (or offers): Sell orders, sorted from lowest price to highest.

The best available prices on each side - known as the best bid and best ask - form the top of book, or what you typically see as the current market price.

How does an Order Book Look?

L2 Book

Bid Size Price Ask Size
99.70 300
99.65 250
99.60 200
99.55 100
BEST ASK 99.50 150
300 99.45 BEST BID
250 99.40
400 99.35
500 99.30
600 99.25

L1 Book

Bid Size Bid Price Ask Price Ask Size
300 99.45 99.50 150

Nanoconda GUI Order Book

Here is an example of an order book, you can see 8 levels depth of the book on the right side of our trading GUI:

Trading Window

Check out our GUI Screenshots and Order Book API

How Is the Order Book Built?

An order book is constructed from individual orders submitted by market participants. These can include:

  • Limit Orders: Orders to buy or sell at a specific price or better.
  • Market Orders: Instructions to buy or sell immediately at the best available price (these consume the order book but do not add to it).
  • Cancel or Modify Instructions: Participants can cancel or change their existing orders, which updates the book.

Matching Engine

At the center of the order book is the matching engine, typically run by an exchange. It continuously accepts, ranks, matches, and removes orders according to strict rules - like price-time priority.

For example:

  • If Trader A places a buy order at $100 for 50 shares, and Trader B places a sell order at $100 for 50 shares, the orders match and execute.
  • If no match exists, the order is stored in the book and waits for a counterparty.

Price-Time Priority: Who Gets Filled First?

Most exchanges use price-time priority, meaning:

  1. Better price wins: A higher bid or lower ask gets filled first.
  2. Earlier order wins: If multiple orders have the same price, the one placed earlier has priority.

This encourages traders to improve prices and rewards quick submission.

Level 1 (L1) vs. Level 2 (L2) Data

Market data providers often talk about:

  • Level 1: The best bid and best ask (top of book).
  • Level 2: Full market depth - the list of all visible orders at each price level.

More advanced participants, like institutional traders and market makers, often rely on Level 2 data for a deeper understanding of order flow and liquidity.

Why Does the Order Book Matter?

The order book is central to market microstructure, which is the study of how markets operate at a granular level. It reveals:

  • Liquidity: How much can be traded without moving the price?
  • Volatility: How quickly is the book changing?
  • Supply/Demand Balance: Is there more interest in buying or selling?
  • Order Flow: Who is pushing the market, and in what direction?

Market participants use this information to make decisions about pricing, timing, and strategy.

Limitations and Nuances

Hidden Orders: Some orders, like iceberg or dark pool orders, are not visible in the public book.

Latency: High-frequency traders may act on faster or more direct feeds than those visible to regular traders.

Gaps and Inconsistencies: In fast markets or during outages, the book may not reflect true interest.

How Traders Use the Order Book

1. Execution Timing

Traders may wait for more favorable conditions (e.g. a large ask being pulled) before submitting their order.

2. Price Discovery

The book helps identify fair market value through the collective behavior of buyers and sellers.

3. Detecting Large Traders or Algorithms

Unusual patterns - like large orders split across multiple levels - can hint at institutional activity.

4. Market Making and Spread Capturing

Traders can place both bid and ask orders and profit from the difference (the spread) if both are filled.

5. Risk Management

Thin order books (few orders, low volume) can mean higher price impact and greater risk.

Conclusion

The order book is more than a list of prices - it's a dynamic, real-time reflection of supply and demand in the market. It plays a central role in price discovery, execution quality, and liquidity measurement. Whether you're a trader, developer, or just market-curious, understanding how the order book works gives you a powerful window into how modern markets function at their core.

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