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How Markets REALLY Work - Depth of Market (DOM) - YouTube
Channel: Critical Trading
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okay let's now jump through a scenario
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in which we'll see how the price really
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moves what you see in front of you is
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called depth of market this depth of
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market displays how many limit orders
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there are at a particular price on the
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left we will see buy limit orders and on
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the right we will see sell limit orders
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this depth of market is nowadays a basic
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future of any charting platform and you
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can commonly find it as a d o M which is
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abbreviation for depth of market one
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important thing to mention is that the
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depth of market only displays limit
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orders this is sometimes called a
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passive order flow on the depth of
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market you cannot see market orders
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market orders are called
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an active order flow and there are
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different tools for displaying them
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another important thing to bear in mind
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is that this depth of market is not
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static because markets are not static
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depth of market is dynamic and numbers
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of limit orders change all the time
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simply because there may be hundreds of
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people watching the market at any given
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time and they are sending orders
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changing them or canceling them so to
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keep it clear and simple in this
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scenario we are going to assume that
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there are only few traders who trade
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this market and we know about all of
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them say that the market opens at 8:00
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a.m. and first trader comes in he wants
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to buy
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he wants to buy five contracts at the
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price of ninety eight so he doesn't want
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to buy now but he specifies the price
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therefore he sends a buy limit order to
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buy five contracts and you now know that
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he's a passive buyer on the depth of
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market his buy limit order will be
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displayed like this it will be on the
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bid side because it is a buy limit order
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and the depth of market will show a
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quantity of five on bid at the price of
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ninety eight one minute later another
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trader comes in he wants to sell
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he wants to sell 10 contracts at the
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price of 99 he specifies the price so he
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uses a sell limit order and he is there
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for a passive seller his sell limit will
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be on the ask side because he's asking
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somebody to buy 10 contracts from him
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and he's asking for a price of 99 per
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quarter
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on the other hand the first trader is
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willing to buy no higher than 98
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therefore his order is on the bedside
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now two more traders wants to buy and
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sell trade the number three who wants to
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buy two contracts at ninety seven and
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trade and number four who wants to sell
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three contracts at the price of one
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hundred on the depth of market we can
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already see these new limit orders
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none of these orders will be paired with
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each other and the price doesn't move
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because all these traders demand a
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different price at the moment two buyers
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are willing to buy at 98 and 97 and two
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sellers are willing to sell at 99 and
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100 respectively so there is no
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agreement between them let's continue
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we've got one more seller trade the
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number five who wants to sell four
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contracts at the price of ninety nine so
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same like trade number two so the ask is
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now 14 and this ask size of fourteen
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consists of ten contracts of trade
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number two and four contracts of trade
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number five still nothing happens but
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suddenly somebody comes in and says I
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don't want to wait anymore I want to buy
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five contracts now and this is our
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aggressive buyer that we were waiting
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for you should remember that he uses a
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by market order and this order doesn't
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specify the price the by market order
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buys the first available offer from a
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passive seller where is this first
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available offer at the price of ninety
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nine so this aggressive buyer buys five
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contracts at the price of ninety nine by
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doing this he cleared five sell limits
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on the ask side that the price of ninety
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nine that means the ask the price of
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ninety nine will be reduced from
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fourteen to nine all of these five sell
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limits at the price of ninety nine
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belonged to trader number two because he
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came first and therefore he has got a
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sell limit for five contracts left still
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waiting to be merged with more
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aggressive by market orders so the price
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from ninety nine there are nine sell
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limits left and they will be filled in
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the following order firstly all of the
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remaining
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cell limits of trade to number two and
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then cell limits of trader number five
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so it's like a queue the limit orders
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are sorted chronologically with a logic
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of first comes first served
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so because the trade of five came in
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later than trader to then he has got to
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wait until the trader two will get
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failed all of his cell limits now
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aggressive seller comes in making the
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price to move the actual price is ninety
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nine because that's the price on which
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the most recent trade took place the
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aggressive seller wants to sell three
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contracts using a cell market order you
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should remember that the cell market
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order is paired with the first available
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bit from a passive buyer in other words
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it is paired with the first available
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buy limit order on the bit side where is
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this first available buy limit at the
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price of ninety eight so the aggressive
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seller sends the sell market order and
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the passive buyer buys from him now
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because this passive buyer has called
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his buy limit at the price of ninety
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eight the price goes down so it can
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match the sell market order to this buy
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limit the aggressive seller sold three
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contracts
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therefore he clears free buy limits at
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the price of ninety eight and there were
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five buy limits of this price in total
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less free of them were cleared by this
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aggressive seller that means that there
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are two more buy limits left to be
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filled at this price notice that the
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price is moved down yet the number of
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sell versus buy orders is equal the
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price didn't move down because there
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were more sellers than buyers but
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because sellers were more aggressive
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than buyers now what needs to happen in
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order for the price to move from 98 to
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97 it's simple there must be more
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aggressive sellers who will clear these
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two more buy limits at the price of 98
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so it's like a barrier this barrier of
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limit orders must be broken in order for
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the price to move one aggressive seller
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comes in he sends sell market orders to
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sell free contracts but you see that at
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the price of 98 there are only two buy
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limits so this barrier of buy limits is
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not strong enough to
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satisfy this aggressive seller so what
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happens to you sell market orders are
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paired with to buy limits at the price
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of ninety eight and this clears all the
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buy limits at ninety eight and then
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there are no buy limits left at this
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price however there's one more sell
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market order left to be paired since
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there are no buy limits left at the
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price of ninety eight the market now
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must move rule over to find more buy
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limit orders so it moves from 98 to 97
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at 97 one sell market order left is
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paired with new buy limit this completes
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the order of aggressive seller to sell
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free contracts this aggressive seller
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therefore moved the market down because
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his market order was paired with buy
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limits at two different prices his sell
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market order for free contracts was
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paired with two by limits at 98 and one
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buy limit at 97 now notice this the
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price has moved from 98 97 despite there
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was one seller and two different buyers
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however the number of buy and sell
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orders is equal sell market order for
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free contract and buy limits for free
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contract in total now what do you see at
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the price of 98 there are no sell limit
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orders at this price do you remember
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that the market order doesn't specify
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the price the price at which the market
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order is filled only depends on the
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availability of limit orders so what are
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the first available sell limits the
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first available sell limits are at 99
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now the aggressive buyer comes in and he
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wants to buy one contract by using a
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market order the actual price is 97
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there are no sell limits in 98 first
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available sell limits are at 99
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despite the actual price being 97 the
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aggressive buyer is filled for 99
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because that's the price at which he
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finds somebody to buy from so he moved
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the market up from 97 to 99 because at
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98 there was no liquidity no sell limit
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orders so the market has skipped this
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price and mu
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of $2.99 straightaway this is called a
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gap the market has kept up from 97 to 99
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the aggressive buyer has got what's
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called a slippage this means that he
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bought for worse price than he was
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expecting
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he sent the by market order when the
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actual price was 97 he would be
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expecting to be filled for 98 because
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logically there should be some sell
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limits in reality there were no sell
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limits so the market has kept up and he
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bought for 99 that means he has called a
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worse price and got a slippage so in
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this situation there was one buyer in
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one seller one buy market order and one
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sell limit order and the price has moved
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from 97 to 99 and now the final
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situation that we will have a look at a
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big trader comes in and he wants to buy
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15 contracts as you can see that in the
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meantime some more passive sellers have
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appeared and sent their sell limit
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orders into the market the last price is
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99 this is the price at which the most
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recent trade has taken place this is the
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price that the big trader is looking at
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when he decides to send his order into
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the market this big trader uses a buy
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market order to buy 15 contracts by
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doing this he will move the price from
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99 to 103 you can see how his market
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order for 15 contracts was spared take a
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moment to have a look at this so there
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was one buyer and many more sellers and
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the price has moved by four points
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however the quantity of buy and sell
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orders was equal 15 contracts to buy and
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15 contracts to sell this is always
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equal and this is how the price moves
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however in reality such big trader is
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likely to use a limit order to open a
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trade because he trades such big
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positions that the potential slippage
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when using market orders is very big so
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to sum it up the price moves in relation
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to market orders and available limit
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orders these limit orders are like a
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barrier when this barrier is not strong
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enough to
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satisfied market orders the price moves
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however the number of buy and sell
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orders is always equal for example in
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this last scenario the price has moved
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from 99 to 103 and there were 15 by
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market orders and 15 sell limit orders
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