How to use market depth for intraday trading: The concept of demand and supply is one of the most important aspects that move the price of the shares in the stock market.
In economics, it is known that supply and demand are the factors that determine the price of an item. In a similar way, even the movement in stock prices is determined by the concept of supply and demand.
Knowing how to interpret the demand and supply of a stock can help us identify its future movements. In this article, we are going to discuss what is market depth and how to use market depth for intraday trading.
Meaning Of Market Depth
Before we understand how to use market depth for intraday trading, let us first understand what market depth means.
The market depth also referred to as the Depth of Market (DOM), is a simple metric that measures the liquidity of a security. The liquidity will be determined based on the demand and supply of the security.
This demand and supply are in turn determined with the help of a number of buy and sell orders that are currently open for that security.
Security with more number of buy and sell orders open is said to have a greater market depth further implying more liquidity. While the market depth of the security is said to be low when there is a lesser number of buy and sell orders.
This means that there will be less liquidity in the stock. The stockbrokers and stock exchanges display the top 5 bid and 5 ask prices along with the number of shares under each price.
This is known as level 2 data or 5-depth as it displays the top 5 prices. However, there are few stockbrokers who display 20 bid and ask prices of security which is known as 3 data or 20-depth
Let us take a look at how the high market depths and low market depths look like
High Market Depth
Here is an example of what a high market depth of security looks like –
As you can see in the image, the stock is displaying market depth data of the top 5 bid prices and ask prices along with the available quantity of shares under each price.
The TBQ and TSQ at the bottom of the table show the total bid quantity and total sell quantity. In this table, you can see that there are a large number of total shares under both bid and ask quantity which leads to the conclusion that the security is liquid by nature.
Low Market Depth
Here’s an example of what a low market depth of the stock looks like –
As you can see in the above image, the volumes of the shares are very low, which means the stock is highly illiquid. Here, you can see that the total number of bid quantity amounts to only 3,483 shares which means the sellers will not be able to sell beyond 3,483 shares.
How To Use Market Depth For Intraday Trading
Now that we know what a stock with high and low market depth looks like, let us now understand how we can use market depth for the purpose of intraday trading.
1. Understanding The Liquidity Of The Stock
Liquidity is one of the key factors that should be considered when executing intraday trades. As the price moves quickly while trading on an intraday basis, it is crucial that the orders are executed instantaneously.
Market depth will help you understand the liquidity of the stock and helps you know how quickly will your orders be executed.
2. Understanding The Support And Resistance Levels
Market depth is used by individuals to gauge the rough estimate of the support and resistance level of stock. An individual might notice a high concentration of orders or volumes placed at specific levels because traders tend to take buy or sell orders at these thresholds.
3. Understanding The Market Sentiment
As Market Depth shows the number of buyers and sellers, it can help individuals understand the demand and supply of stocks. Through this, individuals can identify the market sentiment and take long or short positions based on those sentiments.
Through this article, we have understood what is market depth and how to use market depth for intraday trading.
Though market dept can help you get an idea about the future trend in the price of the security. One should remember that it is only one of the tools that can help you trade and it should not be solely relied upon.
Rather, the market depth should be used as an order management tool and guide for evaluating the sentiments in the market.
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