i. Depth of market shows all the buy and sell trades that are placed on the forex market for each currency pair.
ii. Traders use this data to understand demand and supply.
iii. A tool that scalpers can benefit a lot from.
In the forex market, there are thousands of orders placed and these are executed based on the order matching approach. The Depth of Market shows the orders that are placed in the forex market and can be used to understand the demand and supply.
Depth of Market
We know that the forex market is a decentralized over-the-counter platform for the exchange of foreign currencies. It is a marketplace where buyers and sellers meet and look to carry out transactions in foreign currencies.
Now, like every other market, the forex market too runs on the principles of demand and supply. Where ever there are individuals involved in the act of buying and selling, demand and supply will affect how things work and how prices move.
Now in order to do so i.e. to buy or sell the currency pair, individuals or traders have to be connected to the forex market through a forex broker.
These brokers provide access to the inter-bank electronic communications network on which the forex market functions.
Once access is gained, traders would then place their orders for buying and selling of the currency pairs. Now, this does not happen just in the forex market.
In almost every financial market, traders have to go through brokers to place orders for buying or selling financial assets.
There are hundreds of thousands of traders from all around the globe placing orders in the forex markets. Each one of them participates in different currency pairs at different prices.
So, can traders view details about this? Which currency pair has lots of buying and selling orders? At what price are the most orders placed? This is where the depth of the market comes into the picture.
The depth of market allows traders to see the number of outstanding orders placed at different price levels for a given currency pair.
Depth of market is also known as market depth or even as order books. Different names, but they all serve the same purpose.
So the depth of market basically displays the bids and asks for the particular currency pair along with the volumes.
How to use it?
We now know the purpose of the depth of market and what kind of information it provides to traders. It most essentially allows traders to gauge the demand and supply scene prevalent at that moment in the market in real-time.
The name depth of market is because it allows traders to see how deep the market is i.e. how liquid it is. We know that liquidity is very essential in the forex market.
In conditions of low liquidity, the order will be filled very slow and will not be at the desired prices due to the spreads.
But in conditions of high liquidity, orders will be placed swiftly and at the desired price of the trader.
More the orders shown on the depth of market means that the market is deep, it means that liquidity and volume are high. Less order indicate that liquidity and volume in low.
Depth of market allows traders to understand the market sentiment and see the flow of orders from the broker’s perspective.
What type of traders use depth of market?
This tool of the depth of market is used mostly by scalpers and short-term traders. Since scalpers look to enter and exit the market quickly, the depth of market allows them to identify price levels at which there is a large number of orders.
Scalpers would then enter where there is a large number of sell orders and exit where there are lots of buy orders. Short-term traders that look to trade traditional technical patterns can take trades with extra conviction.
This happens when the trader sees huge orders at the key price levels giving them the indication that other traders are in the market with the same analysis.
Some traders even use the depth of market to find better prices to enter the trades. They would have an analysis performed and will hunt for as good prices as possible.
Traders, both scalpers, and short-term traders may use the depth of market as a standalone tool to take trades or they may even combine it with other forms of analysis and strategies.
The depth of market comes in handy to traders that trade with huge capital. They can use the depth of market tool to look for a cluster of orders and enter at such levels without causing slippages and in a cost-efficient manner.
Will you use DoM to trade?
I hope that after reading this blog post, you are well aware of this tool of DoM and might even use it in trading. Do let me know if you do.
It should be noted that since the forex market is a decentralized market, it is difficult to get 100% accurate order flow data.
This does not mean that data that is displayed on the market depth is unreliable, there might be small discrepancies but if used properly it can be a very reliable source of information.
I mentioned that markets move on the basis of the principle of supply and demand. At times when the supply and demand are equal and there is equilibrium, the markets will not move much and will stay flat.
But as an imbalance occurs on either side, the markets will rally in that direction.
The depth of market allows traders to identify this phenomenon at its initial point and capitalize on this imbalance in supply and demand.
Don’t forget to share this blog post with others and also, feel free to reach out to me for any questions and I will get back to it for sure.