Order Book Trading: DOM, Level 2, Time & Sales (2022)

In this article I’d like to take a closer look at the terms “DOM,” “Level 2” and “Time & Sales.” I’d also like to describe order book trading.

The most common order types

All buy and sell orders are collected and matched in the order book. In this way, market price is continually established. 

Order books exist for all exchange-traded securities.

But before we take a closer look at how market price is formed, it’s useful to review the most common order types.

Buy market order (buy order with no limit price):

The investor agrees to accept the current price when purchasing securities.

Sell market order (sell order with no limit price):

The investor agrees to accept the current price when selling securities.

Buy limit order:

Investors specify a maximum price at which they’re willing to purchase shares.

Sell limit order:

Investors specify a minimum price at which they’re willing to sell shares.

Stop loss order:

A stop loss order is a sell order executed best in the market after a limit set by the investor is reached.

Stop buy order:

A stop buy order is a buy order executed best in the market after a limit set by the investor is reached.

Stop sell order:

A stop sell order is a sell order executed best in the market after a security reaches or falls below a limit set by the investor.

Limit orders and market orders

If you take a closer look at order types, you can see that there are basically only four categories.

  • Buy limit
  • Sell limit
  • Buy market
  • Sell market

Stop loss orders can also be considered market orders because when the stop price is reached, the order is executed at the next available price in the market.

However, these stop loss orders are not visible in the order book. Only limit orders can be seen.

A limit order alone will not be executed. It requires an additional market participant, who enters or exits the market using a market order and thus fills the limit order. This means that market orders are the driving force behind the market.

The order book explained

The order book is also referred to as the DOM (depth of market). The following image shows the order book for DAX futures with the ten best bids and asks.

This image shows a screenshot of DAX-Future order book with the ten best bids & asks.
Order book with the ten best bids and asks

What is Level 2?

A distinction is made between Level 1 and Level 2 data. Both provide insight into market depth.

Using Level 1 data, you only see the first level of market depth in the order book. In other words, you see the best bid and ask prices. To put it another way, only the spread is visible, the difference between the best bid and ask.

  • The best bid is the highest buy limit order.
  • The best ask, on the other hand, is the lowest sell limit order.

In the order book shown above, the FDAX is trading at 12,704 / 12,705. There is currently a one-point spread.

  • 12,704 is the best bid or the highest buy limit order.
  • 12,705 is the best ask or the lowest sell limit order.

So Level 1 data provide the following information:

  • Best bid and ask price with the corresponding volume
  • The last price traded with the corresponding volume

Level 1 data are all you need for pure chart trading.

Many retail traders have probably never heard of or used Level 2 data. It’s really amazing to consider that many people trade with only a fraction of the available information and still think they can trade profitably (even in day trading).

With Level 2 data, on the other hand, you can see the complete depth of market. You view the real market, so to speak.

Market depth varies from market to market, but in most cases full depth is captured by ten digits or ten lines in the order book.

In other words, you get to see the ten best bid and ask prices in the market. 

Level 2 data is more expensive than Level 1, but to get a complete picture of the order book, you need Level 2.

People often underestimate the value of the order book and Level 2 data as trading tools.

The trading industry loves to withhold information

The trading industry, represented mainly by brokerage houses, has no interest in having clients who trade profitably over the long term. There are some players, such as CFD brokers, who even profit when their clients lose money.

On the other hand, as a CFD trader, you don’t usually receive Level 2 data. The industry works hard on making the majority of traders believe they can be successful using charts only.

At some point the industry realized that people weren’t as ill-informed as earlier – that traders understood, for example, that volume provided important information for trading. Since then they have increasingly marketed Footprint and Market Profile charts to the large community of day traders. After all, with these charts, brokers, software providers and other industry players are able to earn additional money. 

Learning to read the order book

But this still doesn’t change the fact that most traders who use Market Profile or Footprint charts still don’t know how to read the order book.

In my opinion, it’s an illusion to think you know what’s going on in markets without working with the order book, including Level 2 data and the Time & Sales list.

All these tools are expensive, but in my opinion, they’re among the most effective ones available to traders.

Why?

Because they force you to immerse yourself in the market.

Of course, it’s extremely taxing, but that’s what trading is about.

If you think you can simply look at a chart, plug in an indicator and trade profitably over the long term, you’re mistaken. There are of course exceptions, but normally you’ll fail.

Anyone can do chart analysis, but that has nothing to do with current market action.

In my opinion, the use of charts alone won’t give you an edge, especially in day trading and when trading smaller timeframes.

Time & Sales

Together with the order book, Time & Sales is the best tool for day trading because it allows you to see the order flow for the security in question.

Time & Sales shows every single trade executed in that security.

In addition to the time of the trade, you see price and volume.

With Time & Sales list alone, it’s difficult to get an edge in trading, but together with the order book, it makes a big difference.

This image shows a screenshot of the time & sales list for DAX-Future.
List of executed trades

In my opinion, there are two fundamental truths in trading: price and volume.

The ability to read the order book greatly increases the probability of profitable trading.

Order book trading

Order book trading involves using the order book together with Time & Sales.

But it’s important to understand both instruments before combining them.

You should also know how the market works, meaning what orders types are available and how they affect the market.

This image shows a screenshot of market depth and time & sales combined for DAX-Future.
DOM combined with the Time & Sales list

The combination of DOM and Time & Sales provides you with an excellent view of the market.

On the one hand, you can see the order volume, the executed trades and the lined-up orders (the limit orders above and below the current market price).

One the other, you see how many contracts are needed to move the price by a certain number of points up or down.

By looking at the speed of Time & Sales and the rhythm of order execution, you can tell if the market is becoming nervous or hectic.

If you compare the Time & Sales list with the order book, you can also follow the changes in the bid and ask prices. Is there an imbalance? Which side is currently stronger?

In addition, you can see whether new volume is coming in and how volume is changing.

Important questions for order book traders

  • How much volume is displayed at a given price and how many contracts are traded at that price?
  • How quickly are the bid and ask being hit?
  • What is the spread? How is the spread changing as orders are executed and execution speed changes?
  • On which side of the spread are orders being executed?

If you’re long and orders are being executed at the ask, it’s sign that there will be continued strength in the market. The opposite is also true.

In addition, you should also know when market participants are usually active in the market and what their normal behavior is.

  • What is the usual volume and the rhythm of trading at a specific time?
  • When does rhythm and/or volume change?
  • What trading systems (algos) are running or could be running and what impact might they have?

There are many factors that need to be considered when trading the order book.

But if you’re willing to put in the effort and master the technique, it can give you a long-term edge in the market.

After all, it’s a simple fact that the majority of traders are incapable of doing so, and many are too lazy.

Order book trading is much more than just looking at the order book and seeing what’s going on in the market. You also need to understand how, where and what is happening, and form an opinion about what is about to happen and where and how it will unfold.

These are not things you see in a chart. You don’t get a detailed view of where and how something happened.

But these are the details you need to get an edge in day trading.

  • What conclusion can day traders draw from orders being executed at the bid?
  • What does it mean if an order is executed at the ask?
  • What does it mean when volume changes?
  • What does it mean when the rhythm of order flow changes?

First and foremost, you need to understand present and past situations. You also need to deduce what the future situation will be in order to be prepared for all scenarios.

That’s what makes trading so challenging and complex.

Concluding remarks on order book trading, DOM and Time & Sales

Even with order book trading, you’ll make mistakes, overlook certain things, and suffer losses. 

You’ll also encounter situations in which you won’t gain an advantage by trading the order book or the algos will screw you over :-).

But in my opinion, if you learn how to use the tools presented in this article, you can gain a long-term edge, and that will translate into solid long-term performance.

It’s also the purest form of day trading. You can’t get any closer to the market than this, and for me, that’s what trading is all about.

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