Order Book & Stop Losses Explained
The order book & stop loss are two key concepts that any cryptocurrency trader must know if they are to stand a chance successfully trading the volatile markets that is cryptocurrency.
In this article, I will provide straightforward explanations to both these trading concepts, combined with an example in order to solidify your understanding.
An order book is the number of buy and sell orders that have been placed at a particular price for a cryptocurrency. The order book is updated in real time and so can be a very useful tool in gauging the sentiment around a cryptocurrency. The order book is also known as the market depth and can be used to provide an indication of the liquidity of a cryptocurrency. Liquidity refers to the ability of a cryptocurrency to be bought and sold quickly without affecting the price. The larger the trading volume of a cryptocurrency, the higher the liquidity, and vice versa.
The red line indicates the people who want to sell, and the green the people who want to buy. The dollar amounts on the x-axis is the price a market participant is willing to buy or sell a particular cryptocurrency, while the y-axis indicates the number of cryptocurrency the buyer or seller wants to trade.
For example, if Bob executed a trade for the sale of a single Bitcoin for $3500, this would be classed as and market order and join the order book. Bob’s executed trade would sit in the order book until it was filled, i.e. until Bob’s trade was matched with another individual who is willing to purchase his one Bitcoin at a price of $3500.
In terms of liquidity, more liquid cryptocurrencies tend to be preferred by traders because it means when they attempt to enter or exit a position, they will not negatively affect the price. In addition, more liquid cryptocurrencies are significantly harder to manipulate, therefore, making them less likely to fall prey to pump and dump schemes that are prevalent within the cryptocurrency space.
If you are ever worried about the liquidity of a cryptocurrency, make sure to look at the order book to get a sense of the market depth.
A sell stop loss is placed on top of a cryptocurrency trade that executes a sell order when the cryptocurrency reaches a certain price. Sell stop losses are placed below the buy-in price and are an effective tool in mitigating risk. In such a volatile market like cryptocurrencies, a sell stop loss is key because it is designed to limit your potential loss on an investment. Conversely, buy stop losses allow you to collect profits if your cryptocurrency were ever hit a certain price above your buy-in price. They are incredibly useful for capturing gains in times of volatility.
For example, if Alice bought the cryptocurrency, Ethereum, at a price of $100 per coin, but she was worried about the price falling below 10% of her initial buy-in price, then she can employ a sell stop loss. Alice enters a stop loss price of $90, and if the price of one Ethereum hit this price point, her holdings will be processed into a market order waiting to be filled. The process is exactly the same for a buy stop loss, except the stop loss price must be above the buy-in price.
The order book and stop loss are two very key tools used many individuals when trading. The order book allows market participants to get an idea as to the liquidity, and to some extent, the sentiment, surrounding a particular cryptocurrency. Whereas, stop losses allow traders to minimize losses, while at the same time, maximizing returns.