What Is the Order Book? (Level 2 Explained)
An order book is the list of every resting buy and sell order in a market, sorted by price. The best bid and best ask are its top two lines, which is the only part an ordinary price chart ever displays, and everything beneath them is the depth behind that quote.
How it works
An order book is a list. On one side are all the outstanding orders to buy, sorted from the highest price down. On the other are all the orders to sell, sorted from the lowest price up. That is the entire structure.
A trade happens when the two lists touch. Someone agrees to pay what someone else is asking, the matching engine pairs them, and both orders leave the book. Everything else in a market is commentary on that one event.
The gap between the two innermost lines is the spread. It exists because if the best bid ever equalled the best ask, they would have already traded and both would be gone.
A candlestick chart shows one number per moment. It cannot show you that there were 200 shares bid at the best price and 40,000 shares bid two cents lower, and those two situations behave completely differently the instant you try to sell.
Level 1, Level 2 and the queue rule
Level 1 is the best bid, the best ask and the last trade. It is what most retail platforms show by default and what nearly every chart is built from.
Level 2 is the rest of the list — the prices behind the best ones, and the quantity resting at each. The name is a data-feed distinction rather than a concept: it is the same book, shown further down.
Depth is the quantity available at each level. It is a measure of how much can trade before the price has to move, and that is the only question it answers well.
It is not a measure of intent. A resting order is a conditional statement, not a commitment to a view, and the person behind it may be hedging something else entirely.
Orders are matched by price first and time second. A better price always goes ahead. Among orders at the same price, the one that arrived first fills first. That is the whole priority rule on most venues, and it is why a limit order joining a long queue at a popular price may never reach the front.
In practice: walking the book
A market order does not get one price; it gets as many as it needs. It takes the best available level, then the next, then the next, until the quantity is filled. The average of those prices is your fill, and the difference between it and the first price is slippage.
Work an example. 500 shares offered at 100.00, 800 at 100.01, 3,000 at 100.03. A market order for 1,000 shares takes all 500, then 500 of the next, and averages 100.005. A market order for 4,000 reaches into the 100.03 level and averages considerably worse.
Nothing about the company changed between those two orders. The only variable was size against available depth, which is what makes depth worth looking at before sending anything large.
Resting orders are not promises. They can be cancelled at any moment, and on a modern venue that happens in microseconds. A large bid you are leaning on can be withdrawn between your decision to send an order and your order arriving.
Some size is deliberately hidden. An iceberg order displays a small quantity and refreshes it as it fills, so the visible book understates what is actually there. Hidden and midpoint orders do not display at all.
When it fails
Reading the book as a signal is where it goes wrong. A visible wall of size is visible to every other participant simultaneously, including the ones fast enough to trade in front of it and the ones who placed it with no intention of being filled.
Displayed size is also only part of the market. Between hidden orders and off-exchange venues, a substantial fraction of activity never appears in the book you are watching at all.
And the speed asymmetry is permanent. By the time a human notices a change in depth and acts on it, automated participants have already responded to it several times over. That is not a fixable disadvantage; it is a reason to use the book for a different job.
Spoofing is the version of this that is actually illegal. Placing large orders with no intention of trading them, purely to move other participants, has been prosecuted repeatedly. The relevant consequence for a reader is simpler than the law: a book you are reading for intent can be showing you intent that was manufactured to be read.
The job the book does honestly is a capacity check. Before sending anything of size, it answers whether the quantity you want can trade near the current price, and how far the price has to travel to absorb it. That question has a factual answer, and no amount of speed disadvantage changes it.
The original data
The one number on this page that is measured rather than described is the spread — 2% of a typical bar’s range on the site’s shared price history, computed as the site’s standard round trip. That figure is the book’s top two lines expressed as a cost, and it is the same figure used on every other costs discussion here.
The honest position on Level 2 is narrow and useful. It tells you what size can trade near the current price right now. It does not tell you what will happen next, and the depth it shows can disappear before you act on it.
Related
The bid-ask spread is the book’s top two lines and the cost of crossing them. Order types are the different ways of joining or removing from this queue. And market makers are the participants who keep resting orders on both sides of it as a business.
I stopped reading Level 2 for direction years ago and I still keep it open, because it answers a different question well: can I get out of this size, at something like this price, right now. That is a liquidity question, and the book is honest about it.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.