What is Depth of Market (DOM)?
Depth of Market (DOM) measures the supply and demand for tradeable assets like stocks or futures contracts based on the number of open buy and sell orders. The higher the quantity of these orders, the deeper or more liquid the market is considered to be.
Depth of Market data, often referred to as the order book, comprises a list of pending orders for a security or currency. This data determines which transactions can be processed and is available from most online brokers, typically for free or for a nominal fee.
Understanding DOM
Measuring real-time supply and demand through market depth helps traders assess the likely direction of an asset’s price. It also indicates how many shares can be purchased without significantly impacting the asset’s price.
In highly liquid markets, a large number of both buyers and sellers exist, allowing a buyer to purchase sizable blocks of shares without causing substantial price movements. Conversely, less liquid markets with fewer buyers and sellers can see significant price changes with the purchase of large share blocks.
DOM is usually displayed as an electronic list of outstanding buy and sell orders, arranged by price level and updated in real-time to reflect current activity. A matching engine pairs up compatible trades for execution.
Most online brokers offer DOM displays, enabling users to view a full list of pending buy and sell orders along with trade sizes, rather than just the best available options.
Key Takeaways
- DOM indicates the current interest in a stock or other asset.
- It acts as a signal for the likely direction of a stock’s price.
- It is employed to determine the optimal time to buy or sell an asset.
How to Use DOM Data
DOM data helps traders predict where a security’s price may head as orders are processed, updated, or canceled. Traders can use this data to understand the bid-ask spread of a stock along with its current volume.
Highly liquid stocks, typically popular large-cap companies like Apple (AAPL), have robust DOM. Such stocks have strong volumes, allowing traders to place large orders without significantly affecting market prices.
Securities with poor DOM, often representing obscure, smaller-cap companies, can see their prices move when a single trader places a large order. Generally, well-known stocks have higher DOM than lesser-known counterparts.
Real-time DOM observation allows traders to capitalize on short-term price volatility. For instance, during a company’s IPO, traders can monitor DOM to buy or sell shares at optimal demand levels.
Example of DOM in Action
Imagine a trader is observing the DOM for Stock A, currently trading at $1.00. They notice there are 250 offers at $1.05, 250 at $1.08, 125 at $1.10, and 100 offers at $1.12. Conversely, 50 offers exist at $0.98, 40 at $0.95, and 10 at $0.93 and $0.92 each.
By analyzing this trend, the trader might deduce that Stock A is likely to rise. Armed with this insight, the trader can decide if it is the opportune moment to buy or sell the stock.
Related Terms: Liquidity, Futures Contract, Order Book, Bid-Ask Spread, Trading Volume, Market Capitalization.
