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How Market Depth Analysis Can Boost Liquidity

July 21, 2020 by Daniels Trading| Futures 101

When it comes to efficient trading, asset liquidity is of paramount importance. Fortunately for capital market participants, futures offer a wide variety of consistently liquid products.

So how can you identify liquidity in the marketplace? There are many methods, ranging from relying on experience to applying technical indicators. However, one tried-and-true methodology is known as market depth analysis.

What Is Liquidity?

Liquidity is the ability of an asset to be converted into cash. Liquid assets are readily exchanged for cash; illiquid assets are not.

Of course, the applications of liquidity are a bit more complex in the futures markets. Generally speaking, all contracts may be quickly converted to cash. However, the price of this conversion varies according to several factors. The most liquid markets exhibit these attributes:

  • Tight bid/ask spreads
  • Strong trading volumes
  • Orderly price action
  • Efficient asset pricing

If you’re an active trader, it pays to engage liquid markets. Liquid markets will provide you with the utmost in trade-related efficiency because prices reflect asset values, spreads are tight, and volumes are consistent. Now, let’s take a look at how traders use market depth analysis to identify inherently liquid securities.

Learn how our powerful software can empower your trades.

Applying Market Depth Analysis

Perhaps the best way to measure a product’s liquidity is through a study of its market depth. Market depth is the total number of buy and sell orders local to a security at any given time. Think of market depth as the checkout line at a grocery store―the longer the line, the greater the market depth. Deep markets are considered to be liquid and ensure that there are ample buyers and sellers at each price point.

Here are three facets of market depth analysis that are used to identify liquidity:

  • Order flow: Order flow describes the number of buy and sell orders hitting the market at any one time. Strong order flow is indicative of deep markets, promoting both liquidity and efficient asset pricing.
  • Volume: Traded volumes are a basic measure of liquidity. In futures, volumes refers to the number of contracts bought and sold. Traders typically study volume with respect to time period or in reference to a specific price point.
  • Depth of market (DOM): The trader’s depth of market, or trading DOM, is a convenient way to monitor evolving liquidity. The DOM is essentially a ladder that illustrates order flow, traded volumes, and price action. For most short-term traders, the DOM is a critical part of order execution as well as analytics.

To many traders, order flow, volume, and trading DOM are vital strategic inputs. A robust order flow guarantees liquidity and produces traded volumes, both of which are reflected on the DOM.

The beauty of this type of market depth analysis is that it is user-friendly and intuitive. You only need to observe the DOM and note the buy/sell orders present at distinct price points. The greater the number of orders, the greater the market depth and potential liquidity.

Getting Started with Market Depth

Among the many benefits of being a modern trader is the availability of technology. Software trading platforms have taken the guesswork out of analytics, specifically as it relates to market depth analysis. For instance, Daniels Trading’s flagship platform, dt Pro, features a robust suite of technical tools, including advanced DOM, charting, and indicator applications.

If you’re an aspiring market technician, dt Pro is a great place to begin your journey into futures. Sign up for your free 14-day trial of dt Pro and get started today!

Demo DT Pro Today

Filed Under: Futures 101

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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