2.07 Measuring market depth and liquidity

In the previous lessons, we looked at how the concepts of market capitalization, as well as bid-ask spread, come in handy while analyzing different cryptocurrencies. This lesson discusses market depth, liquidity, and volatility to get the complete picture of the cryptocurrency market. 

This lesson explains market depth, market liquidity, and volatility.

Contents  

• What is market depth?
• What is market liquidity?
• What is market volatility? 

What is market depth? 

A market is a platform where activities like buying and selling different goods and services take place. So, we can say that a market constitutes buyers and sellers. When we talk about crypto trading markets, it basically involves traders buying and selling digital assets on any given platform. 

Market depth shows various price levels of a cryptocurrency at which people are willing to buy or sell. The quantity of bid-ask prices also affects the market depth. ‘Bid price’ is the price at which buyers are willing to buy a coin, and ‘ask or offer price’ means the price at which sellers are willing to sell their coins. The market depth considers various price levels of a cryptocurrency and shows open orders, bid prices, and ask prices.

Sellers are always willing to sell their assets at the highest possible price, and buyers would like to buy them at the lowest possible price. As a result, there will be a difference in the bid price and ask price, called the bid-ask spread. Market depth or depth of market (DOM) also shows the bid-ask spread of a cryptocurrency. 

Market depth represents the ability of a market to absorb large market orders without impacting the price significantly. If the market has a large number of buy (bid) and sell (ask) orders with different prices, it is said to have a greater market depth. 

If the market depth for any asset pair is strong, it means that there is substantial volume and orders on the bid or ask side. This further implies that even large orders cannot significantly move the asset price. While weak market depth implies that large orders can move the price of the asset impacting the trader. 

What is market liquidity?

Market depth, bid-ask spreads, and market liquidity are closely related terms in trading. All these concepts can be measured from the raw order book of a market. The liquidity of an asset is a very important factor to consider when choosing a cryptocurrency to trade. 

Market liquidity refers to how quickly and easily an asset can be bought or sold on a trading platform at stable prices. The higher the number of bid prices and ask prices and the lower the bid-ask spread, the higher will be the market liquidity. 

If an asset has tighter bid-ask spreads and more buy and sell orders, the market is said to be liquid. When the market has high liquidity, more traders exchange digital currencies in a given period. As a result, trading volume increases. 

What is market volatility?

Cryptocurrencies are often referred to as highly volatile assets. Volatile assets are considered risky investments. At the same time, they also hold opportunities for profits if you make strategic investments accompanied by market research. You would also have to buy and sell digital assets at the right time to leverage the volatility. 

Market volatility represents how the prices of assets are moving in a specific time period. If the prices move drastically (either rising or dipping) in a short period, the market is said to be highly volatile. 

Several factors impact the volatility of digital currencies, such as speculation, media coverage, asset performance, community sentiments, etc. 

Cryptocurrency is still an emerging market with low market capitalization compared to traditional markets like stocks and gold. So, even small changes in its adoption lead to higher price fluctuations.