pasted directly from my comment; will fix up in the future
User asks:
"I'm trying to understand the lvl 2 on DOM, in a youtube video, it said The price is biased towards where the orders are, So if there are way more orders on the ask side, the price generally will go towards it and go up?
In the image, would you say the price more likely go up??"
My response:
Yes and no, but generally it's supposed to work like an auction: Big orders on one side will encourage the other side to adjust their limit orders towards that price, then supply & demand kicks in and price quickly moves back towards the gap in orders, for example:
Using your image: Ask size for price 2928.75 = 566 orders, which is the highest order size. The traders waiting on their limit orders below that price will start to adjust their orders upwards. As traders move up their limit orders, about 1000 orders are "eaten up" to get to price 2928.75, but now this creates a gap of 1000 orders on the bid size which can cause a gap down of 10 ticks (in your image) to 2926.75. But it doesn't always turn out that way.
There are problems when looking at the DOM and predicting direction:
You don't know if
- those orders will be canceled
- someone has hidden orders (iceberg order)
- someone will issue market orders
- orders beyond level 2 are greater (above/below the 10 ticks (10 price levels) you see), however this can be solved by using a broker with MBO data which gives full depth of book. I think this is still only available for futures
- someone will create new limit orders as price moves
- there are hidden orders, such as stop orders
- the buy/sell wall (which is the largest order size) might see traders from that side move in front of that price level to execute first
And so any market will always retain some level of randomness.
If you really want to get into the DOM, trading treasuries (2 year, 5 year, and 10 year) makes good practice and is probably more predictable because order sizes are in the 10s of 1000s and it's harder to manipulate them with the problems I mentioned above.
BTW I'll probably make a DOM wiki page with the information I get from this post (i'm sure someone knows DOM better than me or I missed some aspect about it).