As more tech guys and common people rather than traditional traders entering cryptocurrencies, more concepts on trading needs a revisit and explained in common man terminology to get familiar. Though charts are not new in our day to day life, few of them are specifically useful while trading.
Depth charts is one of those which can let you know about Demand and Supply. It gives a visualization of demand or supply of a particular stock or commodity or a cryptocurrency. Today, we’ll try to understand why these depth charts are needed and how to read them.
You probably already know the relationship between supply and demand.
Depth charts are something to essentially show the supply and demand at different prices.
A depth chart for a bid/ask market has two lines, one for BIDs (BUY orders) and one for ASKs (SELL orders). GDAX live chart has an Green line for BIDs (BUY orders), a Red line for ASKs (SELL orders).
Again, a line on a chart is simply made up by plotting dots. Each dot on a depth chart line represents how much can be traded at that point.
BIDs (BUY orders) are placed with dollars. I might enter that I want to buy 2.0 BTC at $3300 each, but really that is a total bid size of $6600 USD for trade at $3300 or lower.
ASKs (SELL orders) are placed with bitcoins. I would enter that I want to sell 3.0 BTC at $3500 or higher.
I’ve changed numbers compared to Image attached above to make calculations and understanding a bit easier.
Now the charts are cumulative. So if Alice bids 2.0 at $3300 and Bob bids 3.0 at $3400, the cumulative number of bids at $3300 is $16800 cumulative (both Bob’s $10200 plus Alice’s $6600 are for sale at that price point.).
So to plot the BIDs (Green line), at every increment along the horizontal axis (at the bottom of the chart) representing each price point, e.g., $3200, $3300, $3400, etc.) add up all the bids at that price point or below and plot that total along the vertical axis (along the left of the chart) representing total dollars of orders at the level.
The ASKs (the Red line) have the same concept but the total accumulated value shows up on the right hand side, in terms of BTCs but stretched out so that those values correspond to the USD amounts on the left vertical axis (e.g., if the spot price of $3500, then the mark for 100 BTC of cumulative asks would line up vertically with the $350k USD mark on the left side vertical axis.)
So at any point on the Bids (Green) line you can put your cursor there and know exactly how much you could sell (from where it sits on the left / vertical axis) at that price (from where that point sits on the bottom / horizontal axis.)
And similarly at any point on the Asks (Red) line you can put your cursor there and know exactly how many BTCs you could buy (from where it sits on the right / vertical axis) at that price (from where that point sits on the bottom / horizontal axis.)
So that’s the basics on what a depth chart shows.
If you are asking how do you trade off of that, well, that’s leaves the realm of economic charting and basic math and goes instead to psychology. If there is a demand curve that looks abnormal in some certain way, some traders might think that means it is time to buy. Or if the line grows or shrinks, some interpret that as a being a trading signal and trade off that.
PS: This article has been modified from this comment on bitcoin talk.