Market Depth
Market depth is the quantity of an asset that can be traded near the current price without moving it materially. It is the size dimension of liquidity, distinct from the spread, which is the cost dimension. Depth is read from the limit order book: the queue of buy and sell orders stacked at each price level. A deep book has large quantities resting close to the mid, so a big order can be filled with little price impact. A thin book has small quantities, so even a moderate order walks the book, executing against worse and worse prices. A stock can have a tight spread for one share yet shallow depth, meaning the first trade is cheap but a large order is expensive.
Why it matters
Picture the order book as a staircase of buyers below the price and sellers above it. Depth is how many shares are waiting on each step. If the steps are crowded, you can sell a large block and barely descend a step or two. If each step holds only a handful of shares, a big sell order tumbles down many steps, each at a worse price, until it is filled. That tumble is price impact. The spread tells you the cost of the very first step; depth tells you how far you fall when your order is large.
Formulas
Worked examples
Two stocks both quote a 1-cent spread. Stock P has 50,000 shares resting at the best bid and ask; Stock Q has 500. You sell 20,000 shares. What happens?
Stock P is deep: 20,000 shares is well within the 50,000 at the best bid, so the order fills at the bid with essentially no price impact. Stock Q is shallow: only 500 shares sit at the best bid, so the order walks down through many lower price levels, and the average fill is well below the mid. Identical spreads, very different depth, and therefore very different price impact on a large order. Tightness and depth are separate dimensions of liquidity.
Common mistakes
- ✗A tight spread guarantees you can trade in size cheaply. The spread is the cost for a tiny trade. A stock can quote a one-cent spread yet have a thin book, so a large order still walks through many price levels.
- ✗Depth and the spread measure the same thing. The spread is the cost dimension (price of immediacy); depth is the size dimension (how much trades without moving the price). A stock can be tight but shallow.
- ✗Quoted depth is always available. Visible book size can be withdrawn instantly, and in a fast market liquidity providers pull quotes, so realised depth can be far below what the screen showed.
Revision bullets
- •Depth = quantity tradable near the current price without moving it
- •The size dimension of liquidity, distinct from the spread (cost)
- •Read from the limit order book; a thin book is walked by large orders
- •A tight spread can coexist with shallow depth
- •Greater depth means smaller price impact for a given order size
Quick check
Two stocks have an identical one-cent bid-ask spread, but one has a thin order book. A large sell order in the thin-book stock will
Market depth is best described as the
Connected topics
Sources
- Kyle, A. S. "Continuous Auctions and Insider Trading." Econometrica, 53(6), 1315–1335, 1985.Foundational model of market depth and price impact, defining the depth parameter that links order flow to price change.
- Jorion, FRM Handbook (2011)Jorion, P. Financial Risk Manager Handbook. 6th ed. GARP / Wiley, 2011.Identifies depth as the size dimension of liquidity, separate from the spread.