Quote from: Stephen Gornick on February 28, 2013, 11:41:52 PM

Quote from: cilphex on February 28, 2013, 08:38:56 PM

Hi there, I posted this question in the "wall observer" thread under Economics > Speculation, but I think everybody skipped over it. Basically, I don't know how to read the market depth graphs in this thread: https://bitcointalk.org/index.php?topic=85687.0, and I'm wondering if anybody can help me out. I tried googling, but my goog-fu skills aren't good enough because I couldn't really find the answer.

You probably already know the relationship between supply and demand. For instance, a restaurant can sell more tacos at $1 than it can at $2. The restaurant could test the market by offering tacos at various prices. If it records sales at each level (let's say they sell 100 tacos a day when the price is $2, and 500 tacos when the price is $1) it could then plot that data on a graph, and the result would be a line. In most markets the plotted line will have a curve, so that line is called the demand curve.

Now that restaurant doesn't have much wiggle room on its supply, but it could get price quotations from its suppliers asking how at various larger order sizes, what kind of discounts could it get. Let's say if they place an order to buy ingredients for 100 tacos the supplier's best price is $1.20 each. But if they buy ingredients for 500 tacos the price is $0.90 each. Plot those points on a graph and you get another line. Again, with most suppliers the line will have a curve as well, so that line is called the supply curve.

If that's not clear, here's a video describing economic diagrams.
- https://www.youtube.com/watch?v=HfxPqXxq1Jo <-- Demand curve.
- https://www.youtube.com/watch?v=UnVsPEr9teQ <-- Supply curve.

very good explanation. Thanks
Now the depth charts are essentially the same thing, they show the supply and demand at different prices.

http://i.imgur.com/y37wwLo.png

A depth chart for a bid/ask market has two lines, one for BIDs (BUY orders) and one for ASKs (SELL orders). Mt. Gox live chart has an Orange line for BIDs (BUY orders), a Blue line for ASKs (SELL orders), and a third line, Green showing history. Ignore the Green line, as you can't go back in time. Only the Orange and Blue lines matter in the now.

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 $33 each, but really that is a total bid size of $66 USD for trade at $33 or lower.

ASKs (SELL orders) are placed with bitcoins. I would enter that I want to sell 3.0 BTC at $35 or higher.

Now the charts are cumulative. So if Alice bids 2.0 at $33 and Bob bids 3.0 at $34, the cumulative number of bids at $33 is $168 cumulative (both Bob's $102 plus Alice's $66 are for sale at that price point.).

So to plot the BIDs (Orange line), at every increment along the horizontal axis (at the bottom of the chart) representing each price point, e.g., $32, $33, $34, 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 Blue 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 $35, then the mark for 100 BTC of cumulative asks would line up vertically with the $3,500 USD mark on the left side vertical axis.)

So at any point on the Bids (Orange) line you can put your finger 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 simlarly at any point on the Asks (Blue) line you can put your finger 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. But those are opinions.

And for that, that's what that other thread is good for. All 10,000+ comments of it.