→Avoiding illusionary imbalance
=== Avoiding illusionary imbalance ===
Traders should be careful with interpretation of imbalance when computation mode is full depth and selected output is sum, here is why. Imagine that orders are allowed to be placed only in a fixed price range, e.g. between 2600 and 2700. Imagine also that it just so happen that the size at each price level is precisely 100, so by definition there is no any bid/ask imbalance. Still, when price moves up, the imbalance will show order book imbalance in the same direction. This happens simply because there would be less ask levels. In fact, the imbalance would show 100% correlation with the price, but it's obviously a useless signal. The situation of a fixed range of permitted prices isn't purely hypothetical. It's a common practice for most of the exchanges (including CME) to set price limits, therefore this illusion will manifest itself when the sum is computed over full market depth. If market depth data contains only N price levels, then the fixed price limits will be created by the extended order book.
=== Interpretation and trading techniques ===
The indicator provides true measurements of liquidity, but it isn't a buy / sell signal. Its interpretation is the art of trading. Let's assume a significant imbalance where the bid liquidity is is much higher that ask liquidity. If new aggressive orders are equally distributed between buyers and sellers, the price is likely to move up, i.e. following the least resistance path. But if there are market participants who actually look for high bid liquidity in order to sell, then the price may go down.