A heatmap is a price chart with visualised historic orderbook activity.
In plain and simple English: a price chart that also shows all the limit orders that are sitting in the orderbook. Heatmaps can look messy, weird and difficult to understand, but they're actually quite straight forward and surprisingly easy to read. Let's get into it.
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First of all it's important to understand that a heatmap is basically another way of visualising the orderbook. The main advantage of a heatmap is that it also allows you to see historic orderbook activity while a regular orderbook only displays the orders that are currently sitting there.
Tradinglite is one of the more popular heatmap tools out there and it's one that I personally use as well.
There's a free demo version but if you want to use it properly you'll have to buy a subscription. Most heatmap tools are only available for paying users as far as I know. If you want to get a subscription feel free to use my referral link which gives $30 worth of XP which can be used to extend your subscription: https://tradinglite.com/join?ref=ByzantineGeneral I don't mean to shill it's just that for this post I'll be using Tradinglite for examples and the ref link actually benefits you.
The main thing you need to learn when using heatmaps is filtering out noise.
As you can see on the image above, at the top there's a setting for changing the thresholds. For the Binance BTC/USDT spot market I currently have it at a minimum of 0 BTC and a maximum of 400 BTC. It'll still show orders with a bigger size than 400 BTC but with these settings orders with a size of 400 BTC or more get the brightest highlight. I'm also using the "Candyland" theme which ascribes different colours to different size which in my opinion makes it easier to quickly distinguish big orders from smaller ones. The fuchsia colour highlights the biggest orders on my chart.
In this example I set the minimum value at a 100 BTC so that it only shows the biggest orders. The chart's a lot more clean now isn't it?
I personally prefer to always leave the min value at 0 though because sometimes whales spread out their orders in multiple walls of smaller size. If you have the min value at a 100 BTC for example you might not notice those smaller yet significant walls.
Filtering out noise is a bit of an art and there's not one correct way of doing it. Thresholds will also need to change over time because sometimes some markets experience a shift in volume and users. Another reason why thresholds need to be updated is the fact that spot markets are denominated in coins (which means the thresholds are denominated in # of coins too) and as prices fall the same amount of dollars is going to buy more coins of course. So with declining prices the heatmap will most likely become more noisy if you don't change the thresholds. Experience is key here, there's not much more I can say.
But I know you guys, you want to me to say exact numbers anyway.
So here you go (this will become outdated for sure, it's October 2022 at the time of writing). BTC...
Min value always 0
Max Binance USDT: 400 Max Binance BUSD: 200
Max Coinbase USD: 200
Max FTX USD: 100 Max Bitfinex USD: 100
Min value always 0
Max Binance USDT: 2500 Max Binance BUSD: 1500
Max Coinbase USD: 2000
Max FTX USD: 1500 Max Bitfinex USD: 1000
Those are the most important spot markets.
OKX also has high volume spot markets but you'll notice that there's almost no orderbook depth so those charts are near useless. You have OKX to thank for this, they just don't want to spend money on good OB depth. Same thing with a couple other exchanges like Bybit and Huobi.
Here's an example of what an OKX orderbook looks like.
The min value is set at 0 yet most of the chart is empty. This is what trash orderbook depth looks like.
Let's look at some examples of how you can extract value from reading heatmap charts.
First of all it's important to be able to distinguish important orders from the less important ones. Prominent exchanges always have a good amount activity of market makers and automated bot strategies. Market markers simply provide liquidity, algorithms that follow price are usually there to profit from anomalies. These participants don't trade directionally like you and me, they're neutral.
Market makers (or algos catching "scam" wicks) set orders that look like this:
They usually look like a band closely wrapped around price on both sides. These orders don't tell you anything except that there's decent liquidity on this market. I circled around market makers orders but you can see it on the entire chart.
The most common way to use a heatmap is to look for supply and demand levels or in other words: resistance and support.
On the chart above I highlighted a big supply and demand zone with white rectangles. There were clusters of big orders sitting at those levels and it's no coincidence that price stopped and reversed at those levels. If you're looking to sell your long for example and you have a target price in mind, it could be useful to take a look at a heatmap and check if there are large sell orders sitting at that level. It's confluence that your TP is indeed a solid level to get out and on top of that it gives you a chance to potentially front run the rest of the market.
Of course just like every other indicator in the world it's not perfect and it's not always that easy.
Sometimes price just blasts straight through passive orders when the active pressure is just too much.
What you'll sometimes see when that happens is that the level where people filled their limit orders will flip as support or resistance. For example if a lot of people bought and price nuked further down anyway, there's a good chance that those people will want to get out break even so the level turns into resistance.
A lot of big buy orders filled around $19500 but price fell through. When price eventually bounced, $19500 became resistance. It's reasonable to assume that people will want to cover their losses and even the people that bought at a good price, which I circled on the chart, are most likely also going to be taking profit. So there was double sell pressure coming in which you could have anticipated because you saw the real ordeflow activity on the heatmap.
This is why I like data like orderbook data. With simple technical analysis you have to make certain assumptions, with orderbook data and derivatives data you can see how people actually positioned.
Here's one final example of how you can use a heatmap.
If you're looking at the CVD (I also made a post about this if you're not familiar) it's recommended to also take a peek at the heatmap.
Here I zoomed in to the 1 minute chart on the Coinbase BTC/USD spot book.
The volume indicator shows a lot of green delta which means the CVD goes up which means there's a lot of market buying going on. This can give the impression that the spot market is bullish because there's a lot of "buying" happening, but when looking at the heatmap we can conclude that there was actually a big boy trying to passively sell his bag.
There's of course more alpha that can be derived from orderbook data but I'm not going to give everything away just like that, you'll have to do some of the work yourself. But hopefully this gave you some valuable insight. Until next time!