It's true that lots of limit orders are placed far away from
the current price, especially when traders are caught on the
wrong side of a move. It's kind of an attempt to 'psych' out
the market. However, it can also be a good contrary indicator,
as
Steidlmayer pointed out on pg. 153 of "Steidlmayer on Markets"
(3rd Ed):
'One relevant observation I have made pertaining to watching
the book and order flow on my Trading Technologies (TT)
front end is that when the book is stacked (aggregate bids vs.
aggregate offers), the book is usually wrong. When I say
stacked, I mean it has slightly less than twice as many total
bids as total offers or slightly less than twice as many total
offers as total bids. What is probably happening is a trader or
traders on the wrong side of the market are putting in false
bids or offers defending open position, which are cancelled
once the market gets close to the trade price.'
I'm sure many of you are familiar with this situation. There might
be a huge overhang of several thousand sell orders 5 or more
ticks above the market that suddenly evaporate once aggressive
buyers start hitting the ask. I disagree that order book info is
worthless. It is certainly misleading, but that doesn't mean we
should discard it entirely. Perhaps some of you out there use the
huge imbalances (when the book is "stacked") as a clue for reversals
of intraday moves.
Also in S. Korea, we have an indicator called the "buy ratio" which is simply
a ratio of the outstanding buy orders to sell orders. When it's above 1,
the indicator is bullish, and when it's below 1, it's bearish. Of course,
there's more to it than just that, but really fast-moving day traders
like to use it as a momentum signal. I've attached a chart showing the
movements of the buy ratio vs. the KOSPI200 futures from April 6th. It's
pretty amazing how closely the two track each other. (the buy ratio is
in red, and the kospi200 is in blue)