A few weeks ago, we looked at the concept of reading the tape, which is also known as tape reading. We also looked at the concept of imbalance, which refers to the actions by buyers and sellers in the market.
In this report, we will look at the concept of level 2 in trading.
What is level 2 quote?
Level 2 is often viewed as a complex dashboard that shows the order flows in the market. It shows how buyers and sellers are placing their trades. Having a good understanding of how to read level 2 market data can help you determine whether to buy or sell stocks.
Bid and Ask Price
The left side of Level 2 is known as the bid price. Bid refers to people who are trying to buy a stock. In most cases, it is usually red in colour, as shown in the chart below. It is usually arranged in a descending order, with the biggest bids on top.
The right side, on the other hand, is the ask price. It shows the number of people who are attempting to buy the stock and is usually arranged in an ascending order.
The level 2 dashboard is offered by several brokers and other online companies. At Day Trade the World (DTTW), we providethis dashboard in the PPro8 trading platform.
Level 2: participants
There are three key parts of level 2 dashboards.
- Market makers – A market maker is a company that operates in an exchange to provide liquidity. They provide the quotations and are required by the exchanges to buy when no one is buying and sell when no one is selling. By doing this, the market makers help to ensure that there is good order flows in the market.
- Electronic Communication Network (ECN) – ECNs are communication networks that offer order placement systems. There are many online brokers that offer the ECN model.
- Wholesalers – This is a situation where many online brokers share their order flow to wholesalers who them execute the orders.
Level 2 and Time and Sales
The concept of level 2 is usually related to that of time and sales, also known as reading the tape. As we wrote before, time and sales shows all transactions in the market, including volume and the time the transaction went through.
In most cases, the time and sales is usually shown in red and green. The figures are red when they are executed at or below the best bid on level 2. If the price is executed at or above the ask price.
For example, if there are more greens in the time and sales, it shows that there are more buyers in the market, which is likely to push the price higher. Similarly, if there are more reds in the time and sales, it shows that there are more sellers in the market, which could push the price lower.
Benefits of Level 2
There are several benefits of using these quotes when trading. These are:
- It shows you exactly what is happening in the market. For example, you can understand exactly who is buying and selling the stocks.
- It helps you gain an edge against traders using the other types of analysis.
- As shown above, you can combine level 2 with time and sales and find imbalance.
Disadvantages of Level 2
However, there are disadvantages of using Level 2. For example, it is common for market makers to hide their order sizes using an ECN. They can also pump a stock and then dump it.
Level 2 Trading Strategies
There are several trading strategies when trading the market. The most popular is to look at the charts and analyze where the price will move to. On the other hand, there are those professional traders who look at the level 2 charts and attempt to digest what the market participants are doing.
External Useful Resources
- Understanding level 2 quotes: Infographic - Stocktotrade