Level II can provide enormous insight into a stock’s price action. It can tell you what type of traders are buying or selling a stock and where the stock is likely to head in the near term. It can help you better understand open interest in a given stock if you understand what Level II is and how it works.
Key Takeaways
- Level II shows the order book for Nasdaq stocks, including the best bid and ask prices by various market makers and other market participants.
- Level II shows you who the market participant is that’s making a trade, whether they’re buying or selling, the size of the order, and the price offered.
- The players in the marketplace are market makers, the ECNs which are the computerized order placement systems, and the wholesalers that work with online brokers.
- Market makers buy and sell at all times, providing liquidity.
What Is Level II?
Level II is essentially the order book for Nasdaq stocks. Orders are placed through many market makers and other market participants.
Level II will show you a ranked list of the best bid and ask prices from each of these participants. This gives you detailed insight into the price action. Knowing exactly who has an interest in a stock can be extremely useful, especially if you’re day trading.
Here is what a Level II quote looks like:
This tells us that UBS Securities is buying 5,000 shares of stock at a price of 102.5. The number of shares is in the hundreds (x100).
Players in the Marketplace
There are three types of players in the marketplace: market makers, electronic communication networks, and wholesalers.
Market Makers (MM)
These are the players who provide liquidity in the marketplace. They’re required to buy when nobody else is buying and sell when nobody else is selling. They “make the market.”
Electronic Communication Networks (ECN)
Electronic communication networks are computerized order placement systems. Anyone can trade through ECNs, even large institutional traders.
Wholesalers (Order Flow Firms)
Many online brokers sell their order flow to wholesalers. These order flow firms then execute orders on behalf of online brokers, usually retail traders.
Each market participant is recognized by the four-letter ID that appears on Level II quotes. Here are some of the more well-known participants.
| GTSZ | GTS Securities, LLC |
| CDRG | Citadel Securities, LLC |
| UBSS | UBS Securities, LLC |
| DBAB | Deutsche Bank Securities, Inc. |
| JPMS | J.P. Morgan Securities LLC |
| GSCO | Goldman Sachs and Company |
| FBCO | Credit Suisse Securities (USA) LLC |
| NMRA | Nomura Securities International, Inc. |
The Most Important Market Maker
The most important market maker is called the ax. They control the price action in a given stock. You can determine which market maker is the ax by watching the Level II action for a few days. It’s the market maker who consistently dominates the price action.
Many day traders make sure to trade with the ax because it typically results in a higher probability of success.
Why Use Level II?
Level II quotes can tell you a lot about what’s happening with a given stock:
- You can tell what kind of buying is taking place (retail or institutional) by looking at the type of market participants that are involved. Large institutions don’t use the same market makers as retail traders.
- You can tell when institutional players are trying to keep the buying quiet if you look at ECN order sizes for irregularities. These can mean that a buyout or accumulation is taking place.
- You can greatly increase your odds of a successful trade by trading with the ax when the price is trending. The ax provides liquidity but its traders are out there to make a profit just like everyone else.
- You can tell when a strong trend is about to come to an end by looking for trades that take place between the bid and ask. These trades are often placed by large traders who take a small loss to make sure that they get out of the stock in time.
Level II can be helpful for traders looking for information about a specific stock but they should also be aware that some market makers use tactics to hide their trades and actions to throw other participants off.
Tricks and Deception
Watching Level II can tell you a lot about what’s happening but there’s also a lot of deception. These are a few of the most common tricks played by market makers.
Hiding Order Size
Market makers can hide their order sizes by placing small orders and updating them whenever they get a fill. They do this to unload or pick up a large order without tipping off other traders and scaring them away. Nobody is going to attempt to push through a 500,000 share resistance but traders may still think it’s a beatable barrier if a persistent 10,000 share resistance is there.
Order Sizes and Timing
Market makers occasionally try to deceive other traders using their order sizes and timing. JPMS may place a large offer to get short sellers on board only to pull the order and place a large bid. This will force the new shorts to cover as day traders react to the large bid.
Trading Through ECNs
Market makers can also hide their actions by trading through ECNs because ECNs can be used by anyone. It’s often difficult to tell whether large ECN orders are retail or institutional.
What Is a Buyout in Trading?
A buyout occurs when an individual or private equity fund acquires the controlling interest in a company, typically representing 50% or more of ownership. It’s referred to as a “leveraged” buyout if the individual had to borrow the money to do so.
What Is a Short Seller?
A short seller sells a stock that they don’t own. This is accomplished when an investor enters a short sale order in a margin account with their brokerage firm. They’re effectively borrowing the stock for the purpose of selling it.
The short seller can then actually buy the stock and realize a profit if its price plunges. But they’ll lose money if the price goes up.
What Is a Fill?
A fill is a fully executed order for a security. The order has been filled when the price paid fills or meets the price of the order. This doesn’t happen with every trade because numerous conditions must be met to allow it and the fill depends on how the order is placed. A market order is filled when a security hits the best available price. Limit orders are based on a specific price.
The Bottom Line
Level II can give you unique insight into a stock’s price action but there are also a lot of things that market makers can do to disguise their true intentions. The average trader can’t rely on Level II alone. They should use it in conjunction with other forms of analysis when determining whether to buy or sell a stock.