|
 |
LEVEL 2 - How does it work?I have given an introduction on the level 2 already in section 4 but I want to return on it since it is so important to master if you want to consider trading your own portfolio: I do have to emphasize that reading Level 2 is not an exact science, but when it's used in conjunction with an accurate trading system, it can help to show you the way. It is nice to know, by looking at price levels away from the inside bid and ask, that you are thinking along the same lines as the professional players; it is a far better thing to be on the same side of the trade as the professionals, rather than trying to fight them. If you jump into a trade without knowing where you are in the scheme of things and the trade turns against you, you are left feeling helpless with little or no control about what to do. This is usually when sentiment steps in and if you have had a number of trades go wrong you begin to think the market is against you personally. "Sure, as soon as I buy it goes down!" or "They knew exactly when I was going to buy and were waiting for me and when they saw my order they yanked the bids and the stock fell. Someone should have the SEC investigate these guys!" Those are just two of the many accusations leveled at the market and its participants mainly through ignorance of how the market functions and what different trading/investing tools can do for you. So, looking at the Level 2, you will see on the left side the BIDS, and on the right side the ASKS. The highest BID and lowest ASK prices are known as the inside levels. Usually you will see a number posted next to the price and the symbol (or in Canada the Trading Number) which is the volume being offered on the BID and ASK. In a fast moving stock these numbers change very rapidly. Bids are pulled, asks are pulled; huge bid numbers are flashed then withdrawn and so on. To the uninitiated these are illegal games but if one were to look closely at the regulations (which really is a waste of your time to be honest) they are doing nothing illegal. In the "old days" way back in the late 1990s and into this century, Market Makers or MMs only had to post a certain amount of their true intentions. So how do you read the Level 2 screen? When used in conjunction with a reliable trading system, which provides entry prices and target prices, it can be a very useful tool to have in your arsenal.
The biggest mistake the vast majority of traders make is looking at the inside or incorrectly reading the intentions of the professional traders. The first snapshot Level 2 Column 1 shows the Level 2 for RIMM at 1:27EST. At the time the price was 144.57. You can see how the BID and ASK side of the screens are showing choppy levels. Below the inside BID you see 144.55, then 144.43 and so on with very little consistency. The same thing exists on the ASK side EXCEPT if you look further down to the area circled in orange, you will see 6 market participants sitting at 146.00.
Now have a look at the next snapshot. Level 2 Column 2, is about 30 minutes later. You can see how the ASK side at 145.00 has 6 market participants sitting on the inside. As we moved higher, that 145.00 level, which had had only two market participants sitting there, gradually grew. This is key: some would say it was a wall. If the stock was not trading strongly upward, it could be a wall, but by this point in the day the stock had already climbed 5.20 since the open. Now, directly below the 145.00 on the ASK you see nothing but segmented levels all the way until 146.00 where still we have 6 sitting there. By this point on my own calculations, I had 144.88 entries with a target up to 145.30 so that thicker level at 145.00 goes hand in hand with my bullish calculations.
Now, look at the snapshot showing Level 2 Column 3. We are well above the 145.00 price; and have exceeded the target of 145.30 (it did act as brief overhead resistance but the stock continued to move higher). The ask level at 145.50 is beginning to thicken with four market participants and then 146.00 now has seven market participants. The price does not immediately move up to those levels, and sometimes the price can move well away before climbing higher (or falling lower if in a short move). We simply ran out of time. I had planned a trade with 146.66 as my entry point and a target of 148.21, but it was taken out too late in the trading day to have it move higher and we peaked at 146.90 or thereabouts. However, we did move past each of those levels that were building away from the inside BID and inside ASK. In other words, if you look at the trees you cannot always see the forest. If you get trapped into watching the action on the inside you can miss the clues the Level 2 is giving you. Even though the volumes are not great that is because market participants do not want to tip their hands. Many investors feel they should have to send an email to everyone that day telling them exactly what their intentions are, but like any business your approach and the way you accomplish your goals is sometimes proprietary. Why should the professionals have to be so transparent that they are required to tell everyone (including their competition) about their future plans? With time and experience most can learn how to play along with the market. Still, the vast majority want to buy when the professionals are selling, and sell when the professionals are buying. Learning how to stay in a trade is a good thing and being able to read a Level 2 screen, especially for the more active trader who wants to get the most out of their trades, is extremely important but more often overlooked. It is not an exact science, but when used in conjunction with a reliable trading system, it can provide you with a view to what the longer term intentions are for the share price. The same ideas hold true when a stock is falling hard in price. You will quite often see a level about 50 cents away from the inside BID which has a large number of market participants sitting at it, and then another level just like it another 30 cents or so even lower in price. In a downtrend many see these areas as support when it is just an indication that stock is likely to fall at least that low. Short sales and sellers are driving the price down and covering is taking place at lower levels than the current inside BID would indicate. Ignorance may be bliss but in the markets, it can cost you. The more you know the better off you are. I will now compare different Level 2 screens. Each software company offers something slightly different, and what you are striving for as an investor/trader is ease of use and information. The first example Level 2 Explanations shows the Level 2 tool offered by CyberTrader, an American data provider. There have been improvements made upon it since that time. Below is an explanation of each of the important features of this particular Level 2 tool. Then we will compare it to a Level 2 offered by a different company.
A: This tells you how many minimum short shares are available to you should you wish to short any particular stock. In terms of trading, I do stress if there are no short shares available to you as a trader, even though you may never go short, not to bother trading that particular issue, and I will deal with that at the end of this column. B: This tells you the ratio of buy to sell or sell to buy shares being offered. This particular example is running on Demo so it is not quite accurate because of the L1 showing on the ask side, but if it were running live, it would show 934 on the buy side and 354 on the ask side. C: These are the order buttons which can vary as you will see from the other Level 2 screen I will show here. In this case, since we don't own any Intel (NASDAQ: INTC, BullBoards), our only options are to Short or to Buy. Once you make a Buy on INTC a Sell button will appear in place of the Short button. D: These two boxes allow you the flexibility to route your orders via your choice of ECN ( it is showing INET here, which is the old Island ECN) and below that you can choose Limit Orders, Market Orders, Invisible Orders and so on. It is quite flexible and allows the user to decide how to route their orders to the market and what method they want to dispose of or buy a stock. E: This particular Level 2, if one was able to trade options, gives you Option Strings, Level II Options, and Advanced Options, which are all part of the basic Level II screen. You will see on this example different colors on the Time and Sales screen, where the actual prints of sales are shown. The first line is 22.87 100 shares at 12:02pm EST. The different colors can tell you at a glance if orders are being executed below the bid or above the ask, in between the bid and ask, at the bid or at the ask. This helps you to gauge market sentiment. If, for example, you see huge orders going off at a color that indicates they are being executed below the bid, it may show weakness (which is why it is important to be able to scroll down away from the inside to see where key levels are).
On this example of the Level II, A on the ask side of the Level II shows how you can scroll down and see what levels are building away from the inside. In this example we see a Level first at 22.90 then another beginning to build at 23.00. This next Level II is slightly different.
It has Buy, Sell, and Short buttons (compared to the CyberTrader which did not show a Sell button until a Buy was made). It also lacks a ratio read, which I find useful, and contains no shortable shares indicator. However, for the most part the differences are minor and it does, over time, become a case of what you are used to and have become comfortable with. I do know for example, with this Level II that placing invisible orders is not an option. Invisible Orders, in the true Canadian fashion are called Icebergs, or orders which cannot be seen, although I do understand the systems offered through others provide a warning of sorts that Iceberg orders are out there. For those who may be unaware, invisible orders are orders that are sent to the market but do not show up on the Level II screens. You may have seen these for example when the bid is 22.00 and the ask is 22.05 and you see orders going through at 22.03, 22.04, but which do not appear on the Level II at all. It is good if you wish to enter or exit a position and not show your size. You place your order in between the bid and ask and hope there is a matching order out there. If there is they will trigger and the prints will show on Time and Sales but, not on the Level II screen. All executed orders must be shown, whereas all orders placed do not need to be shown. If you feel a stock you purchased is running out of steam and you have 10000 shares to get rid of but do not want to show it to the market, you place it invisible and maybe you find someone who wants to buy 10000 shares but not tip their hand. You get out, they get in, and hopefully the share price then falls making you feel pretty clever! As I mentioned last week, the Level 2, if properly used, can be a useful tool. However, far too many are caught up on what is going on at the inside bid and ask levels and what they see as support is weakness and what they see as resistance is not. A quick glance at many message boards will often find posters complaining about the flashing orders and so on but the reality is, you should not be paying attention to those anyway. It takes time to learn how to use Level 2 and my advice would be to find a data provider that allows you to trade in real time but in Demo form without risking any money. You can then learn how to use the different tools being offered and especially if you have recently changed providers, to become used to the new features. One of the other benefits of trading in real time without risk is that allows you to gain confidence in the way you conduct your trades as the trades you see are going through in real time and your demo orders will only be filled if the real time share volume is there for it be filled. For example, if you place an order to buy 10000 shares at a set price but only 3000 traded at that level, you will only get 3000 on your demo order. At the beginning I mentioned not buying an issue you cannot short. The reasons for that are simple. If you go Long a stock with no short shares available, the professionals know you can only do one of three thing:
I now recommend you dive into the next chapter which also deal with the level 2: Liquidity 
|
|
