What Is Level 2 Trading?

  • August 1, 2018

Watch our video on how to use level 2 trading effectively.

What Is a Level 2 Trade? (Breakdown on Trading)

  1. Level 2 is the order book of Nasdaq stocks
  2. Trading orders are placed through lots of different market makers
  3. Level II shows you the best bid/ask prices from each of the many different market makers

Level 2 trading is a tool used by traders to see bid ask spreads and where the buyers and the sellers are. This is a handy indicator to help gauge taking a possible trade. We talk about the goods and the bad's and how to trade level 2 in the video above.

The market is a battle between the bulls and bears. This war affects price movement. Using L2 is a way to see the price bids and the price ask.

Traders can and will affect price when you're trying to place an order. Hence you need to know the difference between a market order and limit order.

There are many things to consider when trading in the stock market. As a result, you'll want to use the tools at your disposal. Which means you must spend the time to study and practice. Take our day trade course if you need more help.

LEVEL 2 TRADING

Here is a level 2 using thinkorswim. On the left you see the bid's and all the exchanges that the bids are coming though on, and on the right you see the ask or the "sellers"

1. Real Time

What is level 2 trading? It's a service that gives you real time access to orders. In other words it shows real time bid ask spreads. Orders are placed by all kinds of people. They can be market makers or electronic communication networks (ECN).

These orders are put into an order book. This can be added to your trading platform. It gives you depth of price information. In other words, you're getting all the available prices that market makers are posting.

Level 1 shows the best bid ask spreads whereas level 2 includes supply and demand. Traders know that emotion can affect supply and demand.

Greed and fear move markets along with news. As a result, supply and demand are affected. In fact, a 17th century rice trader by the name of Homma realized that emotions had an effect on supply and demand.

He wanted to come up with a way to track that. Hence the invention of Japanese candlesticks patterns. If you're going to trade level two then you need the candlesticks and patterns they form. Take our free online trading courses.

Level 2 Trading

2. Know the Players

You need to know the players that make up level 2 trading. These are the people and algos that we go up against. There are market makers, electronic communication networks and wholesalers.

Market makers give the market it's liquidity. We need liquidity to trade. However they can mess with traders stop losses as well as options contracts. Market makers are required to buy and sell when when no one else is doing so. Hence they make the market.

Electronic communication networks are the algos that trade. They're the computerized orders. Anyone can trade using ECN. Sometimes even the big time traders do because it's all done by a computer.

Wholesalers are just like it sounds. Many times brokers sell their order flow to wholesalers. The wholesalers then execute orders on the behalf of online brokers. Usually retail traders use wholesalers.

How Do You Interpret Level 2 Data

  1. The names on the far left are the different market makers
  2. The bid list shows you all of the different prices people are willing to pay
  3. The size shows how many shares people are waiting to buy
  4. The ask list shows you all of the different prices people are looking to sell at
  5. The size shows how many shares people are looking to sell

What Is Level 2 AX Data?

  • There's something known as The Ax. This is the most important market maker. This market maker controls the price action on stocks. The way to find out who The Ax is is to look at a few days of L2. The market maker who's dominating price action on a consistent basis is The Ax. 

We show how to use L2 live in our trading rooms each day. Check out our trading service to learn more.

1. Should You Use Level 2 Trading to Trade?

You need to know how to trade level 2. It can be a helpful tool because it's telling you a lot about a stock. L2 trading tells you what kind of buying is happening. Is it retail or institutional?

You can find out by looking at the type of participants. The market makers used for retail trading and institutional trading are different. It's popular with trading penny stocks.

You can find irregularities. Usually irregularities are institutional traders trying to keep the buying of a stock quiet.

Another way to trade level 2 is to look at The Ax. Day traders who follow The Ax have a higher probability of success. In order to have success, they're following the market maker that's providing the liquidity.

L2 is showing you available price and liquidity. With that in mind, don't think L2 is a true reflection of what's happening in the market. There are programs that can adjust level 2.

As a result, bid and ask spreads are manipulated. This, in turn, causes traders to panic sell. All that happens without the bid and ask ever actually changing (bookmark our penny stocks list and stock watch lists pages).

2. Beware of the Manipulation

There is manipulation that happens a lot in level 2 trading. That's why when trading level 2 you want to pair it with other tools like Level 1. Knowing how to trade L2 means that you know there's manipulation happening.

Market makers can hide their order sizes. They place small orders and then update them when they fill. They can pick up shares or unload them without making other traders aware.

Smaller barriers look easier to push through than larger ones. That's where they can get you. Market makers can use their order size to trick other traders.

They can get shorts to come on board and then change their order. Which in turn has traders, especially new ones scrambling. However, you can get your own AI trading software that has you running with the algorithm traders.

What Do the Colors Mean on Level 2 Trading?

  1. Here's what the colors mean on level 2 trading:
  2. Green signals price going up or "buy orders"
  3. Red signals price going down or "sell orders"
  4. While signals no change in price
  5. Multi colors on certain platforms just separate data points
Das trader pro level 2

DAS TRADER has an advanced level 2 display, along with hotkeys. A winning combo.

The Bottom Line of Level 2 Trading

Level 2 trading does give you insight into a stocks price. You can use it when trading stocks vs options. When you open an investment account you can add level 2 to your screen. Trading level 2 can be rife with manipulation. As a result, use other forms of analysis to trade instead of solely relying on level 2. 

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