I always tell my trading challenge students, “If you want to learn how to trade penny stocks or just learn to be a day trader in general, then understanding Level 2 quotes is vital to your education.”
It looks really complicated at first, since there’s a lot of information thrown your way, but my in-depth video study guide on Level 2 and this post can help you understand it and pick out the pieces that are the most important.
Table of Contents
- 1 What Are Level 2 Quotes?
- 2 What is Level 2 Trading?
- 3 How to Read Level 2 Stock Quotes
- 4 Level 2 Screen: Live Trading Videos
- 5 Level 2 Quotes Examples
- 6 Top Level 2 Trading Platform
- 7 Benefits of Using Level 2 Quotes
- 8 The Bottom Line
What Are Level 2 Quotes?
Level 2 (aka Level II) quotes come from a trading service consisting of real-time access to the quotations of individual market makers registered in every Nasdaq listed security, as well as market makers’ quotes in OTC Bulletin Board securities.
It allows you to watch the trades being executed right in front of you.
Level 2 gives you more insight than you need about how a given stock is moving — in other words, its price action.
The screen on your trading platform lists the traders who have been active in buying, selling, or shorting shares of given stocks. You’ll also see the direction in which a given stock will probably move over a specific time period and other actionable information.
There are two sections in your Level 2 window when you look at a stock on your trading platform. One side is the bid and the other is the ask. Basically, this is what people are willing to pay and willing to sell a security for.
The bids are usually on the left and the asks are on the right. Your trading software also shows the total number of shares that the buyers or sellers have in their orders. The bid side is in descending order, with the highest bids on the top. The ask side is arranged in ascending order, with the lowest ask on the top.
Think of Level 2 quotes as a way to measure liquidity in a given stock based on how market makers are trading. These are the big institutions and computers that pump millions of dollars into the stock market, so paying attention to their positions can sometimes help you get a better idea of what and how to trade.
There are dangers inherent to this practice, though, so buyer beware. Market makers can attempt to manipulate public perception by changing how they trade.
Importance of Level 2 Quotes
Many people refer to Level 2 quotes as the Nasdaq order book. In other words, it’s where you go to find out where the meat of the stock market is playing out.
In reality, it’s the rest of the Nasdaq order book. You can find the rest in Level 1 quotes. Level 1 provides basic information about a given stock, such as bid, ask, and spread prices in real time. It just doesn’t show you the depth of the order.
For instance. Level 2 quotes tell you whether there are limit orders on a given stock or the position sizes of trades that might be forthcoming. You need Level 2 access for that.
The only greater access you can get is through Level 2I, which is typically only available to market makers. Retail traders and brokers don’t have access to this information, so you don’t need to worry about it.
Level 2 Quotes Definition
Level 2 quotes can tell you exactly what you need to know about a stock’s price action based on how market makers are treating it. I’ll cover the players shortly, but if you follow a specific player based on its position in a stock, you can potentially increase your chances of a successful play.
Keep in mind that market makers might provide the liquidity necessary for the stock market to function, but their goals are ultimately the same as yours: They want to make money.
Nobody — not even a huge institution like JPMorgan — goes in looking for a loss. It happens sometimes as a cost of doing business, but market makers want to profit as much as you do.
Sections in Your Level 2 Window
The arrangement of your Level 2 window will vary depending on what trading platform you’re using. They typically use the same structure, though, so traders don’t have to spend too much time learning a new user interface.
You can get a ton of information here, including bid and ask prices on either side of the NBBO price, which is the best-offer price in the United States for that particular stock.
Remember that these aren’t actual trades. In other words, what you see in Level 2 quotes haven’t happened yet. What you’re looking at is market interest — what is likely to happen in the future.
The bid price is what people are willing to pay for a given security. It’s like an auction on eBay. People put in their bids (offers), and other people try to top them so they can buy whatever product is on offer. In the stock market, traders will only pay a certain price for a stock based on its perceived value.
The ask price is what a stockholder is willing to sell the stock for. It might be much more than the bid price or almost the same. What constitutes the ask price — and the bid price, for that matter — can vary depending on where you’re trading. It’s typically the lowest ask and highest bid prices made most recently.
The spread is the difference between the bid and ask prices. An extremely liquid stock will typically have a narrow spread. The stocks are changing hands so frequently that buyers and sellers easily trade shares. For an illiquid stock, which means there’s not much action, you’ll see much wider spreads.
What is Level 2 Trading?
Three different entities control Level 2 trading.
First, you have the market makers, as I’ve already mentioned. They’re also called liquidity providers. They’re responsible for quoting both bid and ask prices on specific stocks, and their goal is to make money on the spread.
Designated market makers are entities that have received certification by an exchange and that have agreed to guarantee a position in the stock market. It could be buying, selling, or options trading.
Electronic communications networks, or ECNs, are also listed in Level 2 quotes. These are computer programs that execute automatic trades based on market conditions.
Finally, you have the wholesalers. They get order flows from brokers.
When it comes to Level 2 quotes, the ax isn’t a separate player, but instead the dominant player. Think of the ax as the most active entity or person involved with a specific stock.
If you pay attention to price action over several days or weeks, depending on the stock’s liquidity, the ax will emerge from the data. The ax has the largest position in the stock and therefore controls the price action.
How to Read Level 2 Stock Quotes
If you’ve never looked at Level 2 stock quotes before, you might feel a little overwhelmed. That’s natural. Once you understand the data flow, however, it can become second nature.
On your screen, you’ll see the number of shares a market maker wants to buy or sell. It might be listed in full or as a percentage. In other words, if it says 100 and there’s a multiplier of 100, that means the market maker wants to buy or sell 10,000 shares (100 X 100).
You can also look at the volume bars to figure out position sizes at a glance. When the bars are long, it means there are big positions in play and that there’s significant price action. Shorter bars mean the opposite.
2. Market Maker’s ID
Every market maker has a specific identification, or ID. It’s similar to a ticker symbol for a stock.
For example: JPMorgan’s ID is JPHQ.
Then you have the bid and ask prices for the stock, as I’ve already discussed. When you see a wide spread, you might want to steer clear because you’ll have difficulty trading that stock. Even if you’re willing to buy it at or near the ask price, selling it for a profit will prove difficult.
Level 2 Screen: Live Trading Videos
Seeing trades live on your screen is fantastic. If you’ve never seen a Level 2 screen or used Level 2 quotes, you can check out these two videos below:
Level 2 Quotes Examples
Sometimes, it’s easier to understand Level 2 quotes from an analogy.
Here’s an example: Tom has a box of shirts that he wants to sell for $20 each. Sam wants to buy one of them for $19, Jake wants to buy 3 for $17 each, and Ron wants to buy 7 for $18.
A trade will only occur when a buyer and seller have identical pricing constraints, so the current pricing above won’t generate any trades until someone changes their order or a new person comes in.
Back to our example: Let’s say Bob is in desperate need of cash and has an identical shirt to sell. He can look at the Level 2 quotes and know that he can sell it for $19. The Level 2 window will now look like this:
So now that Sam and Bob have matching prices for their buys and sells, the trade will take place. Now that Steve and Amanda have a mutually agreed upon price, a transaction will occur, and the Level 2 box will reflect the instance accordingly. Every time a transaction occurs, it is recorded in what is referred to as the “Time and Sales” box, which lists the price, quantity, time, and market of the transaction.
This part of the Level 2 window contains basic information about the stock — the SPDR S&P 500, in this case. You can see that is includes the intraday high/low, the last trading price, the previous trading day’s closing price, today’s opening price, the current percentage change, and the total volume traded.
Now let’s look at the buy side.
This shows the total number of shares investors are willing to buy at the corresponding prices, just like in our shirt example. The number of shares is divided by 100 for simplicity (the “6” on the top left represents 600 shares).
In this Level 2 window, “39 ARCA 114.01” signifies that within the ARCA network, the best bid from investors is currently for 3,900 shares at a price of $114.01. ECNs are designed to facilitate trading and will automatically match buyers and sellers that have the same price criteria.
Now let’s look at the sell side.
This area shows us the total number of shares available to sell at given prices. The structure is identical to the bid side. As an example, “388 ARCA 114.03” signifies that the ARCA network has a total of 38,800 shares to sell at $114.03.
And now the “Time and Sales” box …
You don’t have to have this box showing, but it can be helpful. Whenever a trade occurs, it will be added to this box.
Here is what the full version looks like.
This shows the price, quantity, time, and ECN used in every transaction. It’s common for multiple trades to take place at the same time since there is more than one ECN available.
So why is this helpful? Since these are real-time updates that traders can see, it can help them to better understand what price their securities are worth at that time. It can also help them analyze in which direction the stock might move.
If there are several orders getting filled on the buy side, this can mean that the stock is heading lower since sellers are rushing to get rid of shares at lower prices. The opposite can mean that the stock is heading higher.
Top Level 2 Trading Platform
If you’re looking for an intuitive Level 2 trading platform, check out StocksToTrade. It’s incredibly easy to use, and it provides all the information you need right on the screen.
In addition to Level 2 quotes, you’ll also get access to market news, analysis, trading videos, and more.
Benefits of Using Level 2 Quotes
You might be wondering why you should bother with Level 2 quotes, especially if you’re just trading penny stocks based on Level I quotes right now.
The answer is simple: More information.
The more information you have as a trader, the more effective you can become. I’m successful in roughly 74 percent** of my trades, and not because I’m a stock market genius. It’s because I know how to do my research.
Without Level 2 quotes, I wouldn’t know what the market makers are doing or how the ECNs are manipulating stocks’ liquidity. Here are a couple other things you can potentially discern from looking at Level 2 quotes.
Strong Support and Resistance Levels
Stocks often trade between consistent support and resistance levels. When those levels are strong, it gives me a fairly strong indication that a stock isn’t going to break resistance or crack support any time soon.
Of course, the unexpected can happen. But when I see a pattern of strong support and resistance, and when the Level 2 quotes bear out my forecast, I feel more confident in my trading.
When Trends Are Likely Over
Paying attention to trends can potentially keep you out of hot water. Stocks can maintain consistent trends over long periods of time, but those trends will eventually end.
If you see that market makers are exiting their positions, it’s a sign that the trend is probably over. Similarly, you might use that information to analyze if a merger or acquisition is about to take place or that some other news has influenced market makers’ positions.
Master Your Skills with the Trading Challenge
If you’re new to trading and Level 2 quotes, or if you need some help mastering your trading skills, I invite you to apply for my Trading Challenge. I’m looking for my next success story right now, and it could be you.
The Trading Challenge allows you to learn from me and my top students. We’ll show you our trades, provide support, and give you access to hundreds of hours of instructional footage.
Ready to take the challenge?
The Bottom Line
Level 2 quotes give you a look at market depth and other information you can’t find in Level I quotes. You’re actually watching how market makers, well, make the market.
Armed with this information, you can potentially boost your trading confidence, whether you’re trading penny stocks or larger-cap securities.
What tips do you have for new investors who might want to learn more about Level 2 quotes and how they work?