reading level 2It's not that easy reading Level 2 when it comes to a stock like INT. Understanding the flow is an art in itself, some say a dying art. Some traders (momentum scalpers) trade using a level 2 screen only, they could care less what the product is, it's all about the numbers on the screen.
A major contributor to daily trading (US) is the high frequency trading bots, they pay no attention to level 2 activity. Bots generally operate through dark pools, they front run trades. These rats will get a rebate (insider info of sorts) a fraction of a second before other trades, they front run all others.
- Market Makers (MM) - These are the players who provide liquidity in the marketplace. This means that they are required to buy when nobody else is buying and sell when nobody else is selling. They make the market.
The Ax
The most important market maker to look for is called the ax.This is the market maker that controls the price action in a givenstock. You can find out which market maker this is by watching the levelII action for a few days - the market maker who consistently dominatesthe price action is the ax. Many day traders make sure to trade with theax because it typically results in a higher probability of success.
Why Use Level II?
Level II quotes can tell you a lot about what is 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 involved. Large institutions do not use the same market makers as retail traders.
- If you look at ECN order sizes for irregularities, you can tell when institutional players are trying to keep the buying quiet (which can mean a buyout or accumulation is taking place). We'll take a look at how you can detect similar irregularities below.
- By trading with the ax when the price is trending, you can greatly increase your odds of a successful trade. Remember, the ax provides liquidity, but its traders are out there to make a profit just like anyone else.
- By looking for trades that take place in between the bid and ask, you can tell when a strong trend is about to come to an end. This is because these trades are often placed by large traders who take a small loss in order to make sure that they get out of the stock in time.
Tricks and Deception
Althoughwatching the level II can tell you a lot about what is happening, thereis also a lot of deception. Here are a few of the most common tricksplayed by market makers:
- Market makers can hide their order sizes by placing small orders and updating them whenever they get a fill. They do this in order to unload or pick up a large order without tipping off other traders and scaring them away. After all, nobody is going to attempt to push through a 500,000 share resistance, but if a persistent 10,000 share resistance is there, traders may still think it is a beatable barrier.
- Market makers also occasionally try to deceive other traders using their order sizes and timing. For example, JPHQ 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.
- Market makers can also hide their actions by trading through ECNs. Remember, ECNs can be used by anyone, so it is often difficult to tell whether large ECN orders are retail or institutional.
Conclusion
Level II can give youunique insight into a stock's price action, but there are also a lot ofthings that market makers can do to disguise their true intentions.Therefore, the average trader cannot rely on level II alone. Rather, heor she should use it in conjunction with other forms of analysis whendetermining whether to buy or sell a stock.