August 23, 2021

Let's talk about level 2

What are level 2 quotes?

Have you ever imagined how profitable trading will be if you have access to information (in real-time) about which market maker is offering the best bid-ask spread and enormous insights into a stock’s price action? That will be great right?

You can get unhindered to information from top exchanges such as NASDAQ on the potential direction in which the market is headed, price action, and the best quotes, among several other useful pointers that you need to make an informed decision about stocks or any other security or financial asset. All we have mentioned so far and much more is what level 2 quotes/level II quotes offer.

If you are still at sea or are not clear on what level 2 quotes are, why you should use them (speaking of level 2 quotes), and how to use level 2 quotes in your trading strategy, you no longer have to lose sleep over it because we have got you covered. We talk you through what level 2 quotes are and how they can help you understand the open interests of any given stock.

What are level 2 quotes?

You can think of a level 2 quote as an order book for NASDAQ. Yeah, that is pretty much what it is but there is more to level 2 quotes than meets the eyes. As you may already know (unless you are new to the stock market), market orders are placed through market makers such as institutional traders and other market participants including individual and retail traders.

When stock market borders are placed, level 2 quotes will provide you with a ranked list of each participant and show you what the bid and ask prices are while also giving you insights about price action. Having access to level 2 quotes means you can tell who has an interest in any given stock and such information has proven to be very useful today traders over the years.

Hopefully, you now know what level 2 quotes are and have also gotten an idea of how they can impact your trading. Having mentioned that, let’s shift your focus to those involved in the marketplace the players.

Who are the market players?

Recall that level 2 quotes provide traders with information about who has an interest in a given stock and other market dynamics such as price action, best quotes, and direction of the market. The big question is who are these people that participate in the stock market and why is it important to keep tabs on what they are doing.

As we hinted earlier, there is such thing as “the players” in stocks and they are generally classified into three groups market makers (MM), Electronic Communication Networks (ECN), and Wholesale (order flow firms).

Let’s a brief look at each of them.

• The Market Makers (MM)

If you are looking for the players that provide liquidity in the market place this is the group of traders. They make the market in the sense that when nobody else is going long and sell when others are not.

• The Electronic Communication Networks (ECN)

These are computer networks that are designed and dedicated to placing orders automatically computerized order placement systems. With that in mind, it’s also worth mentioning that virtually anyone can leverage electronic communication networks in their trading including institutional traders.

• The wholesalers (Order flow firms)

A significant number of online brokers sell order flows to wholesalers who in turn execute orders on behalf of the online brokers (who are mostly retail traders). Now, all market participants can be recognized using a unique four-letter ID that is shown on level 2 quotes. Let’s take a look at some of the popular ones.

GTSZ GTS Securities, LLC

CDRG Citadel Securities, LLC

UBSS UBS Securities, LLC

DBAB Deutsche Bank Securities, LLC

Others include JPMS (J.P. Morgan Securities LLC), GSCO (Goldman Sachs and Company), FBCO (Credit Suisse Securities (USA) LLC), and NMRA (Nomura Securities International, Inc.)

What is Ax?

While researching or discussing players in the stock market, the chances are that you have crossed paths with Ax. Who or what is Ax?

Ax is considered the most important market maker because it controls the price action of any given stock. The million-dollar question is, how do you identify the Ax for any given stock? Contrary to popular misconceptions, finding Ax for a given stock is not Herculean, all you have to do is close tabs and monitor level 2 quotes/level II quotes for a couple of days to see which money maker (MM) dominates price action for the stocks you have eyes on.

The dominant market maker for that stock is known as the Ax. And that explains why most day traders insist on trading with the Ax. Why? Trading with an Ax often results in a high probability of success.

How do Level 2 quotes affect your trading?

Having discussed level 2 quotes, their uses, and players in the marketplace, you have probably been wondering, how to use level 2 quotes and how will it impact your trading.

Will level 2 quotes make you a successful and profitable trader?

Recall that level 2 quotes are intended to give you insights into what is happening with any given stock. If the stock market is bullish or long, level II can tell what kind of buying is going on is it institutional or bullish? And you can tell by simply looking at the participants involved. Mind you, large institutions don’t trade with the same market makers as retail traders.

A quick look at the size of orders coming from ECNs or automated trading systems will tell you when big players such as the institutional traders are trying to be hush about their positions. If they are buying and are trying to keep it quiet, it could signify a buyout or an accumulation. As such, it will be best if you made time to understand dark pools and how to spot irregularities in the market. Think options flow.

Trading with an Ax

Trading Ax is particularly profitable when the market is in a trend. It significantly increases your chances of becoming successful as a day trader because it provides liquidity.

While you are leveraging level 2 quotes in your trading strategy, you should be mindful of the tricks or tactics that market makers use to hide their trades and activities in a bid to throw other participants off and take the lion’s share from the market.

Some of the tactics include hiding order size (by placing small orders and updating them afterward. For example, instead of placing a large or one-time order of 500,000 shares, the market makers can decide to place 10,000 orders and update them when the contracts are filled.

Rounding off

Another trick is making a large offer only to take it back and put up a large bid. For example, one of the participants, say JPMS or GSCO may place a large offer to attract short sellers only to pull the offer and replace it with a large bid (order sizes and timing). This will prompt new shorts to cover while day traders react to the large bid.

Last but not least, market makers can also decide to hide behind ECNs to hide the actions. Recall that ECNs are accessible to virtually everyone and it’s quite difficult to tell what ECN orders are coming from retail or institutional traders.

Remember not to rely on level 2 quotes alone while trading. It’s almost best to use it in conjunction with other types of analysis. That way you will save yourself from deceptive market makers and make an informed decision regarding when to buy or sell stocks.