Level 1, 2, and 3 basics. Also commonly known as level I, II and III.
Stock quotes are constantly changing during a market session. A lot of websites publish delayed quotes. Level 1 and 2 platforms offer real-time quotes for investors while Level 3 offers real-time quotes plus deeper information, abilities, and advantages. Quick Explanation Level 1
Level 1 prices are the best bid and ask prices currently on the system. These have the highest bid price and lowest ask price for each stock or security. Level 1 pricing is what an investor sees for "real time" stock pricing and on the order screen of a regular brokerage account, according to Investopedia. Level 2
Level 2 pricing shows an expanded list of the bid and ask prices. The level 2 pricing includes the size of the bid or ask and who it is from.
Individual traders can purchase a Level 2 quote package from numerous vendors. Some online brokerage firms provide Level 2 pricing for free to traders that have a certain level of activity and commissions. Level 3
Level 3 pricing is for registered market makers who can actually put bid and ask quotes into the electronic trading system.
Level 3 trading is restricted to FINRA--Financial Industry Regulatory Authority--registered firms. Level 3 trading is used by market makers in individual stocks and by the trading desks of stock brokers. The level 3 trading system is not available to individual investors trading for their own accounts. Long Explanation - Level 2
Level II can provide enormous insight into a stock's price action. It can tell you what type of traders are buying or selling a stock, where the stock is likely to head in the near term, and much more. Here we explain what level II is, how it works and how it can help you better understand open interest in a given stock. What Is Level II?
Level II is essentially the order book for Nasdaq stocks. When orders are placed, they are placed through many different market makers and other market participants. Level II will show you a ranked list of the best bid and ask prices from each of these participants, giving you detailed insight into the price action. Knowing exactly who has an interest in a stock can be extremely useful, especially if you are day trading. (For further reading, see our Electronic Trading tutorial.)
This is what a level II quote looks like:
[UBSW, 102.50, 50] which translates to: [Market marker, Price, Size]
This tell us that UBS Securities is buying 5,000 shares of stock at a price of 102.5. Note that the number of shares is in hundreds (x100). Now let's take a look at the market participants. The Players
There are three different types of players in the marketplace:
* 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.
* Electronic Communication Networks (ECN) - Electronic communication networks are computerized order placement systems. It is important to note that anyone can trade through ECNs, even large institutional traders.
* Wholesalers (Order flow firms) - Many online brokers sell their order flow to wholesalers; these order flow firms then execute orders on behalf of online brokers (usually retail traders).
Each market participant is recognized by the four-letter ID that appears on level II quotes. Here are some of the most popular ones:
UBSW UBS Securities
LEHM Lehman Brothers
DBAB Deutsche Bank Alex. Brown
MLCO Merrill Lynch
MSCO Morgan Stanley
GSCO Goldman Sachs
BEST Bear Stearns
FBCO Credit Suisse First Boston
SBSH Salomon Smith Barney
NMRA Nomura Securities
SGAS SG Americas Securities 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 given stock. You can find out which market maker this is by watching the level II action for a few days - the market maker who consistently dominates the price action is the ax. Many day traders make sure to trade with the ax 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
Although watching the level II can tell you a lot about what is happening, there is also a lot of deception. Here are a few of the most common tricks played 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.
Level II can give you unique insight into a stock's price action, but there are also a lot of things that market makers can do to disguise their true intentions. Therefore, the average trader cannot rely on level II alone. Rather, he or she should use it in conjunction with other forms of analysis when determining whether to buy or sell a stock. Long Explanation - Level 3
Level 3 trading is reserved for members of the National Association of Securities Dealers (NASD), which is composed of financial institutions that act as stock market broker-dealers, also known as market makers. NASD is also now known as Financial Industry Regulatory Authority (FINRA).
Level 3 is a trading software platform for market makers. It gives these dealers access to information about competing market makers and their bid and ask prices that shape market activity.
Level 3 traders own inventories of a wide range of stock. Their job is to trade as many shares as possible and profit from the spread, which is the difference between bid and ask prices. Level 3 market makers enter bid and ask quotes, and execute orders.
Dealers benefit from Level 3 by having access to the most current and comprehensive market data available. The platform also allows them to be the conduit for market activity.
For a firm or individual to have access to Level 3, they must gain financial industry certification and become a NASD member. Different states require different licensing for broker-dealers, but most states require at least a NASD Series 63 license.
Level 3 displays on the dealer's screen the most current bids in one column and current offers in the next column. The user also has buttons and forms for entering quotes and executing trades instantly. Resources
(Long explanation, Level 2)
(Long explanation, Level 3)