Level II: What Is It?
from Robert J. Rak
If you've even thought about becoming a trader there's no doubt you've heard about it. It may have been spoken about like some holy grail. It could have been referenced as something one can't succeed without. They're using it in day trading shops. They're using it at home. It is in, and to be in you've got to have it.
It is level II. Now, what exactly is it?
What It Isn't
Before getting into what it is, let's get clear on what it isn't. It isn't a holy grail. It's not something one can't succeed without. They might be using it in day trading firms and they might be using it at home. You might need it, but you surely don't have to have it.
What it is, is a tool. And it is only one tool. One tool implies there are others, and it is in combination with other tools that Level II truly gains its usefulness. Understanding Level II isn't a cure all goes a long way to unlocking the power of it.
Level I
A Level I quote is the most basic information available about a stock. It is information available to all at no extra fee. A Level I quote consists of:
Bid
Ask
Quote size
Last trade
Volume
High
Low
Level II
Level II goes a step beyond Level I. It basically reveals the order book for a Nasdaq stock. But it's not the complete order book, rather it shows the best bid and offer of every market participant who is publicly posting a quote.
The upper part of this Level II display should look familiar, it is basic Level I information. In this example we have, left to right, top to bottom:
Last, Last Size, Change
Bid, Ask, Quote Size
Open, Low, High
To the right is what should be another familiar tool, the tape, or the ticker. It is a list of trades as they happen. The price is given as well as the number of shares traded. Upticks are shown in green, downticks in red, and zero ticks in gray.
But the information we're interested in, at least in this article, is the Level II information that makes up the rest of the display.
On the left side are the current bids of market participants, ranked from best to worst, highest to lowest. On the right are the offers, again ranked from best to worst, here from lowest to highest.
Each line in the display gives three pieces of information. The market maker ID, a four letter identifying code, the price bidding or offering at, and the number of shares being bid for or offered.
For example, on the offer side, the fifth offer down reads as follows:
MSCO 89 1/2 10
What is this telling us? Morgan Stanley is offering 1,000 shares of Sun Microsystems (SUNW) at 89 1/2. Now, where did I get that? MSCO is the market maker ID of Morgan Stanley. Since moscow is on the right side, or offer side, of the window, it is selling stock. The price it would like to sell at is 89 1/2. It is selling 1,000 shares as evidenced by its size of 10 (all sizes shown are in hundreds).
At this point I'm sure you have some questions. I'll try and knock them out one by one.
First, why are some IDs in red while others are black? Easy, in this Level II display (provided by RediPlus) market makers and order flow firms are shown in black while ECNs are displayed in red. If you're not familiar with these participants and how they differ don't worry, that's the subject of a future article. For now just understand there is a significant different between the two.
Levels and Colors
Second, what's with all the colors, the apparent striations? There does seem to be a method to the madness, doesn't there? But of course. Being included in a different color band separates each different price level. As has become standard in Level II displays the first level, or the inside market, which includes the best bid and best ask, is colored yellow. The second level, which is one level away from the inside market, is in green. Beyond these two first levels the standardization isn't so standard. As we'll learn later the first two levels are the most important anyway. The colors of other levels aren't important. So long as you can quickly see the difference between levels the display is doing the job.
Based on the previous paragraph, if you were asked to look at the above picture for only a second, what would be your answer to the following question: are there more buyers or sellers at the inside market? A quick glance would allow you to see the yellow band is thicker on the bid side, thus there must be more buyers. And there you have it, the reason for the color madness.
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