What is Level 2?

Level 1 vs Level 2

There are two levels of share price information. First of all, you have the quote information that you are probably already familiar with. Secondly, you have Level 2, which a professional trader would never be without.

"Level 2 is the actual state of
play in the market"

The quote information is often referred to as Level 1 data. You can see the current price of a stock and the trades that have been made. Level 1 is like looking through a keyhole, you can get an idea of what is going on, but you're not seeing the full scene.

Level 2 lets you see all of the orders to Buy and Sell stock, throwing the door open, allowing you to see what is going on in the market itself. Level 2 tells you what other people want to trade. It shows you how many shares they want and what price they want to Buy or Sell at.

In everyday life, if you want to buy something, you find someone who is selling it. If you want to sell something, you find someone who wants to buy it. The stock market is exactly the same as this. Level 2 data shows you everyone who is trying to sell and buy stock.

The orders in the book are traders putting their money where their mouth is, and as such is a great indicator of market sentiment.

Supply and Demand

Open any economics text book and you are sure to find that the explanation for pricing comes down to supply and demand. If there is more demand than supply then prices will rise and if there are more Sellers than Buyers, then prices will fall.

This simple market model can't be seen simply by looking at Level 1 prices. You get no indication of what is going on beyond the moves of the Bid (demand) and Offer (supply).

In the old days of reading prices off ticker tape, speculators would try to divine the next price move from the sequence before. Those were the days when there could be minutes between ticks though. This is as far from modern trading as the pony express is from email.

Chartists nowadays can point at tick charts and try to understand and predict the movement of the markets. What they are seeing though is a two dimensional representation of past stock movement. What you need is a three dimensional representation of the information that makes up the future.

"Level 2 tells you what other
people want to trade"

While the Buy-and-hold investor sails calmly over the sea of volatility, unshakable in his resolve to ride economic progress to nirvana, the trader is looking to jump onto the volatility and time his entry and exit.

To do this he must have as much information about what might happen to a share price in the near future as possible. To do that he needs Level 2.

Market Depth

Level 1 shows the Bid and Offer (the Buy and Sell price of a stock). Level 2 information covers not only the Bid and Offer for a stock, but also the "market depth". Market depth is the whole spectrum of Buy and Sell orders, showing the different prices and different volumes. Buy orders are on the Bid side and Sell orders on the Offer side.

"Market depth is the whole spectrum
of Buy and Sell orders"

The order book for a stock on Level 2 is like a pile of orders. The Bid orders are buyers wanting to buy quantities of stock at different prices, at the current Bid price and lower. If you want to Sell, you 'hit' the Bid price, which is the price of the best Buy order. If you want to Buy, you hit the Offer price, the price of the best Sell order.

You could place a Buy order on the Bid by entering an order at the Bid price or lower. For example, you could place an order for VOD at £1.50, which is below the current Bid. If the price fell that far, you would get your order filled at that price. Wherever you place an order, you would be added to the end of the queue at that particular price. Level 2 is a queue, and it is the way in which everyone lines up with their orders that makes the market.

While the orders that you see are real, they can be entered and removed by the trader at any time. This means that an order to Buy or Sell can disappear at any point and new orders to Buy and Sell can appear at any time and at any price level. This makes the Level 2 a fluid environment with orders coming and going when they are filled, or just merely cancelled before they are met.

Essential trading tool

The markets are complicated, we'd never try to tell you otherwise. With real orders waiting to be filled, iceberg orders (a large order disguised as a smaller one) and phantom orders designed to spook out other traders, Level 2 is no simple map for the uninitiated. It is the actual state of play though and without Level 2 you may as well trade from the prices in the morning papers.

"Level 1 is like looking through a keyhole,
Level 2 lets you throw the door open"