Level 2 quotes is the term given to enhanced market information that is unique to the Nasdaq, OTC BB and Pink Sheets because, unlike NYSE or AMEX (aka NYSE MKT), these trading markets handle buy and sell orders via an electronic dealer market.
Level 2 quotes use to contain the best means by which a day-trader could trade stocks directly with market makers. However when you consider the growing participation in ECN's and SuperMontage Total View (described under "Real Time Quotes - Explained") this is no longer the case.
Level 2 quotes, and direct trading using Level 2, is only one of the major ways that shares of stock are now being traded on Nasdaq and the OTC markets.
Unless you are a day-trader, Level 2 quotes are not likely going to help you trade stocks.
But knowing about Level 2 access and how it functions is important and helpful in the sense that you will not become confused or fall victim to sites that make you think you do need it just so you buy their services.
In addition, each person who successfully trades stocks are creative thinkers, and may find successful uses for Level 2 quotes that this author is not presently aware of.
In addition, one day you may choose to try your hand at day-trading. By easing yourself into this subject, as revealed on this page, and the previous page on Real-Time Quotes, you will be feeding your mind the information it requires to make sense of all this in the meeting of your investment goals.
In an electronic dealer-market, market makers (dealer-brokers) for each stock actually create or originate bid and ask quotes or orders and directly trade with each other and other market participants providing trade liquidity for the stock. . . and this is what you see taking place in Level 2 quotes.
In what was just described, Market-Makers create liquidity for that stock, thus "making the market" for that stock. Liquidity for the stock is important so that other traders may buy and sell shares of that stock with greater ease.
The NYSE and AMEX (aka NYSE MKT) are auction markets, so no market-maker or dealer-broker activity to see on those exchanges. In an auction market, the orders are created by the traders themselves and one broker-specialist manages all trading activity for a stock - He matches and manages the stock orders of the traders.
Auction market trading is either done electronically and/or in a physical auction-floor style format and/or by phone. Most trades are now filled electronically and/or by phone.
Auction markets also have market-maker type traders for any given stock called 3rd market makers. Such traders, usually firms, trade stock with others on the open market with their own money... And, while these firms do provide liquidity for that stock by their trading, they do not fulfill the same major function/roll that market-makers perform in dealer-markets.
Note that Level 1 Quotes was previously discussed in "Real-Time Quotes - Explained".
Level 1 screens show the best Bid/Offer and Volume information just like any real-time quotes. Level 2 quotes, in addition to Level 1 info, shows the actual trade orders of market makers for a stock and the identity of those traders.
Level 2 quotes shows the viewer of a Level 2 Screen how the prices are arrived at (origin) for a current share price of a stock and the identity of the dealer-brokers, ECN's and Order-flow firms (wholesalers that trades on behalf of a retail-broker for the best prices).
Why is this information important to day-traders?
Level 2 helps them trade with and/or against market makers of a stock for what they feel are the best prices at their origin - one of the Market Makers trading in a particular stock.
I will now go into more detail on exactly what Level 2 quotes is and how it is of value to day-traders.
In an electronic dealer market, broker dealers called market makers create bid and ask prices that compete with each other to buy and sell shares with each other, and with other brokers-wholesalers, and with ECN's.
Day-traders and sometimes swing traders possess and require Level 2 Quotes in combination with Level 2 trading desks through DAT software provided by their brokers so they are able to track nano-price trends and volumes at their origin (the Market Makers) and plan quick in and out trades on these trends. Many such trades are filled each day by day-traders.
If you personally had access to Level 2 Quotes, you would be able to see the identities and bid and ask prices of these broker-dealer market makers along with the volume of their trade orders.
Make a note of the fact that Level 2 Quotes by itself does not give you the ability to actively trade with market-makers; rather, it just gives you the ability to see the trading activity of Market Makers, ECN's and Wholesalers as they actively trade for that stock.
To actively trade using Level 2 Quotes, you also need a DAT Trading Desk from your broker and access to trade directly on the Nasdaq. The SuperMontage order routing system handles all orders, and it routes each order to the appropriate financial market - the market(s) you specify - with high speed and efficiency.
Nasdaq Level 2 orders use to be handled by the following Nasdaq routing systems: SOES, SuperSOES, and SelectNet. . .
SuperSOES (Super Small Order Execution System) and the SNET (NASDAQ SelectNet System) are ECN routing programs owned by NASDAQ. These two programs use to allow individual traders direct access to the Nasdaq and place trades directly to the Market Maker of their choice for a stock just like Level 3 access brokers.
As usual with all ECN Direct Access Trading (DAT), you need Direct Access Software (DAS) provided by your broker, and you always have access to streaming Real-Time quotes.
Using SNET, you had the choice to broadcast your order to all market makers, or to all participants of an ECN, at once so as to capture the best current price from all available financial markets.
• You could not actually see your order placed on a Level 2 Quotes screen like you could for SuperSOES.
• Using SNET, the trade took up to 7 to 11 seconds to complete. Terminating a trade in progress during those 7 to 11 seconds was not possible and therefore could be risky to use since there is really no way to tell which way the market will turn in 7 to 11 seconds. Obviously this fast pace trading is only important for day-traders and sometimes swing-traders.
• SNET, by means of smart routing software, was able to scour many ECN's and the stock exchanges at one time for the best quote price of the stock you were attempting to trade at that point in time, and then automatically fill your order at that best quote price.
SNET was not the only means by which smart order routing was available.
Automated Programmable Algorithmic Trading Software provided by your broker or other sources also used, and still uses, smart order routing systems that are extremely fast and complex and are able to scour some or even all ECN's, Black Pools, Major Exchanges and even Local Exchanges for the best bid and ask prices for a stock in seconds of time.
Such trading software as just described is designed to trade automatically or semi-automatically according to the technical perimeters the trader programs into it.
Intelligent Algorithmic Trading Programs can Learn: The better trading programs are actually able to learn what works and what doesn't to achieve the trader's desired result. Such software keeps improving and the prices are becoming more affordable.
Online brokers could also legally use SuperSOES to place trades for their clients - stock traders like you and me.
Super SOES orders had to be honored by the market maker at the market maker's current advertised bid/ask prices as seen on the Level 2 quotes screen.
The SuperMontage Routing System now efficiently and swiftly handles all orders once only available through the SOES, SuperSOES, and SelectNet (SNET), and does so extremely fast
In dealer-markets, all trading is conducted 100% on computer networks.
Level 2 Quotes of dealer trading activity from these computer networks was once only available to licensed securities agents, but is now available to private or retail investors through many websites and broker account services sometimes for free but usually for a fee.
Access to Level 2 quotes trading is different when compared to DAT real-time access to the NYSE and AMEX (aka NYSE MKT) because NYSE and AMEX (aka NYSE MKT) operate as auction markets not dealer-broker markets. Nasdaq, OTC BB and Pink sheets are dealer markets.
To gain another in depth review of this difference between the Market-Dealer Network, Auction Market and ECN's, see:
Level 2 Quotes (as seen in the Nasdaq and OTC Markets) is different when compared to:
DAT real-time access to NYSE, AMEX (aka NYSE MKT), and ECN's
Nasdaq and OTC stocks traded on Electronic Communications Networks (ECN's) allow trading of stocks from all major exchanges and even OTC stocks between all traders, including brokers, broker-dealers, large firms, and mutual funds.
• Unlike trading on the Nasdaq with Level 2 quotes, ECN's hide the identities of the traders on the ECN's so you cannot tell who is bidding and asking for shares of a stock.
• What you do see on an ECN is your own buy and sell order lots and those of others, but without any identifying info.
Other differences between Level 2 Quotes and ECN's is that ECN's display all actual buy and sell order lots including the number of shares in each lot for all trading on the ECN. This is called unlimited market depth.
Level 2 only provides the best price for orders only by market makers.
ECN's provide a history of buy and sell order lots over a period of time.
The detail of such trades and the depth of the history of trades will depend on the ECN you are viewing, the options you are willing to pay for, on your DAT trading desk.
Only day-traders would be aware of, or concerned with, or need to know the differences between Level 1 quotes, Level 2 quotes, ECN trading data and the real-time quotes as seen on many free financial sites like Yahoo Finance or Google Finance.
Why are Level 2 quotes potentially helpful to day-traders?
Day traders initiate and complete trades on fractions of percent moves in share prices in a very short space of time many times a day. With level 2 quotes, a day-trader can track the potential trading trends of broker-dealers and the other participants and hopefully profit by their trading.
Professional Day-traders use sophisticated intelligent trading software to compete with intelligent trading platforms of other day-traders, broker dealers, firms, and wholesalers.
Level 2 Quotes are necessary for day-trading to be effective in electronic dealer-markets.
The algorithmic programs used by most day-traders are programmed to scour the financial market for the best prices of a stock and execute trades when specific technical indicators or perimeters are met.
Level 2 information for Nasdaq, OTC BB and Pink Sheets stocks allows day-traders to see in streaming real-time the identity of all the market makers, ECN's and Wholesalers trading on a stock, including their competing bid and ask prices.
All of this Level 2 information is displayed on websites offering Level 2 quoting. Such info can be obtained through brokers providing direct access level 2 quotes and/or level 2 trading platform.
A day-trader with an active direct access to a Level 2 trading platform (level 2 trading desk) provided through his broker can now target a stock, see all the market makers and other market participants and their trading activity for that stock, plan trades accordingly.
The day-trader can then shop around and buy or sell shares from competing market makers who are offering what the day-trader interprets as the best quote price for shares of that stock at that point in time.
Programmable algorithmic smart trading software a Must!
As noted earlier, most of such trading strategies are accomplished by successful day-traders using programmable algorithmic smart trading software.
Such day-traders regularly fine-tune the trading perimeters of their trading programs to reflect the particular day and stock they are trading at the time.
Without such programs, the day-trader cannot effectively trade against the high speed and sophistication of the dealer-brokers and other market participants.
Day-traders trade on a variety of financial markets at once to attempt gain the edge - the best price possible at a point in time.
As well, many day-traders, besides trading just on Nasdaq through Level 2, will simultaneously scan ECN's and even Black Pools for the best price they are seeking on a particular stock at a point in time.
The Extraordinary Penny Stock Investor trades on another level beyond the white noise of such quick trades on fractions of a percent of the day-traders, dealer-brokers and other market participants.
The trading strategies of such Extraordinary Investors do not require Level 2 Quotes knowledge at all. Such traders are not trading directly with or against broker-dealers for the best bid or ask price within tenths to millionths of a second frame.
Any serious day-trader will require DAT Level 2 trading access coupled with a DAT smart routing system and intelligent highly advanced algorithmic trading programs, because that is what the big player day-traders including mutual funds, ECN's and other large trading firms and dealer-brokers use to obtain the edge.
This does not mean that day-traders do not day-trade NYSE and AMEX (aka NYSE MKT) shares.
What it means is that day-traders who have a direct connection to the NYSE or AMEX (aka NYSE MKT) and/or to one or more ECN's (Electronic Communication Networks) can now trade directly with brokers, institutions, other day-traders, and other traders that also have direct access trading. Day traders must implement different strategies for trading on an auction market.
A closer look at the Level 1 screen compared to the level 2 screen - what information you would see:
Level 1 screens show Bid/Offer/Volume information but do not show how the prices are arrived at or the identity of the dealer-brokers. You can see this activity displayed by typing in a ticker symbol of a stock on any financial website like charts.com, yahoo finance, google finance, etc.
Level 2 screens, as previously discussed, provides much more information about the stock, including
• details of the current bid and offers of individual market makers
• identifies who the market makers are for each stock
• which lots of shares by each market maker are trading the lowest and highest at any given time
Tricks Market-Makers Play on Day Traders
What has just been described about market maker trading activity is not an accurate description though.
Why not accurate? Not accurate because what you see on the Level 2 Quotes screen of market maker trading activity is not complete - you will not see all the trading activity of market makers or the other major participants.
Market makers play tricks on day traders and other market participants by hiding trades they make or hide the volume of shares traded to gain an advantage over traders and their trading software to make a profit. . .
Market Makers are in the business of making a profit off of other traders and also to keep prices of a stock stable and liquid. Part of the strategy of market makers is to prevent other traders with level 2 Quotes from learning about all of their trading activity. They do this to confuse other traders about trends changes, and turn the tables on them, making profits off of their confusion.
The market maker typically plays this trickery by:
• breaking up large lots of shares he is holding and then trades some or many of his shares on the retail market, like on an Electronic Communications Network (ECN), where all trades are anonymous.
• selling an large lot of shares in a Black Pool, which is a type of ECN where the entire trade is conducted with total anonymity - off exchange in a closed market.
• creating a huge sell or buy order to confuse others that a new trend is beginning. Then, after getting the desired result, they turn around and cancel the order and trade just the opposite.
When broker-dealers trade some of their shares on an ECN this creates problems for day-traders in implementing their strategies. No matter how complex, intelligent and efficient a day trader's programmable trading software is, it will always be flawed and produce errors and losses because not all the data is present due to this trickery by market makers and other participants.
Hard to track Market Maker secret activity on ECN's.
ECN's are the same networks where you or I, and many other retail investors, could trade stocks using DAT broker provided software.
On an ECN ATN (Electronic Communications Network Alternative Trading Network) the individual traders, brokers, day-traders, institutional investors, and dealer-brokers all trade without their identities revealed; so, attempting to locate who the dealer brokers might be that are trading on one or many ECN's is not accurate.
On ECN's all traders are equals on the same field. No Level 2 quotes.
All trade orders are matched and filled automatically and anonymously by ECN software.
Since the market makers' ECN transactions cannot be tracked by level 2 software, day-traders and swing-traders are pretty much in the dark. There is no clear easy way to make successful day-trades with Level 2 Quotes because of this trickery.
Due to the tricks market makers play, technical software, algorithmic trading programs, and even your own logic will be flawed in discerning successful trades because all the facts of the trading activity of market makers is not accounted for when using Level 2 Quotes.
Summary of Level 2 Quotes compared to DAT Real-Time access to a non-level 2 exchange so far
In Level 2 quotes:
• you can see the identification of individual market makers, and other market participants for each stock.
• you can see the number of shares each one trades on the NASDAQ and OTC to other dealers or to other traders that have Level 2 quotes.
• you can see when market makers create bid and ask orders on the shares they possess to compete with the bid and ask prices of other market makers, broker-dealers (who trade shares of their clients)
• you cannot see when market makers trade anonymously on an ECN, or how many shares they trade at any given time.
• you can directly trade shares of a stock with a market maker through a level 2 direct access trading platform provided by your broker.
• On the NASDAQ, you will see at least 3 market makers for any given stock because 3 is the minimum required to manage each stock listed. The average is about 14 market makers per stock listed on the Nasdaq but could be as many as 42 or more market makers on fast moving stocks.
• On the OTC BB, at least 1 market maker is required for each stock
• On the Pink Sheets, at least 1 market maker is required for each stock.
In Real-Time DAT with NYSE and/or Amex (aka NYSE MKT)
• you can see bid and ask orders, the time and amount of shares for each order, the time and number of shares bought and sold.
• Specialists do not create bid and ask prices like market makers do; rather, specialists match bid and ask prices of brokers and traders on the auction floor, by phone and by computer networks.
• you can directly trade shares of a stock with the specialist through a direct access trading platform to that exchange - this is provided by direct access broker.
• On the NYSE and AMEX, only one specialist manages a stock. No competition between specialists.
• The job of the specialist is to match buy and sell orders from the trading public for a stock and to attempt to create equilibrium of supply and demand for buy and sell orders even if that means buying or selling shares themselves.
Level 2 quotes: Final summary and A few extra bits of info that you may want to be aware of. . .
• The Level 2 Quotes is real-time streaming data revealing market-maker quotations, bidding lots, time each bid and sell is filled, and names of all market maker trading on every Nasdaq-listed stock.
• The more heavily traded a stock and the greater the market cap is of that stock, the more market makers are likely involved in that stock. The average market makers per stock is 14. You can see this for yourself by viewing Level 2 Quotes.
• With level 2 quotes, Traders can easily identify which market makers are (or appear) most interested in a stock. This information may be used to identify trading patterns for each market maker and could identify potential trends before they happen. In reality, this does not work as perfectly as hoped for, since market makers will attempt to trick traders - as described earlier on this page.
• Each lot of shares held and traded by a particular market maker has a quote price that changes and may differ from other market makers of the same stock because of competition to sell or buy their lots first and hopefully make a profit. All of this order activity is seen on Level 2 quotes.
• Market makers only have so much time, by law, to hold onto a lot of shares before they must act on them to either buy or sell to other market makers and to retail investors like you and me.
• Market maker' quote prices may also differ slightly from the real-time quotes you see in the Level 1 desktop or on Yahoo Finance because of competitive pricing between market makers.
If you have access to level 2 Quotes but have your orders filled by an online broker, then you might wonder why you didn't get a particular price, or got a better or worse price than what you see quoted by one of the market makers. The reason is that any one of the market makers may be filling your order.
Your online order does not necessarily go to the market maker with the best possible price per share.
• The differences in lot prices for shares between market makers is very small - fractions of a percent in most cases - and need not concern you. You do not have to worry or fret about how a stock is being traded in seconds of time for profit from minuscule moves in share prices.
Why not be concerned? You do not need to be concerned about fractions of a percent profit when, in fact, you are searching to trade shares for an average profit of approximately 3% to 30% per trade and possibly far greater.
In this way, you cleanly avoid all the white noise and sophisticated day traders and market makers play. You avoid the highly intense games so common in day-trading. You are trading on a different band width so to speak.
You have now completed this study on Level 2 quotes
On the next page you will be given a very brief comparison between Level 1 Quotes and Level 2 Quotes. This lesson is short and simplistic and quite effective in getting the point across of just how important each one is for the Extraordinary Investor.
When you are ready, please click on