For the casual trader, understanding the basics of a stock quote is all that’s really necessary. However, more advanced traders that want to know which direction a stock may be headed in the short-term will need information beyond the simple bid and ask quotes.
Level 2 quotes provide traders with that extra bit of info about where buying and selling pressure is coming from and the magnitude of that pressure. Here’s a look at how to read and use L2 quotes.
Most trading platforms provide traders with basic stock quotes. Basic quotes are called Level 1 quotes, and they tell traders the real-time bid and ask price, as well as the last traded price and trading volume.
Level 2 quotes take things a step further, revealing a sorted list of the different open buy and sell orders from different market makers. Market makers are the broker-dealers that hold large quantities of stocks and are charged with maintaining market liquidity by filling third-party buy and sell orders using their own inventory.
In other words, L2 quotes are not just a ledger of all the completed trades. L2s provide a behind-the-scenes look at all the real-time trading action in the market and where it’s coming from.
An individual L2 order will typically have three parts. The first number will be the number of shares the market maker is seeking to buy or sell. Typically, this number is divided by 100 to simplify the order book, so an order size of 29 would represent 2,900 shares.
The second part of an L2 order is the market maker’s ID. The market maker’s ID is typically a four-letter symbol similar to a stock ticker. For example, UBSW is the symbol for market maker UBS Securities. Popular stocks have dozens of market makers actively trading shares on any given day.
Finally, the third part of an L2 quote is the price.
Typically, an L2 quote screen will place active buy orders in one column and sell orders in another, sorting both columns by price.
The single most important piece of information day traders get from L2 quotes is the order sizes putting pressure on both the bid and ask prices. An L1 quote tells traders only what the best buy and sell offers are at any given time. However, L2 quotes tell traders how large those offers are and how many more orders are in line behind them after the first order is filled.
In addition, by watching L2 quotes closely for several days, traders can identify which market makers(s) are dominating the trading action for a given stock. Some traders try to emulate the trading action of the primary market maker, also called the “ax,” because the ax tends to turn a profit over time.
Finally, by looking at order sizes, traders can deduce what type of buyers and sellers are driving the action. One million shares of trading volume split up into 20 different blocks may be indicative of retail trading volume, whereas two 500,000-share blocks suggests “smart money” institutional traders.
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