Level 2 Workings

Q:How does Level 2 works? How do you read it?

A: Level 2 is a way of checking what is happening on a stock exchange to one particular stock in real-time market conditions. You can see demand for a stock and whether there are more prospective share buyers than share sellers, and vice-versa. Level 2 in this respect shows the depth of the market with all pending ‘buy’ orders for a share listed on the left of the screen and the ‘sell’ orders on the right. The orders are sorted on price/time priority basis. Naturally, if there are more prospective stock buyers than sellers for a share at a particular price level, one would reasonably expect the stock price to rise.

On a Level 2 screen the top of the ‘buy’ column usually denotes the highest price that anyone will pay for the stock, while the top of the ‘sell’ column is the lowest price at which anyone is willing to sell. Taken together, they make up the present bid-offer spread. In the below screen buy orders appear on the left and sell orders on the right. The orders with letters against are market makers. So for example EVO are bidding to buy 30000 shares at 7.5p and offering to sell 30000 shares at 9.5p. Trades that appear with an ‘a’ next to them are auto trades, which means that they are direct directly from that order book. Bid and Ask volumes are the totals of all of the orders, Depth is the number of orders on that side of the book.

As orders are fulfilled they are removed from the order book with the consequent trades listed on the far right of the screen. The pricing in the upper right indicates latest highs and low and volume weighted average prices. The volumes on the left show how many shares are traded and how many of those were ‘a’ trades.

Level 2 data is especially useful when used in conjunction with Direct Market Access (DMA). Anyone with direct access (sometimes called DMA for direct market access) can add orders or buy and sell to the central limit order book of the stock exchange. Professional investors, institutions, and anyone that can afford it can get DMA. In the UK, for instance, this allows investors to trade SETS and SETSmm stocks directly with other market participants as opposed to having to go via a market maker and pay their spread.

Those trades may appear anywhere (above or below market makers bids and offers) depending on the price they are looking to buy or sell at.

The numbers on bid and offer only reduce by the ‘a’ trades in the trade history, as only auto trades are dealt via the order book. Other trades are usually buys and sells via market makers and don’t affect the order book directly. That said, a market maker will adjust their own order book position depending on the buys and sells they do off the book too.

Another automatic trade is ‘ut’ for ‘uncrossing ‘trade, which happens when the shares go into auction. This occurs typically in the 10 minutes before official open and 5 minutes after official close (and you sometimes see ‘extended’ auctions, where another 5 minutes or more is added to the closing auction). Auctions also occur during the day when the bid/ask match or cross, or if the share price rises by a given percentage (typically 10%). So to summarise auctions are 10 minutes before the open and can also have a 5 minute extension if the indicative UT is more than 5 percent different to the previous day’s close. Relatively illiquid shares like Tanfield often don’t experience pre open or post close auctions, whereas the likes of RBS always do.

At the very top of the screen the segment and sector is listed, along with the NMS, an abbreviation for normal market size. Market makers have specified sizes under which they agree to deal, called the normal market size, abbreviated to NMS and it appears at the top of the screen. This indicates what quantity of shares the market makers are required to trade at. So EVO (and the other market makers) have to quote for 30000 minimum. They typically quote a wide spread but usually deal well within it. The top trade in that screen shot, at 8.535p was probably a buy but not off the order book, the shares would have come from a market maker. Market makers don’t generally run a completely flat book, they usually have a positive or negative balance of shares.

Those numbers alongside named market makers, although listed in the ‘orders’ columns, are not actually orders. They don’t meant that the market maker is looking to buy or sell that quantity – it is merely the maximum quantity for which their quoted price is valid. If you want to deal a bigger quantity you might need to negotiate a slightly worse price than displayed. Alternatively, if you are a keen active trader, you can obtain a direct access account allowing you to post your own bids and offers on the order book. A fee is usually payable each time you do so.

P.S.: In the snapshot, the example includes a list of trades alongside it. It’s worth noting that the prices of all trades are in a single column. That is all that a serious trader needs to see there. The practice of allocating each trade to one of 3 columns (buy/sell/unknown) is sometimes offered, but is a very crude and often deceptive guide generated by robotically comparing the trade price with the latest bid/offer, even though the trade may have occurred earlier and is being reported late. Such allocations should never be relied on. Nor should daily totals untill adjusted for legitimately delayed reporting of oversized trades.

Price Monitoring Extensions

There can be a Price Monitoring Extensions if the Uncrossing Trade in the end of day auction will be more than (3% for FTSE 100 securities or 5% for all other securities) different to the Volume Weighted Average Price (VWAP) during the last 10 minutes of normal trading then a 5 minute extension is initiated. If the indicative UT after the extension is still outside the limit then a further 5 minute extension is initiated and the UT will be decided at the end of that period.

Level 2 – Why Subscribe?

Imagine you are in a theatre. Like everyone else in the audience, you can see the new play unfolding onstage. But if you are privy to what is going on in the wings, just offstage, you might know a little about what happens next. If the actor about to walk on is carrying a dagger, you can reasonably assume that the story is going to be more gruesome than if carrying a birthday cake.

And so it is with stock prices. The publicly viewable buy and sell price is freely visible centre stage. But pay a subscription for Level 2, and you are allowed to see how many are queuing offstage-left to buy, and how many are queuing offstage-right to sell. You also can see what size orders they are carrying, with what price tag on them. If there is a clear imbalance between those two queues, it can often indicate which way the ‘onstage’ price might move next.

Furthermore, because each player in the queue is time stamped when they join in (or whenever rejoining with a revised price), you can identify which ones are keenly pushing to the front of the queue, and which ones are tentatively backing away (either of which they might do, depending on events centre-stage).

On heavily traded active stocks in the FTSE-100, these indicators are mostly only valid a few seconds or minutes ahead of movements in the publicly visible price. But on slower-moving stocks, especially those involving identified market makers, or a mix of market makers and others, the indications can build over minutes or even over several hours.

In this respect, Level 2 data provides an indication of supply and demand as it happens, so CFD traders can see how many ‘buy’ and ‘sell’ orders are active on a stock in real time. So if more investors are buying a certain stock it may be assumed that demand is rising and there is not a sufficient supply of the stock to meet the demand so it is expected that the price of the share will go up. Skilled viewers of Level 2 data are able to deduce the apparent intentions of certain players, some of whom might repeatedly disappear from the queue and reappear with a different size order at a revised price. In some cases these are players genuinely maneuvering, perfectly fairly, to gain the best deal they can for themselves. In other cases they are attempting to kid the viewer, and thereby lure the viewer into buying or selling. A bit like poker ;o)

Sometimes it is possible to identify behaviour lasting several days at a time, which might usefully indicate some major ongoing disposal or acquisition of stock. One last thing to point out is that although Level 2 is very useful in short term timing of buying and selling of shares, it is of very limited use to the truly long term investor there is no point in them subscribing for it.