How do Level 2 Quotes Help in Trading?
The main advantage of the Order Book of Level 2 Quotes is access to useful information:
- All displayed quotes and orders attributed to specific market participants;
- Total displayed anonymous interest;
- Total size of all displayed quotes and orders.
Generally, it helps investors in the following scenarios:
Understanding real supply and demand
Unlike Level 1 Quotes, which only displays one bid & ask, Level 2 Quotes can provide in-depth quotations of up to 50 bids & asks. Investors can get a fuller picture of the market and better insight in forecasting the potential direction of near-term moves as well as potential floors and ceilings.
The example below shows that in Level 1 Quotes, investors can only see that stock A has 474 shares to buy and only 20 shares to sell. They are likely to think that there are more buyers than sellers. However, with Level 2 Quotes, investors can tell immediately from the chart that selling pressure is much stronger as the red takes up a larger area.
However, investors should bear in mind that bids and asks are just “intents” of buying and selling, not actual buying or selling. Only when orders are matched and executed does the intent become real. Order Book implies the future direction, but the Price Charts confirm it with actual trade executions.
In short, Level 2 Quotes should be used in conjunction with Time & Sales and Price Charts for a more complete analysis of price action.
Seizing trading opportunities
Investors could also decide whether they should place a market order according to the Order Book of Level 2 Quotes. If the asks are high and volumes are low, it might be a bad idea to trade with a market order. The investor could end up paying an unexpectedly high price. If the asks are reasonable with a narrow ask-bid spread, and the volume is high, it's safe and efficient to place a market order. The order could possibly fill immediately at a near price.
On the other hand, investors can set an appropriate limit price to trade according to the quotes. For example, by looking at the information in the picture above, an investor could place an order to buy 100 shares of Stock A with a limit price of $131.48, which is safer than a market order and could possibly fill immediately as there are 700 shares in the market to sell at $131.48.
Reading order-based data feed
If an investor prefers to read the data feed by each order, instead of the accumulated number of shares at a specific price, he could get this information from Market by Order (MBO). MBO describes an order-based data feed that provides individual queue positions and individual order sizes for each price level. That is, investors can view the composition of each buy/sell order in the Order Book through MBO, as shown in example below. MBO gives more insights by providing the details of each bid size at a specific price.
