KEY POINTS
- Level 2 market data consists of the bid and ask prices, the order size for each bid and ask price, the market participant who has placed the order, and the time and sales where you see what trades have been executed.
- Three common ways to interpret the level 2 market data are confirming key support and resistance levels, determinign the potential strength of those key levels, and analyzing the market liquidity if your assset.
- While level 2 data offers great insights into what the big players are doing, it can also be a tool for faking retail traders into backing the wrong horse.
One thing that separates professional traders from average traders is their use of trading tools. One of the most important trading tools in these pros’ arsenals is level 2 data.
In another piece, we described level 2 data and everything you need to know about the tool’s basics. In the rest of this piece, though, we’ll show you how to read level 2 market data like professionals do.
Without further ado, we’ll start this journey by first learning the components of the level 2 order book in stock trading.
Table of Contents
What are the Components of the Level 2 Order Book?
There are four main components of the level 2 market data, and they are:
1. Bid and Ask Prices
These are the prices at which a particular stock is likely to be bought (bids) or sold (asks). Note that these prices are pending orders, and there is no guarantee that the orders will be placed eventually.
The bid and ask prices are usually in separate sections on the Level 2 order book. The bid prices are on the left, and the ask prices are on the right.
2. Market Maker ID (MMID)
The MMID is usually the left-most column within the bid or ask section. It represents what market maker, Electronic Communication Network (ECN), or trader (through the market maker) is placing the limit order for that stock. Depending on what broker’s Level 2 data you use, you may see this as MMID or MPID (Market Participant ID).
3. Order Size
The size represents the volume of shares that the market maker is looking to trade at the accompanying order price.
4. Time and Sales
The orders in the bid and ask sections are pending orders that have yet to be executed. But if you want to see orders that have been executed, you’ll find them in the time and sales section of the order book. This is where you see bid and ask orders that have been executed and are live.
How to Read Level 2 Market Data
There are two common ways to interpret the level 2 data when you read it, and both are related to key trading levels. Then, there’s another way to analyze the volume of the asset.
Let’s see what these are:
1. Confirming key support and resistance levels
One way traders use level 2 data is to confirm where there are support and resistance levels. To do this, you look for price levels with huge order sizes. It’s even better if the orders are from different MPIDs. This means more traders are looking at those price levels for support or resistance.
With this same method, you can also deduce the market sentiment for the stock. If there are bigger order stacks on the bids than on the asks, this may mean that the bulls are looking to take control. Conversely, if the stacks are bigger on the ask side, the sellers are likely in control.
Don’t over-rely on level 2 data. Don’t forget that all the orders are only pending orders. That means a market maker can simply place a large pending order with the intention of deceiving traders into taking positions before canceling that order.
2. Confirming the strength of key levels of resistance and support
Assume the price of a stock approaches a key support level of $10.50. You then go to your Level 2 data to see what orders have been placed around that price area. If there are bigger order sizes on the ask section than the bid area, it means the support level is likely to fail, as more sell-limit orders are there than buy-limit orders.
Conversely, if the stacks of bid prices are larger than those in the ask section, this is likely the confirmation you need that you’re not alone in wanting to buy from that support level.
If you want to go long, you want to see a cluster of orders with significantly bigger order sizes on the bid section than the ask section. And if you want to go short, you want your stack of orders to be bigger on the ask section than on the bid section.
3. Market liquidity analysis using time and sales
Orders executed in the bid and ask sections of the level 2 data are displayed in the time and sales section, which is usually on the extreme right. One of the best uses of this data is to analyze the stock’s volatility. When the time and sales data move very fast, it’s a good sign that the stock is attracting a lot of volume, and the price is more likely to move.
Trading low-liquidity stocks can be frustrating because you may have well-defined support and resistance levels, but there aren’t enough active orders on the stock to cause the share price to move.
Final Word
The level 2 data, as important and powerful as it is, is not the ultimate trading tool. At the end of the day, you get to decide whether to follow what the level 2 data is telling you, which requires just as much courage and discipline as someone who’s only basing their trades on mere technical analysis.
Frequently Asked Questions
Let’s see some answers to some of the most frequently asked questions about reading level 2 data:
Can you see Level 2 data on TradingView?
TradingView itself doesn’t offer level 2 data. However, It allows you to connect to brokers who may offer level 2 data. When you connect to these brokers, you can get their level 2 data feed on TradingView.
What is Level 2 Scalping?
Scalping is a trading strategy that involves making small, rapid trades to capture minor price movements. Traders using Level 2 data for scalping closely monitor bid-ask spreads, market depth, and large orders to exploit short-term inefficiencies.
What’s the difference between Level 1 and Level 2 data?
The primary difference between Level 1 and Level 2 data lies in the depth of market information provided. Unlike Level 1 data, Level 2 data provides market depth by showing multiple bid and ask prices at different levels, order sizes at each price level, and market participants.
Risk Disclosure: The information provided in this article is not intended to give financial advice, recommend investments, guarantee profits, or shield you from losses. Our content is only for informational purposes and to help you understand the risks and complexity of these markets by providing objective analysis. Before trading, carefully consider your experience, financial goals, and risk tolerance. Trading involves significant potential for financial loss and isn’t suitable for everyone.
