Chapter 2-2 Level II

In a previous section, we talked about Level I, which includes the best bid and ask (best prices) for a stock at a given time.  This information is just the tip of the iceberg.  Level II does not only show you the best bid and ask prices, it shows you all the prices (all bids and asks) available for a stock from all available exchanges, including ARCA, NASD, and BATS to name a few.  This provides valuable insight as it helps a trader get a much better sense of where to place his or her order, based on available volume at different prices.  It also provides a better indication of the short-term momentum of the stock.  Moreover, with just a click of the mouse, you can quickly send buy, sell, or short orders as market orders, limit orders, or stop orders.  Simply put, the Level II is the most effective way to track a stock and submit orders.

Level II provides the number of shares at each available price for a stock, as well as through which institution or electronic system the shares are being ordered.  Using a direct access broker and advanced trading software, a trader can choose which institution or electronic system with which to place the order.  A simplified example of Level II is as follows:

Level II


On the left side is the open buy limit orders (Bids) arranged from highest to lowest (best to worst).  On the right side are the best offers (Ask prices), which are open sell limit orders arranged from lowest to highest (best to worst).  The first column on the left side gives a symbol of the institution or electronic system where the order is listed.  The second column is the price of the order and the third column is the size of the order.  Share size is normally in hundreds (00’s), unless followed by an asterisk, in which case it is the exact amount.  In the above example, the best bid is located on NASD for 19,500 shares at 15.33.  The best ask or offer is located on NASD for 17,800 shares at 15.34.  However, it is important to note that there are more shares available on different institutions or electronic systems at both prices as can be seen on the picture.


ECNs (Electronic Communications Networks)

The formal name for an electronic system provided on the Level II is “electronic communication network” or ECN.  An ECN is a computerized system that matches orders for buyers and sellers for a stock.  Since ECNs work electronically, executions through ECNs are extremely fast (a fraction of a second) and this is one of their advantages.  Advanced trading platforms give traders’ access to ECNs.  There are numerous types of advanced software programs out there.  At this point in time ARCA and NASD are probably the ECNs that are most widely-used by traders.

Market Makers (Institutions)

Other than ECNs, there are institutions that appear on a Level II that are called “market makers.”  You can think of market makers as professional traders that are employed by big institutions (like Goldman Sachs and Morgan Stanley).

Market makers have special benefits bestowed upon them by the NASD (who regulate them), because their function is to bring volume to the market for NASDAQ stocks.  Market makers trade for their firm’s account, for example buying shares at the bid and selling them on the offer to profit from the spread.  They can also execute orders for their firm’s clients, who could be individual investors or large institutional clients, such as a mutual fund.