Master the Art of Day Trading: 7 Ways Level 2 Software Can Transform Your Trades!

Level 2 trading software provides traders with a detailed view of market data by displaying the order book, showing bid and ask prices, the number of shares available, and the market makers or exchanges posting these orders. It offers insights into the supply and demand dynamics for a particular stock, which can help traders predict price movements.

Who Invented Level 2 Trading?

Level 2 trading was introduced by the NASDAQ in 1983 as part of its proprietary trading system. This development aimed to enhance transparency in the market by showing real-time order book data.

What Was the First Trading Software to Offer Level 2 Trading?

The first trading platforms offering Level 2 data were those directly connected to the NASDAQ trading system. Early adopters of Level 2 trading functionality included professional-grade platforms designed for institutional and high-frequency traders. Later, online brokerage platforms like Datek Online brought Level 2 trading to retail traders in the late 1990s.

Why Do Stock Traders Like Level 2 Trading Software?

Stock traders favor Level 2 trading software because:

• Transparency: It provides detailed insight into market depth and liquidity.
• Market Trends: It helps identify potential price trends and reversals.
• Order Flow Insight: Traders can see large orders (block trades) and their potential impact on the stock price.
• Scalping Opportunities: It is especially valuable for day traders and scalpers who depend on small price movements.

What Is the Difference Between Level 1 and Level 2 Trading?

• Level 1 Trading: Displays the best bid and ask prices and their corresponding sizes, along with the last traded price and volume. It is simpler and suitable for most retail traders.
• Level 2 Trading: Shows a deeper view of the market, including multiple bid and ask levels, market makers, and ECNs (Electronic Communication Networks). This additional information allows for more strategic trading.

What Online Brokerages Have Level 2 Trading Software?

Many online brokerages provide access to Level 2 trading data, often for a fee or with certain account requirements:

• TD Ameritrade (Thinkorswim)
• Interactive Brokers
• TradeStation
• E*TRADE
• Fidelity
• Webull
• Robinhood (limited availability in some cases)
• Lightspeed Trading

Market Makers or Exchanges in Level 2 Trading

In Level 2 trading, market makers and exchanges are the entities responsible for providing liquidity and facilitating trades. They each have unique codes (ECN) to identify them in the order book. Here’s a detailed breakdown of some key players:

1. NASDAQ

• Code: NASDAQ
• Description:
  • The NASDAQ Stock Market is one of the largest stock exchanges in the world, focused primarily on technology and growth companies.
  • Market makers operating under NASDAQ provide liquidity by buying and selling stocks, often using proprietary algorithms.
  • NASDAQ’s system ensures high-speed transactions and maintains market efficiency.

2. ARCA

• Code: ARCA
• Description:
  • NYSE Arca (ARCA) is a major exchange operated by the New York Stock Exchange (NYSE).
  • Known for its advanced trading platform, it specializes in Exchange-Traded Funds (ETFs) and equities.
  • ARCA provides robust liquidity and competitive pricing due to its fast execution and direct market access.

3. BATS

• Code: BATS
• Description:
  • BATS Global Markets, now part of Cboe Global Markets, is a leading exchange for equities and ETFs.
  • Known for its low-cost trading and high-speed execution, BATS is a preferred venue for institutional and retail traders.
  • It competes directly with NASDAQ and NYSE in the equity trading space.

4. EDGX

• Code: EDGX
• Description:
  • Part of Cboe Global Markets, EDGX is an electronic exchange offering efficient, low-cost trading.
  • EDGX is designed for fast executions and is popular among high-frequency traders.
  • The platform focuses on providing a simple yet powerful trading experience.

5. OTCBB

• Code: OTCBB
• Description:
  • The Over-the-Counter Bulletin Board (OTCBB) is a trading venue for smaller companies that do not meet the requirements for major exchanges like NASDAQ or NYSE.
  • It facilitates the trading of penny stocks and micro-cap securities.
  • Market makers in OTCBB play a vital role in providing liquidity for less-liquid stocks.

6. CHXE

• Code: CHXE
• Description:
  • CHX (Chicago Stock Exchange), now part of NYSE, operates as an electronic trading platform.
  • It provides fast, reliable execution services for equities, catering to institutional and retail participants.
  • CHXE is known for its simplicity and focus on secondary trading of stocks.

7. Y

• Code: Y
• Description:
  • Code Y refers to Direct Edge’s EDGA Exchange, another entity under Cboe Global Markets.
  • EDGA offers low-cost execution and is tailored for traders seeking to minimize trading fees.
  • The exchange competes on pricing and execution speed, primarily targeting cost-conscious traders.

More ECN Codes in Level 2 Trading: Overview and Descriptions

In Level 2 trading, ECN (Electronic Communication Network) codes identify specific ECNs that facilitate the matching of buy and sell orders. These ECNs play a vital role in providing liquidity, executing trades, and increasing transparency. Below is a comprehensive list of common ECN codes and their descriptions.

1. ARCA

• Name: NYSE Arca
• Description:
  • Operated by the New York Stock Exchange (NYSE).
  • Focuses on equities and ETFs.
  • Known for its advanced technology, fast execution speeds, and competitive pricing.
  • ARCA is one of the most popular ECNs for trading ETFs.

2. BATS

• Name: BATS Global Markets
• Description:
  • Now part of Cboe Global Markets.
  • Initially started as an alternative trading platform to challenge NYSE and NASDAQ.
  • Offers low-cost trading and is a leader in U.S. equity and options markets.

3. EDGX

• Name: EDGX Exchange
• Description:
  • Operated by Cboe Global Markets.
  • Designed for cost-conscious traders, with competitive pricing structures.
  • Provides fast executions and focuses on serving institutional and high-frequency traders.

4. EDGA

• Name: EDGA Exchange
• Description:
  • Also part of Cboe Global Markets.
  • Similar to EDGX but with slightly different pricing models.
  • Primarily appeals to traders seeking low fees.

5. INET

• Name: NASDAQ INET
• Description:
  • A high-performance ECN operated by NASDAQ.
  • Integrates seamlessly with NASDAQ systems to provide fast and reliable executions.
  • Often used by institutional traders and high-frequency trading firms.

6. NSDQ

• Name: NASDAQ
• Description:
  • The main electronic trading platform for the NASDAQ exchange.
  • Provides liquidity for NASDAQ-listed stocks and is a major player in the ECN ecosystem.

7. IEX

• Name: Investors Exchange
• Description:
  • Known for its “speed bump,” which introduces a 350-microsecond delay to reduce the advantages of high-frequency trading.
  • Focuses on creating a fair and transparent market for traders.

8. BOSX

• Name: Boston Options Exchange
• Description:
  • A trading platform for equity options.
  • Provides an alternative for options traders looking for efficient execution and competitive pricing.

9. OTC

• Name: Over-the-Counter Trading
• Description:
  • Represents trading of securities not listed on major exchanges.
  • Includes OTCBB (Over-the-Counter Bulletin Board) and Pink Sheets for smaller, less-liquid stocks.
  • Facilitates trading for penny stocks and micro-cap companies.

10. PSX

• Name: NASDAQ PSX
• Description:
  • A price/time priority platform operated by NASDAQ.
  • Offers rebates and incentives for liquidity providers.
  • Popular among institutional traders.

11. NYSE

• Name: New York Stock Exchange
• Description:
  • One of the oldest and most prominent stock exchanges in the world.
  • Its ECN provides electronic trading capabilities for NYSE-listed stocks.

12. CBOE

• Name: Chicago Board Options Exchange
• Description:
  • Specializes in options trading but also provides electronic platforms for equities.
  • Offers advanced order routing and trading features.

13. MATCH

• Name: UBS ATS (Automated Trading System)
• Description:
  • A private ECN operated by UBS, designed for institutional trading.
  • Focuses on matching large orders anonymously to minimize market impact.

14. DRCTEDGE

• Name: Direct Edge
• Description:
  • Now merged with Cboe Global Markets.
  • Known for its simple, cost-effective trading structure.
  • Provides reliable order matching for equities.

15. BARX

• Name: Barclays Electronic Trading
• Description:
  • An ECN run by Barclays for institutional trading.
  • Focuses on providing liquidity and anonymity for large orders.

16. EMLD

• Name: E*TRADE Market Maker
• Description:
  • Operated by E*TRADE to execute trades for its retail clients.
  • Facilitates order routing and execution for equities.

How ECNs Benefit Traders

• Anonymity: ECNs often allow traders to place orders without revealing their identities.
• Liquidity: ECNs aggregate orders from multiple participants, increasing the liquidity of stocks.
• Direct Access: They enable traders to access markets directly, bypassing traditional intermediaries.
• After-Hours Trading: Many ECNs support extended trading hours, providing more flexibility.

By understanding the role and features of these ECNs, traders can optimize their strategies and choose platforms that best suit their needs.

Understanding Their Role in Level 2 Trading

• Market Makers: Provide liquidity by posting bid and ask prices for the stocks they cover. They profit from the spread between the bid and ask prices.
• Exchanges/ECNs (Electronic Communication Networks): Facilitate trades by matching buy and sell orders. They compete on factors like execution speed, cost, and reliability.

These market participants play a crucial role in ensuring liquidity, reducing spreads, and enhancing transparency in the stock market.

How to Read Level 2 Market Data?

1. Columns Overview:
   • Bid Side: Shows the highest prices buyers are willing to pay and their sizes.
   • Ask Side: Displays the lowest prices sellers are willing to accept and their sizes.
   • Market Makers/ECNs/Ex: Identifies the entity placing the orders.
2. Market Depth:
   • The number of orders and sizes at various price levels indicate supply and demand.
3. Order Book Dynamics:
   • Watch for patterns like large bids or asks disappearing, which might signal price moves.
4. Price Action:
   • Compare changes in the bid-ask spread and volume to assess market sentiment.

Difference Between Level 2 Trading and Full Book Data (NASDAQ Full Book or BATS/EDGE Full Book)

Level 2 trading and Full Book data both provide insights into the order book and market depth, but they differ in scope, detail, and intended audience. Here’s a breakdown:

1. Level 2 Trading

Scope and Features:

• Market Participants: Shows quotes from market makers, ECNs (Electronic Communication Networks), and exchanges for a given stock.
• Depth of Market: Displays multiple levels of bids and asks, but typically limited to the top 10-20 price levels on each side of the order book.
• Participants Identified: Includes market maker and ECN codes (e.g., NASDAQ, ARCA, EDGX).
• Focus: Designed for retail and day traders to make informed decisions based on price action, liquidity, and order flow dynamics.

Advantages:

• Simple to read and interpret for active traders.
• Provides key insights into market depth, bid-ask spreads, and supply-demand imbalances.
• Highlights immediate trading opportunities, such as breakouts or reversals.

2. Full Book Data (NASDAQ Full Book or BATS/EDGE Full Book)

Scope and Features:

• Market Participants: Offers a complete view of the order book across all price levels, not just the top tiers.
• Depth of Market: Provides comprehensive data for all buy and sell orders placed on the exchange, giving a broader picture of market sentiment.
• Participants Identified: May or may not identify specific market participants, depending on the provider.
• Focus: Designed for institutional investors, algorithmic traders, and analysts who need in-depth data to understand long-term trends, liquidity, and price stability.

Advantages:

• Full transparency of all orders across the price spectrum.
• Useful for assessing overall market liquidity and predicting large price movements.
• Helps institutional traders gauge the potential market impact of large trades.

Key Differences

Aspect	Level 2 Trading	Full Book Data (NASDAQ/BATS/EDGE)
Market Depth	Limited (Top 10-20 price levels)	Full depth (all price levels)
Audience	Retail and day traders	Institutional and algorithmic traders
Focus	Short-term trading opportunities	Market-wide liquidity and trends
Data Scope	Selected market participants	Comprehensive for the specific exchange
Cost	Typically lower or included in platforms	Often requires premium subscriptions or fees
Use Case	Scalping, day trading	Large orders, trend analysis

Which Is Better?

• Level 2 Trading is ideal for active traders, day traders, and scalpers who need fast, actionable data.
• Full Book Data is better for institutional traders or analysts who manage large orders or require a macro view of market conditions.

By understanding the difference, traders can choose the right tool based on their trading style and objectives. For example:

A hedge fund manager may rely on Full Book data for market impact analysis.

A retail day trader may prioritize Level 2 for quick decision-making.

What Is the Inside Game of Level 2 Trading?

The “inside game” of Level 2 trading refers to strategies traders use to exploit the detailed order book information, such as:

• Reading Fake Orders (Spoofing): Identifying and avoiding manipulation by fake large orders meant to mislead traders.
• Baiting: Moving the bid or ask to lure traders into making unfavorable trades.
• Wash Trading: Simultaneously buying and selling the same stock to create false activity.
• Following Smart Money: Observing significant orders from institutions or market makers.
• Identifying Breakouts: Recognizing price levels with heavy buy or sell pressure that could trigger significant moves.
• Algorithms and Bots: Automated trading programs that execute orders based on predefined criteria. Algorithms often dominate Level 2 data, creating fast-moving and sometimes deceptive patterns.
• Liquidity: The ease with which a stock can be bought or sold without affecting its price. A narrow bid-ask spread and deep market depth signal high liquidity.

Who Is the “Ax” in Level 2 Trading?

In Level 2 trading, the “Ax” refers to the dominant market maker or trader who significantly influences the price movements of a stock. The Ax often has:

• High Order Flow: They consistently place large buy or sell orders.
• Market Presence: Their orders appear frequently in the order book, often at the best bid or ask prices.
• Control Over Momentum: Their trading activity can lead to notable price changes, either by absorbing supply or driving demand.

The Ax can be a market maker, institutional investor, or high-frequency trader who holds significant power over a stock’s short-term price direction.

How Can You Spot the Ax in Level 2 Trading Data?

To identify the Ax, you need to closely monitor Level 2 data for patterns that suggest dominance in trading activity. Here are the key steps and indicators:

1. Look for Consistent Large Orders

• Identify Large Bids or Asks: The Ax often places sizable orders on either the bid (buy) or ask (sell) side.
• Repetition: If the same market maker or ECN code appears repeatedly with large orders, they are likely the Ax.

2. Track Order Behavior

• Absorption: The Ax may absorb large volumes of shares without significantly moving the price. For example, if a large bid stays consistent despite heavy selling, the Ax is likely supporting the stock.
• Iceberg Orders: Look for orders that replenish after partial fills—this indicates hidden size and Ax-like behavior.

3. Observe Reaction to Price Movement

• Control Over Reversals: If a specific market maker or trader consistently appears at price reversal points, they could be the Ax.
• Bid-Ask Movement: If one entity moves their orders aggressively to lead the price up or down, this could be the Ax driving momentum.

4. Dominance in Volume

• High Proportion of Trading Volume: Check if a single market maker or ECN is responsible for a significant percentage of the daily volume in the stock.
• Order Placement at Key Levels: The Ax often places orders at psychologically significant price points (e.g., round numbers).

5. Follow the Spread

• Narrowing Spread: The Ax might tighten the bid-ask spread to encourage trading activity.
• Order Stacking: They may place multiple orders at various levels to create artificial liquidity or control the market depth.

6. Market Maker or ECN Code

• Certain ECNs or market makers are known for being aggressive in specific stocks. Track their activity to spot recurring dominance.

Why Spotting the Ax Matters

Identifying the Ax can provide traders with key advantages:

1. Understand Market Sentiment: The Ax often reflects the intentions of large, informed players.
2. Predict Price Movements: Tracking the Ax helps anticipate price trends, breakouts, or reversals.
3. Enhance Trade Timing: Knowing where the Ax is placing orders allows for better entry and exit points.
4. Avoid Traps: Spotting manipulative moves, such as spoofing or baiting, becomes easier when you know who controls the action.

By combining observation, pattern recognition, and strategic analysis of Level 2 data, traders can effectively spot the Ax and adapt their trading decisions to align with the market’s dominant force.

How Can Traders Use Level 2 Trading in Their Trading Decisions?

1. Spotting Support and Resistance Levels:
   • Look for large bids or asks that act as barriers to price movement.
2. Market Sentiment
   • Bullish Sentiment: Large bids dominating the order book.
   • Bearish Sentiment: Large asks dominating the order book.
   • Neutral Sentiment: Balanced bids and asks with minimal price movement.
3. Predicting Breakouts:
   • Watch for thinning liquidity at critical levels.
4. Timing Entries and Exits:
   • Use the flow of orders to gauge optimal trading moments.
5. Detecting Market Sentiment:
   • Analyze bid/ask pressure to understand bullish or bearish trends.
6. Avoiding Traps:
   • Learn to identify and navigate around spoofing and other deceptive practices.

Example of a Trader Using Level 2 Quotes to Make Decisions

Scenario: A day trader is analyzing the stock XYZ using Level 2 quotes. The stock is currently trading at $50.00, and the trader wants to decide whether to buy, sell, or hold based on the order book data.

Step 1: Observing the Order Book

Bid Prices	Bid Size	Ask Prices	Ask Size	Market Maker
$49.95	1,200	$50.05	800	NSDQ
$49.90	1,000	$50.10	1,200	ARCA
$49.85	2,500	$50.15	1,500	EDGX

Step 2: Analyzing Market Depth

• Bid Side (Buy Orders):
  • A strong bid is visible at $49.85, with 2,500 shares. This suggests strong buying interest and potential support near this level.
  • Smaller bids at higher prices ($49.95 and $49.90) indicate moderate demand but less support if the price starts to drop.
• Ask Side (Sell Orders):
  • A large ask is visible at $50.10, with 1,200 shares. This suggests strong selling interest and potential resistance at this level.
  • The ask at $50.05 (800 shares) indicates moderate selling pressure immediately above the current price.

Step 3: Observing the Time and Sales Data

• Recent trades show $50.00 as the last traded price.
• Many small buy orders are executed, but large sell orders appear above $50.05, suggesting sellers are stepping in to push the price down.

Step 4: Making a Decision

Based on Level 2 data and market behavior:

1. Buying Decision: The trader sees strong support at $49.85 and believes the stock is unlikely to fall significantly below this level. The trader places a limit buy order at $49.90, hoping to capitalize on a potential bounce.
2. Selling Decision: The trader notices large sell orders at $50.10 and interprets this as resistance. If they already hold the stock, they might place a limit sell order at $50.05 to exit before the price faces heavy selling pressure.
3. Holding Decision: If the trader is uncertain about the stock’s movement or if the bid and ask sizes are balanced, they might hold and wait for clearer market signals, such as a breakout above $50.10 or a drop below $49.85.

Outcome

• If the stock price rises and breaks through $50.10, the trader might adjust their strategy to capture upward momentum.
• If the stock price falls and breaks below $49.85, the trader might place a stop-loss order to minimize losses.

Key Takeaways

• Bid Sizes and Ask Sizes: Help identify support and resistance levels.
• Order Placement: Allows the trader to anticipate price movements and set limit orders strategically.
• Real-Time Decision-Making: Combines Level 2 data with time-and-sales information for precise trading actions.

By using Level 2 quotes effectively, the trader gains deeper insight into market dynamics, allowing for informed and timely decisions.

Another Example of a Trader Making Decisions Using Level 2 Tape Reading

Scenario: A day trader is analyzing the stock ABC, which is currently trading at $100.00. The trader is observing Level 2 data and the time and sales tape to decide whether to enter a long position, short the stock, or stay out of the trade.

Step 1: Observing Level 2 Order Book

Bid Prices	Bid Size	Ask Prices	Ask Size	Market Maker
$99.95	500	$100.05	1,500	ARCA
$99.90	1,200	$100.10	2,000	NSDQ
$99.85	2,000	$100.15	800	EDGX

Step 2: Observing the Time and Sales Tape

• Recent trades show consistent buying at $100.00 and $100.05.
• However, there are frequent large sell orders being executed at $100.10.
• The trader notices that despite the buying activity, the price struggles to move above $100.10, suggesting significant resistance.

Step 3: Reading the Tape and Analyzing Behavior

Clues from the Tape:

1. Large Sell Orders at Resistance:
   • Large sell orders at $100.10 appear frequently but are only partially filled, indicating that sellers are defending this level.
   • These orders are replenished as they are consumed, suggesting the presence of a dominant market maker or institution (possibly the “Ax”).
2. Lack of Follow-Through:
   • Buyers at $100.05 are unable to sustain momentum, as their orders get absorbed by the large sells at $100.10.
3. Speed of Transactions:
   • The tape shows a slowdown in the pace of buy transactions as the price approaches $100.10, further indicating resistance.

Step 4: Making a Decision

Based on Level 2 data and tape reading:

1. Short Position Decision:
   • The trader identifies strong resistance at $100.10 due to the large sell orders.
   • They place a short order at $100.05, anticipating that the stock will fail to break resistance and reverse downward.
2. Stop-Loss Placement:
   • To manage risk, the trader sets a stop-loss at $100.15, just above the resistance level.
3. Profit Target:
   • The trader sees support at $99.85 (large bid size) and sets a profit target at $99.90.

Step 5: Monitoring Post-Trade

• If the price fails to break above $100.10, the trader’s thesis is confirmed, and the stock begins to move downward.
• As the price approaches $99.90, the trader observes if the large bid at $99.85 remains intact. If it does, they exit the short position to secure profits.

Outcome

• The stock fails to break $100.10 and drops to $99.85, allowing the trader to close the short position for a profit.
• If the stock had broken above $100.10, the stop-loss would have been triggered, limiting the loss.

Key Takeaways from Tape Reading

1. Resistance Levels: Large, persistent sell orders at $100.10 revealed strong resistance.
2. Buyer Fatigue: Tape reading showed that buyers were unable to sustain momentum, signaling a potential reversal.
3. Replenishing Orders: Repeated large sell orders at resistance indicated institutional control.
4. Quick Decision-Making: By combining Level 2 data and tape reading, the trader executed a short trade with clear risk and reward parameters.

This example illustrates how Level 2 tape reading provides real-time insights into market sentiment, allowing traders to spot potential reversals and act decisively.

Level 2 trading software is an essential tool for active traders, offering detailed market insights that can significantly enhance their trading strategies.