beginner on level 2 few pointers please

[happyhero]

Hi I hope some one will have patience with me as I cant see how to benefit from level 2. My broker is barclays and provides level 2 free to me as I do enough trades to qualify. I have read up on level 2 on different sites but my own broker seems to offer it but no help on how to use it. If I understand right it gives me a live price and I understand that there is right and left which show the buys and sells and the best price is at the top. I see that there are other prices cuing up below, is that right?

I have watched these cuing up prices which I assume will work their way to the top but this has raised some questions; sometimes they never seem to make it to the top, so surely that means they tell you nothing. Also the prices on the left get smaller and smaller and the ones on the right get bigger and bigger as you look down the columns, so I cannot see how they both work there way up and maintain the spread and in any case the price will only be either going up or down and cannot satisfy both sides so what is going on here?

I realise my questions are probably very basic and maybe silly but I have googled away and can only find info telling you what level 2 shows but not how to use it and what it will do ie I don't know how to interpret the information to help me decide what action to take. I have read and read as people advise as I am self taught and trying to further my basic knowledge.

Is there anyone who has the patience to explain some basics on level 2 to me and maybe give me a few tips or pointers or links to kick me off, as at the moment I am not getting any benefit from it and would like to since i can see it. I am sure I must be able to improve on my current trading with a little bit of knowledge about level 2.

Any help appreciated.

 

[Jaydee]

Hi HappyHero

Ok, the orderbook view or Level 2 shows you the passive orders set in the book. Let's have a quick example with just one level to begin with - a stock (XYZ), I've made the name up but it doesn't matter.

XYZ:

10000 102 - 103 15000

The above is called the touch price - that is the best bid and offer avaiable for that stock at the present moment. 10,000 shares are being bid for at 102p - i.e. somebody (or more than one person) wants to buy 10,000 at 102. 15,000 shares are being offered at 103p - i.e. somebody wants to sell 15,000 shares at 103p.

Both the 102 bid and 103 offer are passive orders - they sit in the order book until an aggressive order (such as FOK, market, IOC, at best) hits the bid or lifts the offer.

So, say you wanted to sell 5000 shares at market - well, in this case you would be aggressive and 'hit' the passive 102 bid for 5000 shares leaving the touch price to change to 5000 102 - 103 15000. If you wanted to buy 10000 at the current market price, you would 'lift' the passive offer at 103 leaving the remaining 5000 shares at 103.

So, that's the touch, also known as Level 1. Now, let's get some depth - we'll keep things simple by only looking 3 levels deep. Same stock - XYZ:

1000 102 103 5000
2300 101 105 4000
8000 100 106 1000

So, the touch is 102 bid at 103 with 1000 shares on the 102 bid and 5000 on the 103 offer. However, there's also more orders beneath the touch price. You will see the bids get cheaper as you go down the book, the offers get more expensive as you go down the book. However, the best bid is always someone who will pay the most for something and the best offer is always someone who is willing to sell for the lowest amount.

All the orders in the book, because they are passive, may not get filled. Here we go, an aggressive market order to sell 1000 shares comes in and hits the 102 bid - the touch changes to 2300 101 - 103 5000. Another order comes in to sell 2000 shares at market hitting the bid, leaving the remaining 300 shares at 101. Now, some positive news comes out and traders start buying XYZ with very little aggressive selling sending the price to 111 - 113. Therefore, the offers are now being lifted but the orders originally bidding for 101, 100, etc don't get filled - they sit on the order book until they are deleted or the market does trade down at these prices again.

Another thing - what if the market was 110 - 111 and you wanted to buy at 107. Well, you could wait for 107 to be offered if the stock went down and aggress into the 107 offer (lift the offer) or you could put a passive order in the book to bid for however many shares you want at 107. If the price doesn't trade here, you get no shares and your order sits on the book until you delete it or it expires.

That's a fair bit to take in and I probably haven't explained it too well so ask if you still aren't sure.

Best

JD

 

[happyhero]

Hi JD thank you very much for your patience and help with my questions, much appreciated, your explanation is good but I still have a few questions.

I understand what you have said but using your example the top line is 1000 102 103 5000 which is a spread of 1 and I have noticed the spread mostly stays the same in any company so what if the offers on the right move up quick but the bids on the left hardly move, will it not end up that you could have 1000 102 106 1000 thus creating a spread of 4? I am sure this does not happen as I have not seen the spreads change like this. Can you explain this or what I am missing. Sorry if the answer is already in your explanation and I have not recognised it.

My second question is can you tell me how you would use the level 2 information to your benefit as I cannot see the benefit yet. I see the prices moving up but I also see new prices jumping in so that some of the figures below never work there way to the top. So if you cannot be sure they will reach the top surely it indicates nothing? Maybe an example of either a share you want to sell or buy would help to explain what information you would be extract from the level 2 to help you make the best trade.

I also see the 2 columns have several changing coloures, which change quite fast, whats this all about?

 

[Jaydee]

I understand what you have said but using your example the top line is 1000 102 103 5000 which is a spread of 1 and I have noticed the spread mostly stays the same in any company so what if the offers on the right move up quick but the bids on the left hardly move, will it not end up that you could have 1000 102 106 1000 thus creating a spread of 4? I am sure this does not happen as I have not seen the spreads change like this. Can you explain this or what I am missing. Sorry if the answer is already in your explanation and I have not recognised it.

The spreads can and do change like this sometimes. However, in a very liquid stock trading lots of volume you will find that people start to fill in the bids and offers before the spread widens up too much. For example, if the market was 102 - 106 as you said, a short-term market participant could offer 1000 for 105 and bid for 1000 at 103 hoping to get filled on both sides making 2 ticks in the process. For this reason, spreads in liquid stocks are often very tight. You may get large spreads in thin, volatile order book stocks like Rio Tinto - RIO

My second question is can you tell me how you would use the level 2 information to your benefit as I cannot see the benefit yet. I see the prices moving up but I also see new prices jumping in so that some of the figures below never work there way to the top. So if you cannot be sure they will reach the top surely it indicates nothing? Maybe an example of either a share you want to sell or buy would help to explain what information you would be extract from the level 2 to help you make the best trade.

For the types of longer-term trading I assume you are doing, the L2 display will be of limited value. It is more useful for either very large order placement or short-term trading styles similar to the method I described in the previous paragraph. Such trading styles are very difficult to do through a retail broker due to the profit from a short-term trade not being enough to cover commissions. That said, if you pay attention to the order book, you may develop a better sense of timing and understanding of the market mechanics - you may even be able to pick up momentum trade breaks from points of consolidation when you become used to reading the L2. Practice makes perfect but, just in case you want a bit of a guide, see this post from earlier this week:

http://www.trade2win.com/boards/trading-faq/39638-tape-reading.html#post514172

I also see the 2 columns have several changing coloures, which change quite fast, whats this all about?

They are simply changes to the prices and volumes. One colour will mark an increase, another a decrease.

Hope this helps.

JD

 

[Jaydee]

I see the prices moving up but I also see new prices jumping in so that some of the figures below never work there way to the top. So if you cannot be sure they will reach the top surely it indicates nothing?

Just to add:

That's correct, orders by themselves a long way from the touch may never get filled and, therefore, indicate nothing. Orders at the touch price or near to it also can indicate nothing - why? Well, it's because they can be deleted. Many orders are put into the book to hide a traders true motives or to influence a rival trader in making a bad decision. In this case the orders are called spoofs and they are deleted before they can be filled. You must learn what is real and what is not if you want to learn order book trading. However, if you are trading more long term, please don't concern yourself with the games short-term traders play - focus on longer-term goals and you won't get burned by them.

What are you're trading time scales? If you are holding a trade for more than 2 days, I wouldn't even use the level 2. It is, however, your choice but don't feel you have to use it just because it is available.

 

[happyhero]

Hi JD, thanks once again for all your help and advice and especially for your patience dealing with probably such basic stuff for you. I like to trade for shortish periods, ie I normaly expect only to hold a company for a few months but this obviously alters if it is doing well etc. I never really want to hold anything for a year or longer but this has happened. I would love to trade really short periods ie in and out in a day or 2, the same day would be great but I cannot seem to make enough profit quickly enough this way. I am looking at a few companies but spending more time on and experimenting with Redrow (RDW) at the moment as it seems to have enough movement on many days to maybe make 5% plus in a day but I am struggling and my knowledge is basic.

I would like to understand level 2 better and any other indicator etc (I use RSI to the best of my ability at present) that will help me. I feel any knowledge would help me. At the moment in this volatile time, it seems a struggle to make money no matter what I do, however I am looking for oppertunities to get in on something to make a quick buck. It seems staying in anything for any length of time at the present, you would stand more chance of losing any profit made in the short term. Recently I feel, how nice it would be just to have the odd day where I can walk away at the end of the day with some profit, those days seem rare now.

 

[Jaydee]

Hi Happy Hero

Short-term equity trading for a retail trader with slow connections and high commission fees is pretty difficult to become profitable in. A lot of the traders who trade for a few ticks here and there and get 400 fills a day have very fast connections and are some of the best in the business - these are the guys you are going to have to go up against. I don't want to put you off this but it could take you many months to a couple of years before you find a method which suits you.

If you really want to focus on the intra-day stuff, my advice would be to look into spread betting the indices (FTSE, Eurostoxx [avoid the DAX]) - if you have enough capital you could actually trade the index future itself though someone like GNI.

However, if you want to stick to equity products and trade short-term, try a stock which moves enough to allow you to cover your costs. Watch the order book and look for areas where you can almost 'feel' buying or selling pressure mounting. Something like BHP Billiton (BLT) I used to enjoy a fair bit, BARC is good too but you can't short the bugger at the moment. Also, start thinking about everything in terms of ticks - e.g. RDSB moves in penny ticks so if you have 1000 shares and it moves up 10p you have made £100 - costs. If you had 2500 shares and it moved against you 5p you would lose £125 excluding costs.

Level 2 will come to you with practice, just keep at it. Unfortunately, I can't tell you, 'do this and it will work' because trading isn't like that. You have to develop your own ideas and then put them into practice. There's no such thing as a quick buck in trading - only if you gamble and get lucky and the chances are you will gamble again and lose it just as quick. Don't get despondent and keep trying. It may take several years to become profitable.

 

[Jaydee]

I've just been having a look at Redrow and it seems like an interesting stock to trade on the more intermediate-term. I'd like to give you a couple of ideas here. However, I want to be careful about giving too much specific advice as what to do regarding trading this, as the landscape is dynamic and can shift on a daily basis. Advice I give one day may be irrelevent a couple of days later because the trade sentiment may have changed. This is why I suggested in my previous post that you have to develop your own ideas and put them into practice. Trade and then evaluate the method, evaluate your execution (both the close and open), enhance the method, enhance the execution, rinse and repeat the process - that, in my opinion, is how trading goes and how a trader becomes better.

Right, looking at Redrow, it has been in a steep long-term down trend since 2007. It has rallied recently over the last few months, following a stong upward trend. On the Fundamental side, Redrow builds housing estates and flats - not a good time for property at the moment so RDW may suffer for a while longer yet. Overall, pretty much bearish sentiment.

What about the UK market overall? Well it's not looking great and there is still a lot of uncertainty about the future of the World Markets, especially the property makets - it may possibly change with this US Bailout situation but nobody knows.

So, putting a plan together:

Since we don't know what the US Congress is thinking regarding the bailout, the trade should be defered until an announcement is made (I think they have until Friday) to see how the market reacts to the news. Aside from that, though, we may be looking for a short position in light of the small amount of basic analysis in the previous paragraphs. The volatility of the stock needs to be looked at so a sensible stop loss can be placed if the trade is wrong.

Let's have a look at the entry - you decide to enter a short position once the trend of the upward rally has broken (just an example idea for an entry). You notice the stock trades in a range of around 22p a day and, therefore, decide to set your stop to 22p. If you get stopped out it is for one of 3 reasons:

1) Your stop was too tight
2) Your entry was too late giving you poor position
3) Your short was wrong and the market actually continued upwards

If the trade goes well for you, you should look towards an exit. Try to figure out if the market is behaving normally. Is the down move still happening? Is it just rallying to continue moving downwards? Is it reversing?

However you finish the trade (for profit or loss) evaluate it afterwards. If you made a loss because you stopped out, figure out why you were stopped out. If you made a profit, did you run the trade for all it was worth or did you only take a small amount of the move? Continue to ask and answer these questions and imporve your methods and you will get there.

A couple of other things:

Don't get despondent when you lose trades. You should have no expectation that the trade will be a winner or loser. You only care that you do the right thing in either case.

Put a certain amount of money in your broker account - something you can afford to lose. Now, work out a way so you don't risk more than 1% on each trade while you are trying to develop your ideas.

Keep at it.

JD

 

[Davy]

I must say I like your style JD!

I've seen a few of your posts now and it's always refreshing to come across such consice wisdom.

Your advise seems to have Van K Tharp writen all over it. Is his material where you got your base level of knowledge from or is it just years of experiance in the market?

 

[Jaydee]

I must say I like your style JD!

I've seen a few of your posts now and it's always refreshing to come across such consice wisdom.

Your advise seems to have Van K Tharp writen all over it. Is his material where you got your base level of knowledge from or is it just years of experiance in the market?

- Thanks, I'm glad you liked it.

It's not from Van K Tharp as such as I only read his book a couple of months back and most of the trading books have the same advice - so I may have recycled some advice from the all the books I've read. Even though I'm a discretionary trader, I'm pretty systematic in my approach, so a lot comes from the Richard Dennis and Turtles like Curtis Faith ideas of how to evaluate yourself and trades.

My L2 advice comes from intraday DMA prop trading equities where everything is Orderbook and not chart focused -it's probably the hardest type of trading I have ever done (and ever will). Hence, why I was putting Happyhero off trading purely off a L2 - however, it is a very useful skill to have once you have spent the time with it IMO. It's always the last thing I watch before making a trade.

And the rest comes from me getting my backside kicked in the market and spending sleepless nights wondering why

 

[Davy]

I liked "The Way of the Turtle" too and I feel that I have a good base level of knowledge about the markets, psychology, risk management, key indictors etc.. but I'm wondering, do you know of any concise books about day trading systems in particular?

I've noticed on various intraday charts that identifying solid trendlines and suport/resistance levels can prove to be very profitable, but I'm having a hard time coming up with anything particularly systematic.

Thanx for your time

Also, what do you mean by discreationary trader?

 

[Jaydee]

A discretionary trader is one who trades at their discretion - i.e. they trade as and when they feel like it rather than following a rule based (set in stone) system. However, I still believe most discretionary traders are actually just loose systematic traders without realising.

As far as books go, I don't know any that will actually help find methods that work. Books have only served as a guidepost for me in evaluation and performance measurement - a lot of the books I have read are utter rubbish and I wish I hadn't wasted my time. Most of what I find works for me I got from trial and error. It gets to a point where everything you read is the same advice wrapped up in different packaging, so it has little value.

There are a lot of posts in the First Steps and General Trading forums which may be good for inspiration. Other than that, all I can recommend is keep trying and learning from your mistakes until something 'clicks'.

 

[eliau]

Jayedee-- Untill Somthing Clicks?

Why are you as a senior member acting like yu dont want to give info!!!

for all the nubies here:

before puttiong hard earned money here pls let me make this easier:

1. read the tape-- vadim graifer book!!!!!

2. you have to be in theta mind state to trade- biomechanical trader chapter (robert deel book).!!!!

3. study market internals-mastering the trade-jhon carter!!!!

4. Technical Analysis - all you have to know for day trading is MA's and Support and resistance.

All the best !! And luck to With god help

if somone needs help here- i am here

 

[eliau]

Oh if you want the books give me your email.

 

[timsk]

Jayedee-- Untill Somthing Clicks?
Why are you as a senior member acting like yu dont want to give info!!!
here

eliau,
Your comment suggests to me that you've not read the thread. Jaydee's advice has been absolutely top drawer throughout and he's obviously gone to a great deal of trouble to answer the questions raised very clearly and very comprehensively. As a 'T2W Advisor', I'd second his comments about the value of books. You can read all the books in the world and be an 'expert' in the theory of trading, but this will be of limited help when you come to do it for real. You may be an expert on football and passionate about the game - but that doesn't mean you're any good at playing it. Additionally, I agree with Jaydee that trial and error and experience are what counts in trading; finding out what doesn't work is as important as finding out what does work. And what works for me may not work for you - and visa versa.
Tim.

 

[raysor]

A discretionary trader is one who trades at their discretion - i'.

You may be right. But a discretionary client is one who let's his broker make dealing decisions without recourse to the client.

 

[raysor]

I realise my questions are probably very basic and maybe silly but I have googled away and can only find info telling you what level 2 shows but not how to use it
Is there anyone who has the patience to explain some basics on level 2 to me

I think you have to realise that the bulk of business is done by PROFESSIONALS and like poker the best players don't give away their hands. The SETS system was supposed to give more transparency & liquidity but it hasn't. You should learn about how the old jobbing system worked and this might give you a better insight. I don't mean to sound condescending and I commend you for wanting to learn the "rules" of the game, but the market, I suppose, is a continuously moving target. For example on a market driven stock you might, naturally, assume that the MM with the best bid or offer will be the best place to go. But a dealer with years of experience in the market will intuitively know he is not the best place to go.

 

[Jaydee]

I think you have to realise that the bulk of business is done by PROFESSIONALS and like poker the best players don't give away their hands. The SETS system was supposed to give more transparency & liquidity but it hasn't. You should learn about how the old jobbing system worked and this might give you a better insight. I don't mean to sound condescending and I commend you for wanting to learn the "rules" of the game, but the market, I suppose, is a continuously moving target. For example on a market driven stock you might, naturally, assume that the MM with the best bid or offer will be the best place to go. But a dealer with years of experience in the market will intuitively know he is not the best place to go.

When you say market driven, do you mean Order Driven or Quote Driven? It sounds like you mean Order Driven but you don't have to have active market makers in a purely Order Driven market.

 

[raysor]

When you say market driven, do you mean Order Driven or Quote Driven? It sounds like you mean Order Driven but you don't have to have active market makers in a purely Order Driven market.

Well I call it market driven, but Quote driven sounds good. Market driven is where the Market Makers (the "Market") are making the prices (Quotes). As I understand it (I'll get shot down again here, you are a clever lot!) there are three sytems in operation. Market driven (all market makers), Order driven (SETS) and SETSMM (both together).

 

[Jaydee]

Well I call it market driven, but Quote driven sounds good. Market driven is where the Market Makers (the "Market") are making the prices (Quotes). As I understand it (I'll get shot down again here, you are a clever lot!) there are three sytems in operation. Market driven (all market makers), Order driven (SETS) and SETSMM (both together).

Not trying to shoot you down, just making sure I know what you meant. That's right, the trading systems are as you said - there's a new one now called SETSqx which has intraday auctions at set periods of time and is quote driven for the rest. It's basically what SEAQ became.

I steer clear of quote driven markets - they aren't liquid enough and I'll only consider shares on those platforms if I wish to invest in a microcap stock (it would have to be a real diamond in the rough though ) Plus, as you said, the market makers know how to play the game.