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Nasdaq Level II
By Bruce Mushial
We've all heard of NASDAQ Level II, but what
is it? How can it make your trading more successful? Are there
any shortcomings of the Level II system? Before we look at
the Level II system lets clarify what Level I and Level III
are since they sometimes come up. Even though Level II has
been available to investors for a handful of years now, Level
I is what most investors use. Level I is a display of the
best offer and best bid price for a stock. The offer or ask
price is what you have to pay for a stock and the bid is the
price you can receive if you sell shares of a stock. If you
go to the web site of Charles Schwab or CFSB Direct and get
a quote you will typically receive the current bid and ask
price for the stock. Level III isn't some as yet unreleased
enhancement to Level II, but rather a specialized Level II
system for market makers to be able to add or change information
to the entries they make to the system. So what is so fancy
about Level II? The Level II screen is displayed as two columns
of prices for a given stock. The right-hand column contains
a list of shares offered for sale and the left-hand column
contains a list of what someone is willing to pay for shares
of the stock. The lowest offer and the highest bid are at
the top of each column. This is called the inside market and
usually there is a small difference between the prices at
the top of each column. You might be able to buy CSCO at $19.59
but the best price you can sell it for is $19.48. The difference
is called the spread. The most important information on
the Level II screen is the quantity of shares available at
each price, and the fact you can see the price and quantity
of the orders lined up behind those at the top of each column.
If you have 2000 shares of CSCO to sell it is nice to see
what price you will get for them. The top bid may be at $20.00
for 500 shares, and then you might get $19.96 for the next
1000 shares and $19.94 for the last 500 to complete your order.
This may not seem that monumental but if you are trying to
sell 2000 shares of a thinly traded stock after-hours you
may see that you can only sell 700 shares at or near the highest
bid but you will have to accept 75 cents less if liquidate
the entire position. It can be very enlightening to see how
thin the markets are in some stocks. If you trade the same
stocks frequently you get to know what positions you had better
be out of by the close or hold overnight because you'll get
killed if you try to exit a position in the after market.
Where do the entries on the Level II chart come from? They
are the pending orders from the 9 ECN's (Electronic Communication
Networks) and from the approximately 500 market makers who
are registered to buy and sell NASDAQ stocks. Although not
the most important information on the Level II screen, each
bid and ask are accompanied by the abbreviation of the ECN
or market maker handling the transaction. Some traders carefully
watch at what levels particular firms have placed orders on
specific high-volumes stocks, believing these give hints of
where program trading may begin to occur. The nicest feature
of the Level II screen is it's not just there for your information
but it is there for you to place your trades through.
If you like an offer or bid that you see, just select the
entry and it's most likely yours. Different brokerage firms
work differently, but after you've selected the entry you
have 4 or 5 seconds to confirm the selection (usually with
just a second single mouse click) and you have become the
other side of the transaction displayed. In a fast trading
market you can lock-in a price as long as you are the first
person to select the transaction and confirm it in the required
time limit. With many "on-line" brokers you are
entering your transaction information into their fancy formatted
interface, which is then sent to an in-house trading desk
to be paired of with current inventory the firm owns or to
finally be forwarded to a market maker or ECN. With Level
II you see the actual offers from market makers and ECNs in
real-time and instantly decide to be the other side of the
trade presented. Many investors complain that they got a quote
and entered an order but it didn't get filled or the market
ran away from them too quickly, but with Level II you are
actually sending a confirmation to the NASDAQ computers that
the transaction has been completed. Some firms only provide
Level II to certain traders that do a minimum number of trades,
while others will provide it for a monthly fee. The active
investor that isn't using Level II should check with their
broker to see if it is available to them. Level II executions
can make your trading more successful.
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