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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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