Learning to read level 2 quotes is mandatory for active penny stock traders, it helps them choose the best time to execute a trade. They provide a trader with useful information about a stock’s current price action. A level two quote shows who is trading a stock, the price they’re trading at, and the number of shares.
Orders are placed through market makers, electronic communication networks, and wholesalers. It is through this system that potential buyers are matched up with sellers in order to exchange the stock.
Market makers are the participants that provide liquidity to the markets. Because penny stocks rely highly on liquidity, market makers serve a vital role in the OTC and OTCBB markets. Without them, the market would not flow and change as it does. The bids from market makers make up part of a level two quote.
Electronic communication networks allow a place for anyone to trade through. They are systems that automatically match up interested buyers and sellers. Because anyone can use them, sometimes larger market makers will use them as a way to disguise their true intentions. They may use an electronic communication network to hide a large order.
Wholesalers work with online brokers to execute orders on their behalf. Wholesalers purchase a large number of orders from smaller firms, and some market makers, and execute the purchase or sale for them. The benefit for market makers is that their order can be disguised with other similar orders in order to influence the market.
Level II quotes show the size, bid and ask price, and origins of orders. Traders use them to see if they should buy, sell, or avoid a certain stock. Following “the Ax” is one way that quotes can be used to a trader’s advantage.
The Ax is the market maker that controls the action of a particular stock. Because the Ax is the dominant controller of the price action, following their trends usually leads to success for traders. Since they’re controlling the price, there’s a good chance they’re going to win and send the stock in a profitable direction for themselves.
Though they give insight into a current stock’s price action, some market makers will use tricks to disguise or hide their orders. By going through an ECN, they can mask large orders. They may know that traders are watching the bids and ask to see which market makers are trading, so by going through other avenues or firms, they can hide large trades.
Conversely, watching L2 quotes for market makers who are placing orders in between the bid and the ask price gives clues as the end of a strong trend. Big traders will often take a small loss in order to get out of the stock before it’s too late. For large institutions, a small loss is favorable to losing a lot to staying in too long as a trend is ending.
Brokers and websites offering free and paid Level 2 Quotes include:
- Interactive Brokers
- MB Trading
- TD Ameritrade
- Merrill Lynch