Video Synopsis 

In this video: The most effective traders are able to consider multiple variables in parallel … The more information you have, the smarter your trading decisions will be.

Level 2 is like an ongoing ledger of buyers and sellers and the prices they’re willing to pay … Looking at this data can help you determine entry and exit points. 

In this lesson, Tim guides Matt through the basics of Level 2 — what it is, what the information means, and how to use it to inform potential trades. 

Throughout the conversation, you’ll see several key points highlighted. To further your education, you can reference your “30-Day Trading Starter Kit” guide. Once you’re ready, complete the workbook assignments and quiz for today. 

Several common stock market terms were mentioned — they’re highlighted in orange text. You can find the definitions in the “30-Day Trading Boot Camp Glossary.” 

Have fun! These lessons are meant to enrich your trading … It’s a lot of information but it will begin to click over time. Laying this foundation of knowledge is so important if you want to be a trader for the long haul!

Level 2 Overview: Understanding Market Depth 

Matt Monaco:

We’re back again. We’re going to focus on Level 2 — The importance of it, what it shows, and why you need it on top of a basic chart, which is considered level one. 

I’m going to pull up a screenshot here of StocksToTrade. Could you give us a basic overview of what this Level 2 box is? What are the different sides, why is it different colors? What is this showing us?

Tim Sykes:

Sure. On the left side, these are the bidders. These are people who are trying to buy the stock. 

You can see there are three bidders at $23.40. They’re offering the highest price to potentially buy the stock. That’s why they’re in green versus the next offer, which is $23.34, so that’s not quite as high. The $23.40s are first in line to buy if the stock comes down to $23.40.

On the right side are the sellers. And in the green box, you see three sellers at $23.63 and $23.64. So this is the bid and the ask, and the difference between them is the spread. 

The bidders are trying to buy the stock at $23.40. The ask is people trying to sell the stock at $23.63.

It’s no different than if you go to some auction for artwork and people are bidding for the artwork.

Say they want to bid $5,000 but the artist wants $7,000. That’s what the bid, the ask, and the spread are. And a little further on the right is the time and sales. 

The last traded price was $23.41, then it was $23.50. So between the bid in the ask, that’s where the transactions are.

And sometimes the transaction is on the ask. If somebody initiates the trade and they want to buy right at the price that the sellers are asking … or somebody wants to sell it at the bid, that’s what the $23.41 is. 

Sometimes you can negotiate in between. So if you don’t want to pay the ask price, you might want to put in a bid of $23.50. And that way, yes, you’re above the $23.40, but you’re not quite willing to pay the $23.63.

Key Point: Level 2 Can Help You Determine Entry and Exit Points

Level 2 gives you insight into what prices buyers and sellers are looking for with particular stocks. Among other things, this can help you determine entry and exit points.

And then there’s also the size on the ask. You can see each of the asks has a size of 100, and on the bid, you see 300, 500, and 500. 

But the difference is, aside from just that’s the position size that they’re trying to buy or trying to sell, you can also mask your order. 

So even though someone might be looking like they’re going to sell a hundred shares at $23.63, for all you know that might be a 10,000 share order.

Brokers now offer the opportunity to mask it, so you can’t really trust the size. For me, I don’t even trust just the bid or the ask because people can put in fake orders.

And then when they’re getting executed they pull the order. They’re just trying to play mind games with you to make you think that there’s more support and more bidders versus there might not really be a bid. And they just want to make it seem like there’s a bid.

I’m much more interested in the trend. So I use Level 2 compared with the actual stock chart. And as I’ve been saying, I like stock chart patterns and I want the Level 2 to kind of concur with the pattern. 

If a stock is breaking out I want the Level 2 to be strong. I want there to be a lot of bidders. I don’t want there to be a lot of asks. If there are some big sellers I want the bidders to kind of chew through the ask. 

What I often say is that sometimes when a stock can’t break out it’s because there’s a wall of sellers.

And let’s say $23.63 was an important point on the chart — in this example it doesn’t really matter — but let’s just say in a hypothetical example, $23.63 is the three-month high…

If there are 10,000 shares trying to be sold there and there’s no budging, it’s like the wall that will never break versus if it’s a three-month high and it’s gradually getting chewed through. If it goes $23.63, then $23.64, $23.70, that’s a technical breakout.

I like to buy breakouts, but I want the chart to be a breakout. I want the Level 2 to be a breakout, and I want it to be convincing. 

Sometimes you just get a breakout by a penny or two, and then look at this. We have sellers in the red at $23.64, $23.65, more sellers at $23.65. And it looks like actually a pretty big seller of 1,405 shares at $23.65 in the yellow. 

Every single penny, there are sellers higher. The best breakouts, the best stocks, when they break through a key level, they just can really explode and you don’t really have to worry about sellers every penny higher.

Key Point: Compare Level 2 to the Chart

Tim doesn’t execute trades based on Level 2 alone. He uses it to confirm the trend he sees on the chart.  

Matt Monaco:

Yesterday we talked about different order types. When you personally are buying and selling, do you put a limit order on the ask? Do you try to bid to get in, what are the benefits, drawbacks?

Tim Sykes:

Yeah, good question. I always use a limit order, first of all. I never want a stock so badly that I’m going to put in a market order because a market maker can literally just give you whatever price they want. 

Even in an orderly market if you use a market order, they might just screw you. So if you look at the MM IDs on this Level 2, you see EDGX, NSD, NSDQ, and ARCA on the left side, those are on the bids.

On the right side, you see EDGX, NITE, EDGA, NSD, DATS, and ARCA in red. These are all different market makers that you route orders through. 

I like putting in a limit order at the current ask if I’m trying to buy. If it’s a fast-moving stock, if a stock just had news, I might give that limit order a little wiggle room.

If I was trading a stock where I saw the ask at $23.63 but they just announced a big contract with Google, I might recognize that it probably will blow through $23.63 very fast. So I might put my limit trying to buy let’s say 500 shares with a limit of $23.70.

You want to give fast-moving stocks a few extra cents padding just to try to make sure that you get executed. But you don’t want to just get it at any price.

If there’s a fast-moving stock and the stock is at $23.63, and I want to buy the stock because I think it’s going higher … I’m not going to put my limit at $24 because that’s 35 cents per share higher. That’s too much. So I want to give it a few cents padding, but not a huge amount.

And then if I’m trying to sell, again, it’s why am I selling? Is the stock failing to break out? And if it’s a fake-out breakout, I need to get out before other people realize that it’s a fake-out. Like I said, I’m going to give it a little padding. 

So if I was trying to sell this stock at $23.40, I might put my sell order at $23.35. 

If the FBI is raiding their headquarters — which is possible because a lot of these penny stocks are pretty sketchy — I don’t care whether I get out at $23.40 or $23.35.

I might put my limit at $23 if there’s breaking news that’s really bad, and I just want to get out before other people see it.

So you have to determine how fast is the stock moving and why you’re getting in or out for specific reasons. And that way you can determine your position size. You can determine your padding. But always use limit orders. Never use a market order.

Key Point: Never Use Market Orders — Always Use Limit Orders

If you place market orders, your trade will be executed at the best possible price — for market makers. To ensure that you get a price that matches your trading plan, it’s always best to place limit orders.

Matt Monaco:

Does Level 2 matter more or less in the different types of markets, like OTC versus listed stocks? Do you take it into consideration?

Tim Sykes:

100%. I love OTC stocks because they’re less choppy. OTC stocks don’t trade premarket or after hours by and large, so a lot of the orders pile up. 

Let’s say an OTC company has good news overnight or right before the market closes. If anybody sees that news and wants to buy anytime in the next day, all of those buy orders pile up and try to get executed right at the market open at 9:30 a.m. 

This usually creates a gap up or a morning spike as the market makers like to spike this stock when there’s say 200 different people who want to buy and only seven people who want to sell. That’s versus Nasdaq or other exchanges where they trade pre-market. They’re usually more liquid. They’re easier to get executed.

Even if you put in an order on an OTC stock, you might not get executed for a few minutes. It’s a much smaller exchange, and that can lead to good and bad. 

The good thing is if a stock does have good news — if there are a lot of buyers — it pushes the price up. And if you’re already long, it’s just like surfing. You’re riding a wave of buyers. 

But it’s bad if you’re trying to sell into a panic and you can’t get out because everyone else is trying to sell too. So you have to think about the differences between Nasdaq or listed stocks and OTC.

Matt Monaco:

In the news, you hear a lot about high-frequency trading and algorithms. Is there any way people can see this in Level 2? Do you care about those?

Key Point: Conspiracy Theories and Fishing in Small Ponds

According to Tim, it’s easy to get lost in the minutiae of speculating on Level 2 information … Don’t lose sight of your goals. Level 2 is only a piece of the puzzle with trades — not some secret code to crack.

Tim Sykes:

I hear conspiracy theories all the time. You never really know who’s behind any order. Like I said, they can mask the order size. Most of the small stocks that I trade, they don’t. No one on Wall Street really cares about penny stocks or OTC plays, so there are very few big traders. 

There are very few algorithmic traders. That’s more for bigger companies. And again, this is why I like fishing in my small pond instead of the ocean that’s Wall Street. I don’t want to compete against big hedge funds and their algorithmic trading and big money. 

I like competing against idiots. With penny stocks, there’s just not a lot of competition. You’re trading against mostly average people — a lot of financially naive people who think that the penny stock is the next Microsoft, which it never is.

Matt Monaco:

Awesome. Well, that’s all I had today for Level 2. Thanks again.

Tim Sykes:

Cool. See you tomorrow.