Day traders use a variety of market data to make their trading decisions, typically known as “Level 1 and Level 2 market data.” This data includes information about current prices and recent trades. Level 2 data provides more information than Level 1 data. Traders decide which type of market data they need for trading and then subscribe to that data through their broker.
Level 1 Market Data
Basic market data is defined as Level 1 data. Level 1 data provides all the necessary information for trading in most chart-based trading systems. If you are trading using a price strategy or an indicator-based strategy, Level 1 data is all you need. Level 1 data includes the following information:
- Bid Price: The highest price at which someone is willing to buy the asset
- Bid Size: The number of shares or contracts that people are trying to buy at the bid price
- Ask Price: The lowest price at which someone is willing to sell the asset. It is also referred to as the “Offer Price”
- Ask Size: The number of shares or contracts being sold at the ask price
- Last Price: The price at which the last trade occurred
- Last Size: The number of shares or contracts involved in the last trade
Speculators, or traders who trade based on changes in how bids and asks are presented by other traders, use Level 2 data which provides multiple levels of bids and asks.
Level 2 Market Data
Level 2 data provides more information than Level 1 data. Primarily, Level 2 data not only shows the highest bid and ask but also displays bids and asks at other prices.
- Top Bid Prices: Displays the top five to 15 prices at which traders are willing to buy the asset and have placed an order for it. This means you not only see the current bid but also all bids that currently fall below it. In actively traded stocks, there are usually bids every $0.01 below the current bid, and in actively traded futures, there will be a bid at every tick below the current bid. If there is a gap between the current bid and the next one, this typically means that the stock or contract may have a wider spread between bids and asks compared to stocks that have bids or asks at every visible price level.
- Bid Sizes: The number of shares or contracts that people are trying to buy at each bid price.
- Top Offer Prices: Displays the lowest five to 15 prices at which traders are willing to sell the asset and have placed an order for it. In actively traded stocks, there will be offers at every $0.01 above the current ask, and in actively traded futures, there will be offers at every tick above the current ask.
- Offer Sizes: The number of shares or contracts available at each offer price.
Level 2 market data provides the additional information needed for trading based on the changes occurring in the bids and asks. Some traders like to monitor the number of shares being bid for against the number of shares being offered for sale, which may indicate the more eager or stronger side and could predict the short-term direction of market prices.
This strategy is combined with monitoring recent trades. If most trades are happening at the bid price, it suggests that prices may decline in the short term, while if most trades are happening at the ask price, prices may rise. These methods can also be combined with chart-based strategies.
Is known
Level two is also referred to as the “order book” because it displays all the orders that have been placed and are waiting to be filled. An order is filled when someone is willing to trade with someone else at the same price. Level two is also known as “market depth” because it shows the number of contracts available at each of the bid and ask prices.
Data Availability and Pricing
Market data comes from the exchange that offers the market. For example, the New York Stock Exchange (NYSE) provides level one and level two data for the stocks listed on the NYSE. Day traders receive market data through day trading brokers. Level one and level two data is available for futures and stocks. Some forex brokers also offer level two data, although not all of them do.
Level two data costs more than level one data for stocks and futures. Some brokers may offer all market data for free, but they typically charge higher commissions to compensate for that. For forex brokers that provide level two data, it is usually not charged.
Frequently Asked Questions (FAQs)
How do you use the order book for trading?
The detailed data about trading orders can help you make trading decisions. How you use the data depends partly on your trading strategy, but generally, the order book gives you more details about the strength and volume of trading orders. For example, if there are more orders on the buy side than the sell side, this indicates a bullish signal and can increase your confidence in bullish trades.
How do brokers profit from the bid-ask spread?
Brokers and other market makers profit from the difference between the bid price and the ask price, also known as the “bid-ask spread.” Buyers pay the bid price, sellers receive the ask price, and market makers keep the difference. The profit may be half a cent or two cents, but market makers do this thousands of times a day.
Source: https://www.thebalancemoney.com/order-book-level-2-market-data-and-depth-of-market-1031118
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