What is Level 2
Level 2 is a subscription-based service that provides real-time access to the NASDAQ order book. The service provides price quotes from market makers registered in every NASDAQ-listed and OTC Bulletin Board securities. The Level 2 window shows the bid prices and sizes on the left side and ask prices and sizes on the right side.
BREAKING DOWN Level 2
Level 2 provides users with depth of price information, including all the available prices that market makers and electronic communication networks (ECN) post.
Level 1 offers enough information to satisfy the needs of most investors, providing the inside or best bid and ask prices. However, active traders often prefer Level 2 because it displays the supply and demand of the price levels beyond or outside of the national best bid offer (NBBO) price. This gives the user a visual display of the price range and associated liquidity at each price level. With this information, a trader can determine entry and or exit points that assure the liquidity needed to complete the trade.
Price movement on Level 2 is not necessarily an actual reflection of the recorded trades; Level 2 is just a display of the available price and liquidity. This is an important distinction because high-frequency trading programs frequently adjust Level 2 bid and ask prices violently to shake the trees and panic onlookers despite the lack of actual executed trades. This practice is common in momentum stocks.
Level 2 and Reserve and Hidden Orders
Many ECNs, which are the automated systems that match buy and sell orders for securities, offer the ability for traders to post reserve orders and hidden orders. ECNs generally display the best available bid and ask quotes from multiple market participants, and they also automatically match and execute orders.
ECNs offer a reserve order option, which is composed of a price and display size along with the actual size. This order only shows the specific display size on Level 2 as it hides the true size of the entire order.
Hidden orders, which are an option where investors can hide large orders from the market on the ECN, function in a similar way but are invisible on Level 2. This allows for more discretion in determining prices. The best way for users to determine the status of reserve or hidden orders is to check the time and sales for trades at the indicated prices.