By James Woolley
Many people who invest in the stock market pay a monthly subscription for access to Level 2 data. They may even be lucky enough to get this data for free in some instances. However although this data can give you a slight edge, it is not always that beneficial.
For those that don’t already know, Level 2 data basically lets you see the order book for any given stock. So you can see how many orders are waiting to be filled on both the buy and sell sides of the order book. Therefore you can see how much demand there is for a certain stock and see how many buyers and sellers there are at any given moment.
The trouble is that it is only really useful if you are trading short-term price movements. If there is a big imbalance on the order book with ten times more buys on the left-hand side, ie the buy side, than the right, then you would expect the price of the share to move up a couple of pence in the next few minutes or hours (depending on how actively traded the stock is).
This is great for those placing spread bets who can generate profits from such small price moves. However for share traders who are using a conventional broker, it is no good at all because you often need the price to move about 1% in your favour just to cover the stamp duty and dealing costs.
Similarly if you are a long-term investor it won’t be that useful because it doesn’t really matter about the short-term price movements that occur. It is the long-term price movement that you are most interested in. Nevertheless Level 2 data can at least help you with your timing of your entry point or exit point because this data may help you get a slightly better price if you wait a bit longer, for instance.
Another downside of using Level 2 is that because it is only a snapshot of the order book, you may enter a position based on this data and then find that the picture suddenly changes when a flurry of new orders come on to the order book later on. Unfortunately there is nothing you can do about this because there is no way of predicting the number of orders that may be placed at any time in the future.
So the point is that Level 2 is quite useful for determining short-term price movements in various stocks, but it is definitely not foolproof. It should really be used as a guide more than anything else, rather than a concrete trading signal.
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