author : Clem Chambers

level 2 Articles

by Clem Chembers



Get The NASDAQ Level 2 TotalView Trading Edge

When knowing the bid and ask is not enough, Level 2 electronic order books like NASDAQ TotalView can give retail traders the tools to succeed.

There is no such thing as too much information when it comes to investing and trading. On a level playing field, if used in trading, our money will simply earn a little more than if it were parked in a certificate of deposit. Not many of us would go to the expense and trouble of speculation if that were the case, and for every trader happy to live without alpha†, there are a thousand who would choke on the prospect.


However, of those thousand hungry traders, more than half are likely to end up with less than alpha, and many will end up worse off than if they had put their cash in a sock. There are several reasons why trading can be worse for your wealth than buying a CD. First, trading tends to be a game of winner takes all. In trading, there is no such thing as "enough," and that means the gains go to the winners - often in big lumps - while others are left, at best, with the crumbs.

This is because in reality, no trading environment is a level playing field. So many variables are involved in trading that it is in effect an arms race, and the losers in this preparation for battle end up ceding to the parties with an edge. An edge is all it takes to make the difference between success and failure, and when traders use big positions to capture tiny but regular gains, that critical edge can be minute.

Stock buyers are familiar with the concept that delayed price quotes are not good enough. These days, no one would consider it prudent to buy a stock off of a 20-minute delayed price, yet today, Level 1 is as obsolete as 20-minute delayed data because the real action in the market is going on in Level 2 data.

Level 2 is the core of any market, and even those markets still driven by humans have their own version of Level 2. Level 2 is the next level of key information that sits below the bid and ask; it is a list of all the outstanding buy and sell orders that can be accessed by a trader who wants to buy and sell.


NASDAQ's TotalView order book (Figure 1) is the virtual representation of tumultuous pits like the CME or the stately commodity "rings" of the London Metal Exchange (LME) or the old market makers of yore.

Essentially, a market is its Level 2, and for NASDAQ, its TotalView product is the ultimate view on the vast liquidity that drives this market. If trading without Level 2 is like driving at night with your headlights off, trading Level 2 on NASDAQ without TotalView is like driving at night with only your parking lights on. TotalView shows the most complete state of the market for any stock on NASDAQ and is indispensable to any but the most trenchant buy & hold investor.

According to NASDAQ, TotalView is twice as fast as Level 2, has 22 times the liquidity on display, and three times the liquidity on display within a nickel of the inside. Because of this, however, TotalView is a monster of a datastream and it is not surprising that while NASDAQ Level 2 is widely available, TotalView can be acquired only from a select number of suppliers.

One of the important features of TotalView is that it displays anonymous interest and interest by participants below their best prices. This creates a clearer picture of order flow and liquidity trend, and where pools of liquidity lie. This information is missing from older-style Level 2, and while TotalView can be valueless from moment to moment like with most precious data, when big opportunities come by, this tiny edge can be the difference between profit and catastrophic loss.

While it is easy to say how powerful a tool is, it is harder to give concrete examples of exactly how a tool like TotalView can help a trader. As such, here is a simple example. Imagine a situation where a major stock is tanking, for whatever reason. Such a situation represents the kind of opportunity where a trader can make his payday. At some point, however, the stock will reverse, and the resulting bounce can wipe out profits and inflict serious losses on the trader who is short. Using TotalView allows you to see the book activity and get a feel for how trading is affecting the price. If the price is being driven down by small volume hitting the ask, that underlines the stock's weakness and indicates that the plunge will continue. Likewise, a sudden firming on the ask - with sell orders being taken without a downward price movement - suggests that a price level is forming.

This interaction between passive buying and selling and active buying and selling is key to judging this kind of "fast market" action - something barely visible on the bid and ask or the charting equivalent. However, with TotalView, a clear picture of the order book as it builds on the bid and ask gives a full picture of supply and demand on the buy and sell side of the market.

Markets are about trades and order flow; the former is well understood and well covered by Level 1. When the bid or ask is hit, a trade is printed. A trade hitting the bid is a sell and a trade hitting the ask is a buy. Trade-weighted transactions are the backbone of much trading, and this is summarized in the VWAP (volume-weighted average price). The opposite side of this coin is the flow, which is the polar opposite of the trade report; it is the order flow that sits passively on the order book waiting to be hit.

While anyone can see the trade prints, only a TotalView user can get a full picture of the passive order book flow. Flow is an exciting edge for traders, as there are not only two kinds of flow - an insertion of a bid or ask order - but also the opposite, a deletion of a bid or ask order unexecuted. Unlike trades with a two-dimensional buy or sell, the order book flow is four-dimensional. If it weren't bad enough to trade only two out of the six order book dimensions, while everyone is watching the trade record, only a select group of traders are watching the order book flow. As such, the advantage of trading with TotalView is further compounded.

Returning to the earlier example of trading a collapsing stock, now imagine watching a TotalView screen as the price falls away. In addition to observing the effect of trades hitting the book and the buildup and collapse of the bid and ask, you can also summarize the insertions of orders entering the bid and ask queues and their corresponding deletions. Not only is this a complete picture of the market at and around the price, it is a clear view of the market beyond - a vital territory when a market is swinging wildly, at just the moment when a trader can make or lose the most. What's more, while a trader using Level 1 can see trade numbers going through, the TotalView trader can see the volume of orders entering and leaving the market beyond the tiny world of the bid and ask. This opens up visibility of action in the vast pools of liquidity beyond the immediate price.

So there's a simple example of several important edges that a trader using TotalView will have over other traders without it. Clearly, while it is hard to imagine that equally skilled traders competing in such an event for the trading dollar would come out even if one had TotalView and another didn't, there is yet another level to TotalView that any serious trader would immediately grasp.

All traders look for the "philosopher's stone": the trading edge that will bring them the huge profits that most likely lured them to the market in the first place. While backtesting the time series may bring about a startling revelation, the fact is that a million traders have trampled the ground already, sifting and searching an infinite permutation of ideas to find that same thing. If these opportunities exist (and I can tell you from practice they do), then they are not, in my experience, to be found far behind the leading edge of trading technology. It is only on the frontier of trading that the unexploited opportunities lay to be found by the adventurous and determined. Today, this frontier is mapped on the NASDAQ by TotalView, and for now, it is by and large an underpopulated terrain filled with promise.