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What Is Level 2 Trading and Why Is It So Important?

  • 12 mins read
level 2 trading

Trading is all about getting information and knowing how to interpret this data to find successful trades. If so, then you would think that the most crucial factor is the reliability and the format in which a trader receives the information.

Level 2 quotes are by far the ultimate market data source to get more detailed and complete information.

So, in this guide, we’ll explain everything you need to know about trading using the level 2 order book. We’ll also help you find ways to access level 2 data and explain the difference between level 1 and level 2 and level 2 and level 3. 

First, what is Level 2 Data?

Level 2 market data is an order book that gives retail traders and institutional players a more detailed set of information about the traded asset. Unlike the level 1 order book that shows the last bid prices and ask prices, level 2 shows the complete list of bid and ask, the market maker who placed the order, and the quantities (the size of the order).

In most cases, level 2 order boxes show around 5-10 best bid and ask prices, though, in some exchanges, you may get access to up to 40 bid and ask prices. To be able to use level 2 market data, a trader must have access to assets traded on an exchange. So, for example, when trading assets on a stock exchange, options, or futures contracts (commodities, forex, indices, etc.) – a trader can get access to level 2 data.

How Does Level 2 Market Data Work and How to Read Level 2 for Day Trading?

Level 2 is often perceived as a complex data service; however, knowing how to read and understand level 2 trading is actually very straightforward.

Simply put, a level 2 market depth order book shows the asset’s supply and demand offer in real-time. In addition, the vast majority of level 2 order books on different trading platforms look pretty much the same, so once you learn how to read and analyze level 2 data, you’ll be able to use it on any trading program. 

As you can see in the image below, the list of buyers is on the left side of the screen, and the list of sellers is on the right side. In this example, the first buyer offers to buy 600 shares of Intel at 29.33 via INCA market maker (Instinet). On the right side of the screen, the first seller is willing to sell 1000 shares at 29.36 via NFSC market maker. This is, in a nutshell, how level 2 market data works.

level 2 market data example

Moreover, the level 2 order book also shows a time sales box where you can see every transaction made on the specific market, including the price and quantity. If the transaction is displayed in red, it means that the order was made on the bid side. If the transaction is displayed in green, it then means that the order was made on the ask side. 

Note that the time and sales screen is an extremely valuable asset for day trading. Because the market is highly manipulated by market makers who place orders and suddenly disappear or use various automated order types – the time and sales will help you get facts and see only the executed trades.

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The Benefits of Using Level 2 Trading Data

Trading with level 2 data is a necessary trading tool for active intraday traders and scalpers. Almost every proprietary trader uses a level 2 order book to analyze the markets and place orders. Many of these traders will tell you that it’s impossible to day trade without using the level 2 data service.

Some of the key benefits of using level 2 trading data include:

1. More Information

The main benefit of using a level 2 order book is, obviously, the wealth of data and information related to the specific asset. While level 1 gives you the first buyer and seller, level 2 gives you much more information.

Additionally, level 1 could be highly misleading as many traders use a unique technique known as AX trading. By using this technique, a trader is placing 100 shares to sell, but the order book shows just one share (yes, it’s possible to do that). In the level 1 order book, you would think that selling pressure is rising (as you’ll see one share on the bid side), while in the level 2 order, you can see how buyers are eager to buy more as you can see the full list of buyers and you can identify this trick. 

In some scenarios, you can also know when a big institution enters a specific market. In commodity futures and bond futures markets, you can even identify when governments are entering and buying (or selling) in large amounts.

Furthermore, once you learn how to identify when a big player is entering the market, you can take a direction with the institution or big investors that have a significant position in the market or the other way. With level 2 data, there are many tricks and new ways to predict where the market might go next.

2. Easier to Know the Market Sentiment with Level 2 Market Data

Undoubtedly, as you have more information about the specific asset, you may better understand and feel the sentiment in the market. Just visualize it like a food market where buyers and sellers battle to get the best prices for their interests. Well, that’s level 2 market data – the ultimate tool for centralized exchanges to present a real sense of a market.

3. You Get the Best Prices

Another benefit of using level 2 data quotes is that you can negotiate to get the best available prices. In other words, you can change your orders, set subsequent orders, etc.

This is particularly important when you trade derivatives and options. For example, let’s assume you are trading the Apple stock 146 June call option contract with a level 2 market data, and the Apple share price (underlying asset) is trading at 146.14.

The orders placed in the market are based on the price movement of the AAPL share price, and thus, every price movement impacts the option price. In this case, let’s say the Apple stock price action is rising, and you placed an order to sell the option at 2.48 when the bid price is 2.41. Then, as soon as you noticed the price is rising, you can immediately change your order to 2.50, 2.55, or even higher to get the highest price.

How to Trade with Level 2 Data – Tips and Strategies

As we have previously mentioned, the level 2 order book is a valuable and effective trading tool. So, you need to get familiar with several techniques and trading strategies when using level 2 market data. Those include:

Low Liquidity Can Be an Advantage

A common technique among day traders is to find markets with low liquidity and set orders on both sides or get an execution on one side and switch to the other. It’s a risky strategy, but it may generate consistent profit over the long run if you learn how to master this technique.

By being completely neutral when using this trading strategy, you basically wait in the queue on the bid or ask side. Then, once the order is executed, you can place another order on the other side and wait again in the queue.

Scalping Trading

Scalpers typically try to capture minimal price movements – a few ticks, cents, etc. They use one-minute or five-minute charts and often make many daily transactions to collect small profits. 

To scalp trade, they must use level 2 trading data and various automated order types. As they usually buy and sell large numbers of shares, futures contracts, or forex lots – they use sophisticated market orders to open and close their traders without showing the number of shares they hold.

Trading Breakouts

Even though it is possible to trade breakouts with a level 1 order book, doing it with a level 2 data book is much clearer and more effective.

When you look at the price ladder with level 2 data, and you see the pressure building up or down to break the highest or lowest level of the day (or week/month, etc.), then you can easily find the right entry-level and make profits while trading the breakout. Ultimately, you can build a trading strategy entirely around this concept. 

Follow the Prints

As we mentioned earlier, the time and sales screen is a vital tool to understand the flow in the chosen market. If you know how to read it correctly and avoid all the false order placements made by market makers, you can find many trade entry and exit points.

For example, if you notice print after print of sell orders on the bid side, that means sellers are willing to sell the asset at any given price on the bid side. There’s no doubt that the momentum is bearish in such a scenario, and you’ll enter a short-selling position (or exit an existing long position).

Level 2 Trading in Different Markets

Generally, you can trade almost any asset using level 2 market data. As long as the asset is listed on an exchange, you’ll be able to get access to level 2 trading. But the benefits of using level 2 market data have a higher impact on some markets than others. 

Level 2 Option Trading

Level 2 options trading offers more flexibility in terms of how traders can trade options. In my view, if you are planning to trade options, the first thing you should do is to get access to level 2 options data. Even if you are not going to use level 2 as a trading strategy, it’s a must-have tool you need to trade options.

The main reason is that options are derivative instruments tied to the underlying asset. So, the option’s price often stays the same for several minutes or even hours. But the orders in the level 2 order book change constantly, and in many cases, you can use it to your advantage.

Level 2 Data in the Stock Market

As stocks and ETFs are traded on centralized exchanges, this is the easiest way to access level 2 trading. As a matter of fact, most banks and online brokerage firms offer level 2 stock trading as part of their basic packages. Furthermore, with a quick search, it is even possible to get stocks and ETFs level 2 data for free online. 

Day trading stocks, ETFs, and especially penny stocks using level 2 data is highly recommended. Most active Penny stocks trade on the OTC and have a low trading volume, meaning it is fairly easy to manipulate prices. For that matter, level 2 can be incredibly useful. For instance, when you notice an important market maker placing a large bid and the order flow is changing – it would potentially be a successful trade.

Here’s an example of what level 2 data looks like on a web page. Source: OTCMarkets.com

Level 2 Data in the Stock Market

Level 2 Data Futures Trading

The futures market is the most important and developed financial market worldwide. This is where commodities, metals, global indices, interest rates, bonds, and FX currency pairs are traded and shipped worldwide. So, being the most developed market, it is not surprising that you get access to level 2 data, meaning you can trade any asset listed on the specified exchange with level 2.

However, take into consideration that this service is usually costly. Assuming you’d like to open a futures trading account and get access to level 2 data, you need to focus on one market. Otherwise, it could be expensive as brokerage firms charge a high fee for providing level 2 data.

Level 2 Data in the Forex Market

Getting access to level 2 data in the forex market is perhaps the most complicated of all. The reason is that the forex market is decentralized, where there’s no exchange or physical location where traders buy and sell currency pairs.

Yet, if you wish to trade currency pairs with level 2 data, you can do it in the following ways: trade FX currency pairs via future contracts or open an account with an Electronic Communication Networks (ECN/STP) or Direct Market Access (DMA) forex broker. The first option requires a high initial deposit and typically high fees. The second option requires a lower initial deposit though you must check with the brokerage firm that they indeed offer access to level 2 data.

Level 2 Trading – Pros and Cons

Below, we mention some of the key advantages and disadvantages of using level 2 market data:

Pros

  • A level 2 market data shows more detailed information about what is happening in the market – easy to absorb the market sentiment
  • There are many strategies and trading techniques that are not available when using a level 1 order book
  • Easier to scalp trade assets with low liquidity – setting orders on both sides
  • Ideal trading tool for active day traders
  • The time and sales box is an extremely valuable tool

Cons

  • Less suited for long term investors
  • Many tricks of market makers may cause unexpected losses
  • Not available for all markets – CFDs, FX currency pairs (not futures), etc
  • Level 2 trading can be confusing when trading volatile assets

The Bottom Line

Most day traders incorporate level 2 market data into their trading setup as it gives them a clearer picture of what’s happening in the market. It is one of the most valuable tools as it provides more detailed real-time data for a given asset and ultimately can lead to various strategies and techniques to trade the markets. 

If you are planning to day or scalp trade, level 2 market data can open up a new door for you to the trading world. Of course, it does not guarantee success, but it will help you develop new ways to see the markets and understand how prices move and how market makers can push prices in a specific direction. 

FAQs

What is included in level II market data?

Essentially, level 2 data providers show the highest bid and ask prices, the market participants who placed the offer, and the size of the order (the quantity). These bid and ask prices are displayed in a ranking list from highest to lowest, meaning the best bid and the best ask prices.

Is there Level 2 trading in the forex market?

Basically, there is no level 2 trading in the spot forex markets. As we mentioned earlier, only centralized exchanges can give level 2 data as they have a list of all buyers and sellers. Yet, you can trade forex using level 2 market data if you decide to go via futures exchanges where they provide level 2 training data. 

Do you need Level 2 data to day trade?

Not necessarily. Many traders have made consistent profits without using level 2 market data for an extended period. But in my view, it is a unique tool that may help you understand the sentiment in the market. For instance, when you are looking at the level 2 order book and see many buyers and a few sellers, you can assume that the price will rise soon, and vice versa. 

How to find a level 2 trading platform?

Well, it’s not so easy, and some brokers charge a high fee for access to level 2 data. But first, to find a level 2 trading platform, you must find a brokerage firm that gives you direct access to a centralized exchange. Additionally, it’s better to focus on one market to reduce the cost of the trading platform. 

That said, some of the most popular (and low-cost) brokerage firms offering level 2 market data include TD Ameritrade, InteractiveBrokers, FirstTrade, Robinhood, Fidelity, TradeStation, NinjaTrader, etc. Additionally, many online banks offer to trade with level 2 data.

Can I find a level 2 trading demo account?

Only a few brokerage firms offer a free demo account with access to level 2 trading. Still, from our research, some of the best online brokers offering level 2 data on a demonstration account include Sterling Pro, TD Ameritrade ThinkorSwim, and IG Markets.

What is the difference between level 2 and level 3?

Brokerage firms offer two types of DOM (depth of market) – level 2, also known as L2, and level 3, known as L3. There’s not much difference between the two except that level 3 shows a long list of buyers and sellers than what a trader will get using level 2. The most significant benefit of using level 3 is predicting and placing stop orders and taking profit orders. 

Can you trade CFDs with Level 2 data?

Theoretically, it’s possible, but you cannot really trade CFDs with level 2. Some CFD brokerage firms give you access to level 2 data, although the CFD contract has level 1 data only. You can use the level 2 data to make trading decisions and analyze the market; however, you cannot place orders and see them in the order book. This is because CFDs are derivative contracts traded outside exchanges and usually involve just two parties (a trader versus the broker or other traders in the network).

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