Lecture Notes: Mastering Tape and Level Two Reading for Trading

Introduction

• Objective: Understanding and improving the ability to read level two data in trading.
• Challenges: Initial difficulty in connecting changing numbers to market events and future predictions.
• Importance: Reading level two and tape provides a trading edge.

Setup and Importance of Level Two

• Markets: Applicable to various markets (e.g., S&P 500, Bitcoin, commodities, individual stocks).
• Broker Platforms: Different brokers have different default displays for level two.
  • E*TRADE: Cleaner display for visualizing market depth.
  • Thinkorswim: Not user-friendly for over a decade.*

Understanding Level One vs. Level Two

• Level One: Shows best bid and offer.
  • Example: Bid $505.20, Offer $505.21.
• Level Two (Market Depth): Shows market makers, prices, and share sizes.
  • Example: NSDQ with order size 600 shares, 1-cent spread.

Reasons for Selling on the Offer

1. Iceberg Orders: Selling a larger position hidden behind the displayed order.
2. Rebates: Exchanges like NASDAQ pay small rebates for selling on the offer.
3. Best Price: Achieving the best price, though it requires patience.

Visualizing Market Depth

• Color Coding: Differentiates between price tiers.
  • Example: Green for first level, Red for second.
• Purpose: Easier differentiation of buyer and seller stacks, indicating supply and demand.

Time and Sales Pairing

• Purpose: Provides context to whether orders are being placed or are static.
• Focus: Primarily on the ask price, with peripheral monitoring of tape for red (bid) and green (offer).
• Hidden Sellers: Identifiable when large buy orders do not move the price.

Trading and Market Dynamics

• Indicators: Level two alone is not an indicator; must be paired with chart patterns.
• Context: Large sell orders near resistance points (e.g., whole dollars) are common.
• Trader’s Insight: Experience and intuition play a crucial role in interpreting level two data.

Practical Application

• Visualization: Changing level two display colors for clarity.
• Pairing with Tape: Ensures complete market picture.
• Interpretation: Recognizing patterns, such as churning, that indicate resistance.

Conclusion

• Steps to Mastery:
  1. Change color settings for better visualization.
  2. Pair level two with time and sales for context.
  3. Train focus on the most informative aspects: ask price, bid spread, and large orders.
• Trading Strategy: Combine level two data with chart patterns for a strategic edge.
• Risk Management: Trading involves risk; results vary.

• Next Steps: View related episodes for deeper insight into tape and level two reading.
• Reminder: Trading is risky; utilize strategies with caution.