Doc Maher discusses Level II quotes when trading NASDAQ stocks.
As you already know, volume can impact the price one receives if the order size is disproportionate to the average daily volume. This was covered in yesterday’s post along with the beginnings of how the NASDAQ Marketplace works. Today I will continue with that section which involves Level II quotes.
THE PLAY – Long Stock
TRADE FORMATION
On August 15 the trader entered the following positions (quantity was not disclosed):
Bought to open JOSB at $27.00 at 11:19 AM
Bought to open JOSB at $27.68 at 1:16 PM
Sold JOSB at 27.18 at 1:38 PM
The trade note stated:
Wow! I just gave back my profit! I doubled my bet at $27.67. I entered a market sell when the real time price was $27.30. It filled at $27.18. It looks like selling 2000 shares at once really hurt me and got me a bad fill.
MARKETPLACE and LEVEL II
One of the requirements of being a market maker on the NASDAQ system is that one must post prices where one is willing to buy and sell the security for which one makes a market. The buy price is called the bid and the sell price is called the ask or the offer. One must also post the size. This means how many shares one would buy or sell at the posted price.
When you enter a symbol to get a quote on a stock, you see the current bid and ask prices and the size of this quote. However, this quote could be a combination of two different market maker firms. This is because the “best” quote is all that is displayed to the general public. Best refers to the highest price one is currently willing to pay and the lowest price one is currently willing to offer. These are generally not the same market making firm. What you can’t see are the prices and number of shares bid and offered by other market makers that are not currently showing the most competitive or “best” quote – unless you have access to Level II quotes.
Before people start arguing for or against the usefulness of Level II quotes, please save those comments for another time. The only reason I am using Level II here is to clearly illustrate and explain how orders get filled.
At the right is a screen shot of Level II data for Microsoft. This screen is split into two parts, with four columns on each side. The first column for each part is the Market Maker code (MMID). The next column is either the Bid price or the Ask price. The third column is the size in hundreds of shares for its respective quote price. We will ignore the time column for this discussion.
At the top on the left, you can see INCA bidding $55.74 for 7 shares of MSFT. Remember that this 7 represents 700. On the right, ARCA is offering 400 shares at the same price, $55.74. These orders are at the top of the list because they are the “best” bid and ask prices currently available. This top line would be what you normally see as the bid and ask when getting a quote on MSFT.
Click the image to view more detail.
Below this line we can see a number of other firms that have bid and ask prices that are not as competitive, commonly referred to as “away” from the market. For instance FBCO is bidding $55.73 for 100 shares and CINN is offering 5500 shares at $55.75.
Since the best bid and ask are the same, what should happen here is that INCA should get 400 shares from ARCA at $55.74. This will not fill INCA’s order completely so INCA’s bid of $55.74 would stay the best but the size would be reduced from 700 to 300 (7 to 3). CINN would now become the best ask at $55.75 and it would move to the top. These prices and sizes move up and down very quickly throughout the day as the market moves and orders get placed, filled, and cancelled.
As I mentioned, many different firms may make a market in the same stock. According to NASDAQTRADER.com there were 67 different firms buying and selling MSFT for the month of July. The more firms that are trading a stock, the more competition there is to provide the customer with the best price. This adds to the stock’s liquidity.
MSFT has an average daily volume of 69 million shares. Not all of the firms traded the same amount of volume though; the top 15 traded the lion’s share. The lowest volume traded by one of these firms was BUCK (The Buckingham Research Group Incorporated) with only 350 shares in July.
As I explained more firms trading the stock should add to the stock’s “thickness” or liquidity. However, it’s even better if more firms share the bulk of a stock’s volume. This also makes for more liquid trading. If there are fewer firms, or if only a couple dominate the volume, you could see how that might make the stock less liquid. For JOSB there were 38 firms in July so it seems that liquidity would not be a problem.
In the next and final post in this short series I will talk about Market Orders and Limit Orders and what you need to know to protect yourself in these volatile times.
"Income Trader"
Doc's previous posts: Three Factors That Affect Execution Price and Three new tools: EPS, P/E, and PEG
Click here for a list of previous TradeKing All-Star blogs.
Nicole Wachs contributed to this post.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Jonathan F. Maher, PhD has a professional business relationship with TradeKing.
