Market Depth – Advanced

In this article we are going to be taking a look into advanced Market Depth data and how to use it to our advantage, a few things we will be touching on are;

• Market participants, their rolls and I.D numbers
• Level 3 data and why it’s used
• How to spot algorithmic trading
• Tricks and deceptions played on level 2
• Spotting institutional investors on Level 2

Market depth gives you a short term snap shot of the strength or weakness of the current sentiment of a stock, with that information you are able to produce an educated guess as to the direction the stock will travel. Keeping in mind there are many games investors like to play to give the illusion of larger strength or weakness a stock might have. We will be touching on those tricks and deceptions later in this article.

Market Participants

1. Market Makers (MM) – These are the players who give liquidity in the marketplace. This implies they are required to purchase when no one else is purchasing and offer when no one else is offering. They make the market. The Market Maker purchases and offers the stock to financier firms.

2. High Frequency Trading (HFT) – It is an electronic framework that uses computers to input a large number of buy and sell orders at very fast speeds. It uses complex algorithms to analyze multiple markets and execute orders based on market conditions.

3. Retail Traders – A retail trader/ investor is someone who buys and sells securities within their own personal account and not for a company or organization.

4. Institutional Traders – Are individuals that purchase securities within accounts for a group, fund or institution.

In our previous post about Market Depth – Basics we talked about level 1, 2 & 3, in this post we will touch more on level 3 as its important to understand why institutional investors use it and what they can see.

Level 3 – This is only used on the institutional level of trading, level 3 quotes grant an investor the ability to enter or change quotes, execute orders, and send out confirmations of trades. Retail traders do not have access to level 3.

Algorithmic  Trading

Algorithmic trading is a series of powerful computers running mathematical formulas making decisions to buy or sell financial securities on an exchange. Algorithmic trading represents around %70 of overall trading volume, in Canada house #13 (Instinet Canada Ltd.) is well known for its algorithmic trading.

Tricks and Deceptions

• Ice berg orders -Market makers can hide their order sizes by placing small orders and updating them whenever they get a fill. They do this in order to unload or pick up a large order without tipping off other traders and scaring them away. After all, nobody is going to attempt to push through a 500,000 share resistance, but if a persistent 10,000 share resistance is there, traders may still think it is a beatable barrier.
• Prop bid/sell orders –Prop bids are a form of market manipulation, these bids are placed just outside of the “buying zone” to create the illusion there is larger interest in purchasing the stock then there really is.  “Assume the highest bid price posted by a market maker for a stock that has been heavily promoted is $1.75. The stock promoter then gets his cronies to place bids through different brokerage firms for a few hundred shares at $1.70, $1.65 and so on. This layering absorbs some of the selling pressure and prevents the stock from falling sharply, while the appearance of a number of bids placed through different firms gives sellers the impression that demand for the stock is much greater than it is. This may cause sellers and short-sellers of the stock to rethink their strategy and back away from attempts to drive down the stock.” – Investopedia

Broker ID