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are unable to see the buys and sells that the market markers are doing "behind the curtain." |
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Although altogether irrelevant for the occasional investor, it is quite relevant for the active trader. I mention it only to indicate one of the ways the individual trader, even with Level II, is at a disadvantage compared to the institutional players. |
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Level III: The Heavy Hitters |
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Most of the day trader software packages don't include access to the major league where only the heavy hitters are playing, and this layer of the game is taking place on what is called Level III. In this league, the players are trading large amounts of stock to each other on one of the electronic networks, Instinet. And they are doing it for slightly better prices than you will see disseminated on Level II. |
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The purpose of their using this Level III system is that they are able to buy and sell blocks of stock anonymously. They not only make money on the spread between the bid and the ask that shows up on Level II, they also "scalp" a better price in the stock they buy and sell to each other than the prices that go out to the public. So, they effectively make money two ways. And they do this repeatedly, earning a nice profit along the way. |
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None of this activity shows up in the Level II screen. It is possible for the individual active trader to passively monitor this Level III activity by paying $200 per month to the exchange. But the cost to be able to actively trade with live Level III is a cool half million dollars. Welcome to the big league, where membership has its privileges. |
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The Level II screen has different colors to represent the best price, the next best price, the third best price, and so on, both to buy and sell the stock. It identifies the name of each market maker at each price. When the stock is active, the colors change rapidly with each change in price. The colors make it easy for those viewing the screen to quickly assess how fast a stock is moving at each price. |
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When you watch Level II quotes, it looks something like a fast game of Pac-Man. You see two rows of prices on your screenone to buy and one to sell a given stock in varying amounts by market makers. As shares are bought by and sold to the public, the lumps of shares are "eaten up," and leave the screen. Each market maker waits in line for his or her turn to offer a lump of shares to be consumed. So, as each market maker's supply of stock is eaten, the next one in line comes to the head of the line. |
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