Supply and demand drives the price for everything in the marketplace. In today’s article, I’m going to be explaining how you can see the supply and demand for any stock using a service called Level 2.
Basics of Supply and Demand for a Stock
Before we cover what Level 2 is, we first have to understand the basics of the supply and demand for a stock. What many people don’t realize is that when you are trading there is ALWAYS another person on the other side of the trade. For example, if you want to buy 200 shares of Facebook at $134 dollars per share then another person is selling you those shares. You are betting that the stock will go up and they are betting that the stock will go down. In every trade there will always be a winner and a loser.
The bid for the stock is what YOU, the trader, can currently SELL the stock for in real-time. The ask is what YOU, the trader, can currently BUY the stock for in real-time.
- Market Maker
Market Makers provide liquidity for the markets. There is a market maker for each stock and they facilitate trading by buying and selling shares to keep the market for the stock running efficiently. In contrast from you as the retail investor, market makers BUY on the bid and SELL on the ask.
When people talk about size, they are referring to the supply and demand currently for the stock. When you place an order, it is routed to one of the exchanges. The bid size is the number of shares being offered for purchase at a specified bid price that a buyer is willing to purchas. For example, if you had 200 shares of Facebook and wanted to sell them at market price, then your order would be routed to the exchange with a Bid size of 200.
- Level 1
Level one quotes are simply the currently bid and ask for a particular stock in real-time. A typical view of level one can be seen below.
Notice how we see that the size is represented as 600×300.
This means currently there is 600 shares on the bid (demand side) and 300 shares on the ask (supply side)
**Important Note** When the Bid size is greater than the ask size then we can expect an increase in the share price for the stock. Remember, the bid size is the demand side, so the more demand relative to supply, the greater likelihood in increased share price!
Level 2 is a subscription based service that provides real-time access to the NASDAQ order book composed of price quotes from market makers registered in every NASDAQ-listed and OTC Bulletin Board securities. It’s basically Level 1 on steroids. Looking at level 2 data, you can see an in-depth view of all the current orders out for a particular stock, the size of those orders, and what exchange they are being routed to.
The bid price (demand price) are on the left and the ask prices (supply price) are on the right. You can see how each price has the size of shares listed next to it. From looking at level two data you can see all open orders for a particular stock and how many shares each order has been placed for.
Advantages of Looking at Level 2
As I mentioned previously we know that if there is more bid size than ask size, we can expect an upward price movement of the stock and vice versa. One other advantage of looking at level 2 is to see where there could possibly be some major resistance in stock price by having many orders out for a particular price relative to demand. Take a look at the picture below to see if you can spot where we might see some resistance in Facebooks stock price.(Look at the ask side)
If you guessed 133.43, then you would be right. You can think of these massive orders as being a clog in a drain pipe. The stock price wants to move higher but it will not be able to blow past these prices when there is so much congestion (supply). Once the demand picks up the stock will be able to move on to higher price levels.
- Day Trading
Using level 2 can be a powerful tool if you are day trading. The real-time view of the supply and demand for a stock will give you a good indication of a short-term price move. When I was day trading, I used level 2 to give me a better indication of when I should enter or exit a trade.
- Price Breakouts
Currently I use level 2 to help me predict price breakouts of a stock. As I said there can be major resistance points in a stock’s price and when this resistance is broken, we can see an upward move in the stock price. You will often find these resistance points at certain moving averages such as SMA and EMA. I can also use level 2 to help me exit a trade if there is massive supply causing an short-term pullback in the stock.
Homework: Click here for a link to all the main brokerage firms that offer Level 2 data for free. I currently use it on Streetsmart edge. I would not pay for this service! There are plenty of places you can access it for free. Start watching the data during the trading day to get a better idea of the supply and demand for a stock.