In another post, I talk about understanding Level 2 screens from a supply and demand perspective. This article builds on the supply and demand concept by focusing on who is supplying and demanding shares of a stock. This doesn’t matter as much to me for bigger board stocks, but I will always analyze the market makers for an OTC penny stock.
What are Market Makers and Why Are They Important?
Market makers control the stock market, which means that the fate of your stock is in their hands. When you place an order for a stock, your order is sent to a market maker who fills the order for you. Think of a market maker as a middle man of sorts. If you want to buy 100,000 shares of a stock at $0.05/share, you send the order to your market maker and they present that order to sellers. Just like if you wanted to buy a house for $500,000, you would tell your real estate agent, and they would pass that offer along to the seller. Modern technology makes placing orders a speedy process that most give little thought to. It’s easy to look at a Level 2 screen and think of all market makers as equals, but each market maker is unique and understanding their behavioral trends can help you place better orders. As we know from a previous article, supply and demand levels are what determine a stock’s value. Knowing your market makers allows you to understand who controls the supply and demand for a stock, giving you a more thorough understanding of your market environment.
Knight Capital Group (NITE) market makers.
Which market makers are important?
Different market makers will be important for different stocks. It’s important to analyze the level 2 screen for each stock individually. Keep in mind, that different market makers may behave differently on each stock. The best way to figure out which market makers are important is by analyzing the level 2 screen for a couple of days to get a feel for how the stock trades. Look for things such as which market maker controls most of the volume, how many shares the market maker shows vs. how many they actually sell, the size of the spread, and how fast the market maker allows the stock to move in either direction. I also like to check a stock’s historical trading volume by market maker. Market makers are required to submit their reports of shares sold each month. The data comes out at the end of the month, so it’s not real time, but still a handy tool. You can check the monthly share volume report for a stock by clicking here.
Remember, the main focus is to learn how a stock trades and all analyses should be relative to this goal.
I don’t want to talk too much about specific market makers, as that could take all day. I’ll just cover some basics:
Notable Market Makers for Penny Stocks
When most traders place an order to buy/sell a stock, it usually goes through a wholesaler or ECN (electronic communication network). Some popular market makers for these types of transactions include NITE, ATDF, ETRF, and ARCA. A look at a monthly share volume report will show you that these market makers handle a lot of volume. Certain brokers allow you to choose which market maker you route your order through, however, most discount brokerages such as E*TRADE will route it automatically. When I see these market makers on a level 2 screen, I will usually analyze the orders to gain some insight into the psychology of the traders in a stock. I assume that these orders have been placed by traders (not MMs) until being given a reason to assume otherwise. So, for example, if I see ETRF put up a bid to buy 100,000 shares of a stock, I will assume that was placed by a trader and not just an MM trying to balance the market. That being said, the latter is also a possibility and these MM’s can still play games and manipulate a stock price. Regardless, analyzing these orders can give you some insight as to how traders/MM’s expect the stock to move on a given day.
If you have been trading penny stocks for some time, you’ve probably heard the term “dilution” thrown around quite a bit. Dilution hinders a stock from running and can push the price down as well. Dilution is most noticeable when a market maker shows a certain amount of shares at a specific price, but sells much more than the amount shown (soaking up size). For example, VFIN may be showing 10,000 shares for sale but actually selling hundreds of thousands. When I see a market maker who is infamous for dilution on a level 2 screen, it is a red flag. Frequent dilutors include but are not limited to VFIN, VNDM, PERT, and VERT. I view dilution on a level 2 screen the same way I view a resistance level on a chart; price levels that will be hard to break.
Here’s an example from last week’s trading of MYEC:
Anything catch your eye when you look at this?
The first thing I notice is market maker “VNDM” on the ask at .016. So, why is this significant? I’ve been watching this stock for awhile, and market makers such as VNDM and VFIN will often sell massive amounts of shares at a certain price level (dilution), hindering the stock from going up.
If you just looked at this Level 2 screen from a supply and demand perspective, things would look great. It appears that there is much more demand then there is supply, meaning the stock could run soon. Analyzing the market makers allows you to understand that there is probably a lot of supply around .016, making it difficult for the stock to run.
The stock chart confirms this. Below is a 5-minute intraday chart of MYEC’s trading action. Notice how the stock cannot break above .016 towards the end of the day. Every time it gets close, it is pushed back down as traders realize that it will be hard to break that price level.
Now, at the end of the day, VNDM moved his ask price up to .019.
To me, this means the stock has room to run up to that level, however, by this point it was too late. Many traders already got their shares for cheaper and have less motivation to push the price up. I bring this up because it’s another important point about the effects market makers have. Traders want to enter a stock when they think it has the potential to move up. When a market maker holds the price down through dilution, they make the stock less appealing. Additionally, a lot of buyers end up getting their orders filled at cheaper prices, meaning they have less motivation to buy shares at higher prices on the ask. Knowing that a stock has been diluted is a great way to understand the psychology of the traders involved.
Other Important Points:
Soaking up size – Soaking up size is when a market maker buys or sells more shares of the stock than they show on the level 2 screen. If a market maker is soaking up size on the ask, there’s a good chance it’s dilution and this is a bearish sign. If a market maker is soaking up size on the bid, that means they could be accumulating shares or creating a level of support, which can be a bullish sign.
Shorting – Many people make the assumption that market makers want to see a stock rise in price. Keep in mind that market makers can short sell a stock and profit on the way down.
Fake Big Orders – One of the best ways to mess with the psychology of the market is to show big orders on a level 2 screen. Big orders on the bid make it seem like there is a large demand for the stock, while big orders on the ask make it seem like there is a lot of supply. These levels can act as mental support and resistance levels for traders using level 2 screens. Market makers know this and can place big orders to move the stock in a certain direction. For example, if I buy 100,000 shares of a stock at .03, and it runs to .04 where there is a market maker showing 5 million shares for sale, I (along with other traders) may sell the stock. The large order may not even get filled at all, however, its presence alone has an effect.
Market Makers are Traders – All this talk of shorting, soaking up size, and fake big orders can seem like a crazy conspiracy theory. I’ll admit that there are some crazy market maker conspiracy theories out there, but it’s important to remember that market makers are traders. Just like other traders, market makers are trying to make money. Yes, it is their job to keep a balanced market, however, they are also responsible for remaining profitable. This is important to understand because it can shed light on a market maker’s intentions. For example, if a market maker shorts a stock at .02/share and the stock runs to .04/share, you could understand why the market maker may have motivation to push the price down. Don’t get paranoid and automatically assume market makers are manipulating a stock; just be conscious of what is going on and look for red flags.
In no way is this article intended to be a comprehensive guide on understanding market makers. I’ve barely brushed on the topic. My main focus is to stress the importance of knowing about market makers and how they operate. The best kind of analysis you can do is real-time. Observe different market makers and their behavior and do the research necessary to allow you to make smart trading decisions. Understanding the behavior of market makers can add a whole new dimension to your trading strategy.
Most people are aware of how supply and demand works. Chances are you learned it for school, business, or some other reason. It is an extremely basic concept, yet a lot of people tend to forget how applicable it is. I don’t really care about how supply and demand works at a macro scale. I’ll leave that to the economists. What I do care about is the psychology behind supply and demand because it affects the markets. Before we move on, let’s look at a basic supply and demand chart and draw some basic insights.
I’m sure you’re familiar with this chart, but a good refresher couldn’t harm. You can draw a lot of insights from this graph, but there is one I care most about for this post.
As supply goes up, demand goes down.
Yes, this is very basic, but start to think about it in terms of the stock market. The psychology behind it is extremely powerful.
When it comes to the market, “supply” would be the sell orders, or the ask prices, and demand would be the buy orders, or the bid prices. This is how you should be thinking of Level 2 screens. They are simply supply and demand tables.
Now, that we look at a Level 2 through a supply and demand lens, we can understand how every single order affects the balance of the stock market. Now, let’s draw one more insight from the supply and demand chart before we move on.
As demand increases, or supply decreases, price goes up.
As supply increases or demand decreases, price goes down.
Let’s apply this to the market. As the orders on the bid side of a Level 2 screen increase in volume and price, the stock price goes up. As the orders on the ask side of the Level 2 screen increase and volume and decrease in price, the stock price goes down. This is still basic economics, but it needs to be understood before we move on.
What is the point of all this?
I get it, you didn’t like economics in high school, so why am I bringing it back to haunt you now? The answer is simple; understanding how supply and demand works can help demystify a Level 2 screen. Level 2 screens may look complex, but they are incredibly simple. You need to understand how they work before you can gain any valuable insight from them.
The bigger point here is learning how to time your entries and exits properly with respect to supply and demand. This is incredibly helpful when dealing with illiquid penny stocks. I don’t put as much thought into this when dealing with higher volume big board stocks that trade thousands of shares per second. There’s usually not enough time to do an in-depth analysis. For illiquid penny stocks, analyzing a level 2 screen from a supply and demand perspective can give you great insight into how a stock will perform on any given day. I use this type of analysis to predict how certain stocks will perform during a day based on supply and demand. I will also place my orders in a way that will be most beneficial to my end goal.
Let’s look at an example
Here is an example that comes straight from today’s trading session. Before scrolling down to see my insight, do a quick analysis to see what you can infer from this Level 2 screen.
For the first three price levels (as shown by different colors), we can see this:
There are 185,000 shares on the bid side (demand).
There are 1,626,000 available on the ask side (supply).
So, supply is greater than demand, and, as we know, that is an easy way for a stock to go down in price. Yes, other factors play a role, but this article is focused on Level 2 analysis. Does this mean the stock will automatically go down? Of course not, but it would be much easier for the share price to go down than it would to go up because it would take less volume.
This is intended for determining intraday trends, as the Level 2 screen will change the next day. Also, keep in mind that supply and demand levels can shift intraday, with or without a catalyst. The supply and demand distribution can help you understand the psychology of the traders involved in a given stock.
Here are some insights we can take away from this Level 2 screen.
Buyers are in control – There are so many people trying to sell this stock, yet only a few people trying to buy it. Sellers are trying to unload over 1.5 million shares. If they sold into the bid, they would drive the price down too far and wouldn’t get the exit they desired. Therefore, someone who is bullish, can take advantage of this setup to get cheap shares. If someone put in a buy order for 500,000 shares anywhere between .0042 and .0045, they would be offering the sellers a chance to unload a lot of shares. The order may not get filled, but that is okay. It’s not like there is a lack of shares available.
Sellers are being foolish – This is by far one of the most frustrating things that can happen when trading these kinds of illiquid penny stocks. A stock will be having a slow day or be moving up gradually and someone will try to unload a large amount of shares. People complain about this all of the time, often referring to these huge orders as “walls” or “blocks” on the ask. These walls deter buyers from buying shares at the ask price, because there are so many shares available (Supply is greater than demand). Buyers want to buy shares when they think a stock will go up. A huge “wall” on the ask makes it difficult for a stock to move up. Notice that there were only 3.3 million shares traded this day. Yet, someone is trying to unload 860,000 shares in one order. It would take roughly 25% of the daily volume to fill that order alone and there are still plenty of other orders that need to be filled. I don’t like complaining about other people’s trading styles, because they should just be accepted as part of the market environment. That being said, there are certain strategies that are counter productive. When you put a huge block of shares on the ask during a low volume day, you are hurting your own cause. You want to sell your shares, yet you are creating a supply and demand distribution that favors buyers. Think about it. People don’t line up hours in advance to get the new iPhone because they know there are plenty to go around. They line up because they know supply is low and demand is high. People are literally fighting to spend their hard earned money on an expensive product. Do you think there is a low supply of iPhones because Apple didn’t have time to make enough? Don’t be naive. Apple understands supply and demand and uses it to their advantage. Sure, it would be nice to sell a ton of phones all at once, but, ultimately, that would hurt their cause. The point is simple. When you are selling shares, you need to do so at the right time and in a way that will support your end goal. This leads to my next point that combines my first two points.
Some days are meant for buying, others are meant for selling – As a swing trader, it is crucial that you understand this. Not every day is going to be a good day for selling shares and you cannot be panicked by price dips. Some days are meant for buying, even if you already have shares. A simple look at this level 2 would tell you that sellers outnumber buyers, and, therefore, buyers are in charge. If you are looking to buy shares, this would be a great day. If you are looking to sell shares, you will want to wait because every order you add to the ask (supply side) gives the buyers more power. When buyers are in charge, it doesn’t mean the long term trend will be bearish, but the daily trend certainly won’t be bullish unless the supply and demand levels shift. Success in the stock market is all about seeing what others don’t. You can take advantage of panic, greed, and hype if you have good foresight. Trying to sell a large amount of shares on a day when buyers are in charge is like showing your hand in a game of cards. You are giving your opponents an advantage. You are saying “I am willing to sell all of these shares at this price” when there is a slim chance that you will ever get your order filled. Now buyers know your exact plan, but you don’t know theirs. Maybe buyers were willing to pay more for the shares before they saw how many you were willing to sell at a certain price. Maybe they would have bought your shares progressively if you didn’t show them all at once. Be smart. Test the waters and see what buyers are willing to do. Start with a smaller order and see how buyers react. The same thing applies to buying shares. No need to put in a huge order as the highest bid. Start small and see if the sellers come to you. Sure, you may rack up some more broker commissions, but you will have a better plan that will make you more money in the long run. In short, understand whether the level 2 setup for the day favors buyers or sellers and plan accordingly. Be smart and be patient. You may want to get in or out of a stock fast, but planning entries and exits properly is far more important.
You can “manipulate” a level 2 screen in your favor – Last but not least, understanding the supply and demand distribution can actually help you manipulate a stock in your favor. The word manipulate can have a negative connotation, but that is not the case here. You are not doing anything shady. You are simply placing strategic orders to support your end goal. On this particular day, sellers were clearly in charge. Buyers wanted to buy 185,000 shares and sellers wanted to sell 1,626,000 shares. There is an imbalance. Anyone who looked at the Level 2 screen would be hesitant to start buying shares because the price could drop fast if someone sold into the bid. If you want to show the market that there is more demand for this stock, you can create that demand by building bid support. If you placed a few orders totaling 1,000,000 shares on the bid side, there would be a better balance. Of course, you better be prepared to pay for those shares, however, sometimes, just showing the bid support is enough to push a stock price up. You should never use this solely as a bluff, but if you are bullish on a stock, you can use this strategy to share your sentiment with the market. The market may see the bid support and decide to buy on the ask because they have a nice safety net if things don’t go as planned. This is most feasible when you already own shares and want the price to go up. Otherwise, it is pointless. Think about this. If you have been watching level 2 screens for awhile you have definitely experienced this setup. A stock is running up or down and then it hits a huge order on the bid or ask. This order acts as a wall because it would take a lot of shares to break past it. A lot of the times this order won’t even be fully filled, but the fact that it is there is enough. For example, let’s say a stock has run from .03 to .035 intraday on 10 million shares of volume. Traders are bullish until someone puts an order to sell 2,000,000 shares at .0351 on the ask and suddenly momentum slows. People make take chips off the ask but the stock bounces back down. The seller may only sell a few hundred thousand shares, but they were able to push the price down because they messed messed with the psychology of the market. All of a sudden, many traders will go from being bullish to bearish in the short term as a trend reversal may be in the works. This seller made it seem like it would be difficult for the stock to break past that point, so people start taking profits in case the stock drops. Of course, sometimes all of the shares will be purchased, which is why you never want to do this solely as a bluff. It is a tool and it needs to be used properly. This strategy should only be attempted if you know what you are doing.
This article ended up being much longer than I planned, however, there was a lot to say. The main point is that you need to understand how fragile the markets are and plan your orders accordingly. You can’t simply place orders at a certain price because it’s what you want. I’d love to get my ideal entry and exit for every trade, but that’s not always feasible. You need to react to the market conditions and place trades around them. Remember, there are traders who watch the level 2 screens for a stock all day. These traders analyze every order that comes onto the screen. You want to send the right message. Focus on what your order says to the market.
Always try to figure out whether sellers or buyers are in charge each day and formulate a plan accordingly. Think about the psychology behind the level 2 screen and learn to analyze it without emotion. Remember, your biases don’t mater in the short term. You may think a company is amazing, but if people are selling off, you will want to create a plan to react. Maybe you will increase your position that day. Maybe you will sell some shares to lock in profits. The choice is yours. If you can master the art of analyzing a level 2 screen, you will have a competitive edge over other traders.
Charts are extremely insightful; there’s no doubt about that. They can be used to garner a lot of insights about any stock for any given time frame. While this can be very helpful, there are some things that are more difficult to read with charts. There is where Level 2 analysis and tape reading comes in handy.
I’m always interested in finding out about important price levels. Charts are great for plotting support and resistance, but it can sometimes be difficult to see which prices attract the most buyers/sellers, and how strong support/resistance levels really are. I like to gather information about the volume for each price level of a stock. For example, if a stock has a daily range of $4-$5/share, where is most of the price action taking place? Are the majority of shares traded around $4 or $5? While you can gather this kind of insight from a stock chart, I much to create a bar chart that makes this data easier to comprehend.
StockCharts.com has a tool that allows you to plot the volume by price for free, however, I’m not sure how accurate the data is as I have not tested it myself. They do not show any values on the x-access which can make it more difficult to decipher the day. Additionally, their intraday charts are not free and I have never paid to try them. That being said, it is still a handy tool that I use to get some insight on a stock’s long term price action.
To use this free tool, just go to StockCharts.com > Enter a Ticker > Scroll down to the “Overlays” section > Choose “Volume by Price” > Click Update
This is what the result looks like (Black bar being buy volume, red bar being sell volume):
The free StockCharts.com tool is handy for doing a quick analysis, however, I much prefer to do my own as it allows me to get my data straight from the source and analyze intraday trends. So, let’s get started.
What you will need to do this:
1. Microsoft Excel (or a similar program)
2. Access to Time and Sales Data for a given time range
Step 1: Download Time and Sales Data
I use ETRADE Pro as my charting software, so I will use it for this example, however, you can use any Time and Sales data as long as it is accurate and can be imported into Excel.
For ETRADE Pro, go to Tools > Time & Sales > Type in a Ticker > Choose Your Time Range > Go to Settings to make sure all rows are showing (Set Max Rows to 65,000)
I usually use an intraday time range because I day trade volatile stocks so I care most about daily price action
I’ll use a stock called MYEC for this example.
Once this Screen has shown up, go to Settings > Export to CSV…
Step 2: Open Data in Excel
Now that you have exported the Time and Sales data, open it in Excel. It should look something like this:
This spreadsheet is showing the data for every single trade on MYEC for the time period I chose (1 day). Now we need to consolidate the data
Step 3: Consolidate the Data
Click on an empty cell in your Excel spreadsheet. Go to the Data ribbon and click “Consolidate”
The Function field should be left as “Sum”
The Reference field should be set to encompass all of the data from the Price and Size columns.
Check “Top Row” and “Left Column”
You should see something like this:
Click OK and make sure everything looks right. Make sure everything looks right.
Now, you should have a table that shows the volume by price, without any duplicate prices.
Lastly, you will want to go to the Data Ribbon > Click Sort > Choose Descending
This will sort the data by price.
Note: If you don’t care about tiny price swings, you can format the cells of the original data to round to a certain decimal place. Just select the cells under the Price column > Right click > Format Cells > Number > Set decimal place accordingly. This may make the data easier to read. For this example, you could format it so that all prices are rounded to the nearest thousandth (eg: .036, .037, .038, etc).
Step 4: Create a chart
The table you have just created is insightful, however, a chart is much more visually appealing and easier to read.
Highlight the data we just consolidated > Go to the Charts Ribbon > Choose a Chart Type
I am going to use a clustered bar chart for this example, but different charts work better for different stocks. For example, a pie chart would be very helpful for a less volatile stock.
Format your chart however you would like. I’m not going to go into that because it’s not the point of this post.
Here is a sample of what the chart should look like:
Step 5: Analyze
Now, you have done all of the busy work and it is time to analyze the results. MYEC daily range was .0335-.0398, but the true range was closer to .034-.0375. From the above chart, we can see a few really important levels. There is the most price action around the .035-.0352 price range, with some decent action between .036-.037. This means that there are a lot of buyers/sellers in those areas so those are the price ranges where the stock is most liquid. Also, notice how there is heavy volume around whole numbers like .035, .036, and .037. You should be conscious of this when planning your exit. I’m not going to go into a deep analysis here because that would take all day, but you should be using this chart alongside your stock chart. This can be a great tool for gaining even more insight about daily price action.
Look at the 5-minute candlestick chart for MYEC from the same day. The chart is a mess. The .035 level looks like support and .0375 looks like resistance, but it is difficult to tell how strong those levels are and if they even matter (considering they were breached a few times and the stock is trading on low volume)
Now, combine that your chart analysis with a simple price by volume chart and you can get a lot more insight.
It is important to keep in mind that this is just another tool to help you gain more insight into a stock’s price action. You can follow my tutorial exactly how I laid it out, but I would recommend tailoring it to fit your own needs. Mess around with Time and Sales data from different time ranges, try different kinds of charts, and organize the data in different ways.
Like any trading tool, this is only as valuable as you make it. Similar to RSI’s, MACD’s, and Bollinger Bands, the power is in the analysis, not the actual tool. See how you can incorporate this data into your strategy and trade accordingly. Personally, I find this data to be extremely insightful because it is straight from the source. All technical indicators are based around price action and the Time and Sales data. Tape reading is extremely powerful, and this is one of many ways to create visual representations of the tape. See what you can do with it!
When it comes to timing an entry into a stock, people always want to find the best price possible. This is pretty obvious, considering that the point of buying a stock is to make the most money possible. Most people assume that the best price possible is the lowest price, however, this is not always true. If a stock is very liquid, and trading on high volume, you will want to enter at the lowest price possible once your indicators tell you to buy. With an illiquid, low volume stock, I take a different approach. I try to buy the stock at a price that will support the overall health of the stock and price action.
Let me use an example to demonstrate:
This is the Level 2 screen for a stock called MYEC on Thursday, May 1, 2014.
Important things to note are:
The last trade was at $0.031/share. There are 260,000 shares on the bid at $0.0309/share and 10,000 shares on the ask at $0.031/share. It’s also important to note that VFIN is a known dilutor and is probably selling much more than 10,000 shares. He is only obligated to sell 10,000 shares at $0.031/share, but he can sell as many as he wants.
So, let’s look at the first bid order of 25,000 shares at .0309. While it would be nice to get cheaper shares, this isn’t always the best move. A stock needs upward momentum in order for it to run. If the 25,000 share order at $0.0309 gets filled, the momentum has shifted downwards. The bidder now bought a stock that is moving downwards. Assuming the price stays at $0.0309/share, the bidder has a $0 net profit. Additionally, a level of bid support has disappeared. There are still 10,000 shares on the ask at $0.031, but now there are only 235,000 shares on the bid at $0.0309.This means the stock can now go down much faster because there are less shares being demanded on the bid. So, let’s do a quick recap. By buying shares at $0.0309 the buyer has shifted momentum downwards and lowered bid support, making it easier for the stock to drop. So, how much did he save by buying on the bid instead of the ask? $2.50! For a mere $2.50, this buyer has damaged the price action of the stock.
Now, let’s look at how things would have played out if they bought at the ask. Take those same 25,000 shares and purchase them on the ask at $0.031/share. Let’s assume that VFIN is only selling 10,000 shares, although, realistically, he probably will sell much more. If this buyer bought on the ask, they would take out VFIN’s 10,000 shares. This would mean that there are now 15,000 shares on the bid at $0.031, 235,000 shares on the bid at $0.0309, and 109,000 shares on the ask at $0.032. The buyer purchased shares and helped move the price up. This setup is much better for supporting a run. Sure, the seller only got 10,000 of their 25,000 shares, but now if someone sells the remaining shares (15,000) on the bid, the price is just going sideways and not down. Additionally, other investors now see stronger bid support and a chance to break the daily high of $0.032. Now, if VFIN had more than 10,000 shares to sell, the buyer would get their 25,000 share order filled on the ask while helping chip away at the large order. Once again, this helps support upward momentum. Other investors may see people chipping away at the ask and decide to join in because a run seems possible. Additionally, there are still 235,000 shares on the bid at $0.0309 so if the stock starts turning, there is enough support to get out before taking a major loss.
Don’t get me wrong, I do not always buy shares on the ask, but for the most part I do. First of all, it almost guarantees that you get shares. Secondly, you are helping support and upward momentum which is a large reason you got into the stock in the first place. All that being said, this strategy needs to be evaluated on a case-by-case basis. It is important to think about the overall trend of the stock. If it is going down, there is no reason to buy on the ask because you probably do not have the power to trigger a reversal. Your order size will also play an important role here. In this case, the bidder who wants 25,000 shares at $0.0309 is only saving $2.50 by not buying on the ask, whereas the 235,000 share bidder is saving $23.50. Depending on the size of your order, as well as your exit strategy, you will want to think about how much money you will be saving compare to to what you are doing to the stock’s price action. For example, if 235,000 shares get filled on the bid, the bidder saved $23.50, however, the next level of bid support is at $0.0287. People may see a big sell order get filled for 235,000 shares and begin to think that sellers are in charge. This could cause the price to drop further. If someone then sells at the $0.0287 bid, the 235,000 share bidder’s shares are now worth $517 less than when they bought them. This means that this bidder lost $517 to try to save $23.50.
One last thing to keep in mind is your exit strategy. If you are buying shares to scalp intraday, a savings of $23.50 may be more significant than if you are in it for the long haul. However, if you are going long on the stock and plan to hold for awhile, those savings may be insignificant. That being said, if you are going long, you may not care about the intraday price action so it may be worth it to save $23.50.
As you can see, there are a lot of things to take into account when placing an order on a low volume stock. There are no strict rules. The point of this article is just to get you thinking about the ramifications of your orders. Cheaper is not always better. Try to place orders that allow you to get a good price on shares while supporting the price action of a stock. The more traders that do this, the better chances stocks can run.
Utilizing Level 2 screens is a great way of gauging the supply and demand for a stock on any given day. Unlike a simple Bid/Ask quote, the Level 2 screen gives a much deeper insight into the supply and demand for each stock because you can see a multitude of different orders.
One thing I pay very close attention to is the amount of shares on the bid compared to the amount on the ask. I incorporate the observations into my risk/reward analysis strategy. I’ll use an example to illustrate my point. This example is live from today’s trading.
A simple quote from your broker would tell you this:
Last price: $0.0256
Bid: $0.0256 (74,000 shares)
Ask: $0.028 (190,000 shares)
When you do a more thorough Level 2 analysis, you can see this:
367,000 shares would need to be purchased on the ask to push the stock price to .03 for a 17.2% gain from the current price level.
225,000 shares would need to be sold on the bid to push the price down to .0162 for a 36.7% loss from the current price level.
Considering the stock has only traded 163,000 shares today, a price movement in either direction could have a huge impact.
This analysis shows that the stock could drop faster than it could go up. If you were to do a basic risk/reward analysis, you would notice that the stock has a higher chance of risk than it does reward.
All of that being said, it is important to keep in mind that this should not be the sole basis for your judgment of a stock. I happen to be long on the stock above even though I mentioned the short term risk is higher than the short term reward (intraday).
Other factors play a role. First, and most important, not all orders are shown on Level 2 screens. Only one order is shown for each market maker. There may be stronger bid support or resistance on the ask. Sometimes you can see this during the day as price goes up. Additionally, people may also enter new orders as they see the price shift in either direction. It is important to learn how a stock trades. For example, the stock used for the example has stayed in the range of $0.025-$0.028 for quite some time. There are not too many anxious buyers or sellers, but big catalysts are expected. This means that it is still prone to risk, but historical data lets us know that sellers are not looking to bring the price down quite yet.
Overall, this method should be used to help find true support and resistance levels. Utilizing this strategy can help minimize your risk as you are more aware of how the public perceives the value of the stock. This is especially helpful when contemplating entering a position during a breakout. The price of the stock may be skyrocketing, but without strong bid support it could fall fast. Similarly, if more shares are available on the ask, this can create resistance. Try to use this strategy to understand how fast a stock can rise or fall intraday.
One of the biggest things I look out for when watching Level 2 screens is large order sizes on both the bid and the ask. A large order on the bid can represent strong support, while a large order on the ask can represent strong resistance. I use large orders on the bid as a confirmation of strong support, meaning that it would be hard for the stock to drop below a certain price level because there is a buyer willing to purchase a lot of shares. This is not fool proof, as sometimes shareholders with large position sizes will use these large bid orders to unload their shares. Nonetheless, having a large order on the bid is better than not having one.
That being said, I pay much more attention to the large orders on the ask, as they can sometimes create a “wall” that is hard to get past. Often times, these orders create intraday resistance levels, which is a sign that the stock may not be able to fully breakout.
So, what exactly is a big order?
The answer to this question is relative to the stock and its volume for the day. I don’t have a golden rule that I use to guide my decisions. Instead, I watch the Level 2 screens closely and see how the market reacts to large order sizes. Sometimes, a “hero” will come in and take out the entire order, allowing the stock to run again. Sometimes, people will take small chips off the ask, without really making a dent. This usually leads to sideways price action. When buyers realize that the price won’t be moving up anytime soon, they sit back and hope others do the work. Often times, the stock will bounce off the newly created resistance level, as investors lose faith in the stock’s ability to move past that price point. Other times, the stock will move sideways for a bit, as new buyers are not as aggressive, but sellers have yet to push the price down. Sideways action accompanies by low volume is one of the biggest indicators for me. If I catch on to the trend fast enough, I will sell my shares. If I don’t sell right away and the price drops, I will keep a note of where the large order is and sell my shares before the stock reaches that price on the way back up.
Here is a fictional example example based on patterns I have seen in the past:
A stock is trading between 30-50 million shares a day.
Small order sizes are usually 5,000-50,000 shares
Medium order sizes are usually between 50,000 and 100,000 shares
Large order sizes are usually between 100,000 and 250,000 shares.
If someone puts up 250,000 shares on the ask, this won’t be too detrimental. It can be taken out with one larger order or a combination of smaller orders.
If someone puts up 1,000,000 shares on the ask, this is a red flag for me. An order of this size may represent 2-3% of the daily trading volume. It would take so many small and medium orders to take this out, or a few large orders. At this point, I will take a step back and see how the market reacts. Maybe 4 large buyers will take out the block on the ask, but that is not always the case. The stock may rebound of the price level of the large order, as it may seem hopeless to get past it.
Here is an example that popped up on my trading screen as I was writing this:
This example is fairly similar to my fictional example above. There are some small orders between 5,000 and 50,000, medium sized orders between 50,000-100,000 and larger orders between 100,000-250,000. Notice that there are about 1,000,000 shares available at .021/share. This makes it harder to get past that price level because the sellers over power the buyers. This leaves room for new sellers to jump in front of that order by selling cheaper shares, which can slowly drag the price down, and as of now, that is exactly what is happening. Of course, this stock is trading on exceptionally high volume of 250+ million shares, so the level may be breached, but you get the point.
The reason why this whole phenomenon plays out the way it does is fairly simple. Stock trading is based around supply and demand. When there is more demand than supply, the price goes up, and vice versa. When buyers see that there are a lot of shares available at a certain price (supply), there isn’t as much demand. After all, these shares may be available for quite some time. This means that there is no pressure to buy. Day traders want to buy stocks that will go up fast, so they don’t have to sit on the shares for too long.
It is also important to note that some people take advantage of the psychological phenomenon triggered by these large orders. If a stock price is skyrocketing, someone may place a large sell order on the ask to keep the price down (they may be short the stock). If a stock price is dropping rapidly, someone may place a large order on the bid to create an artificial support level. These buyers/sellers may have no intention to get their entire order filled, and sometimes these orders will be removed when price action changes.
You should always be paying attention to where the large orders are. Sometimes, they will only appear for a few seconds, before being hidden by a smaller order from the same market maker. Level 2 screens are very insightful, but they do not show everything at once. They just show the lowest ask price and highest bid price for each market maker. Pay attention to where the large orders are as they may indicate future support and resistance levels: levels you may want to buy or sell at.