Level 2 is an in-depth format for trading shares that lets investors view extensive pricing data and market depth from a variety of exchanges. Using the Level 2 trading data traders can gauge market sentiment and liquidity to improve their trading decisions. It also allows them to place orders at any level and potentially within the spread when trading CFDs.

Most investors who receive share price data from the news media only see the so-called “Level 1” information, which consists of the latest bid and offer prices. Sometimes they are simply quoted a single “mid” price. In reality, the bid and offer are not the entire market. They are, respectively, the highest price buyers are willing to pay (bid) and the lowest price sellers are willing to receive (offer or ask).

Behind the bid and offer, however, there is a queue of other orders at different price levels. For example, different traders might input orders to buy or sell 100 units at Price A, 100 units at Price B and 100 units at Price C. These buy and sell prices and volumes are called the “order book”.

By accessing “Level 2” information through their trading platform, investors can see the entire order book and gauge the actual volume of orders waiting to be filled, as well as the spread between different price levels in the order book.

When trading high-volume shares like Lloyds or BP, most market orders from retail investors will be easily filled at Level 1. For less popular shares, however, there may be insufficient liquidity for the buy/sell order to be immediately filled at the level 1 price. Instead, the order will be partially filled at level 1 and the remainder will be filled at level 2 bid/offer price. For large enough orders of illiquid shares, sometimes even level 2 is insufficient and orders will need to be filled at prices corresponding to levels 3 and/or below.

Understanding Level 2 trading helps avoid the problem of insufficient liquidity and being filled at worse buy/sell levels that the investor originally wanted. Reading the order book can be crucial for investors who wish to trade less popular stocks amongst the Mid-Caps and the Alternative Investment Market (AIM). These shares can often offer volatility and big share price moves that are more attractive than their bigger counterparts. The trade off, however, is that entry and exit orders are harder to be filled at the “market price”.

London Stock Exchange (LSE) currently offers 2 types of electronic trading. The flagship service, SETS, provides Direct Market Access (DMA) to the central market for most liquid securities, meaning traders can buy and sell shares directly from each other. The alternative service, SETSqx, is set up to accommodate smaller, less liquid shares by using a combination of DMA and market makers, who are typically large brokerages that provide the necessary additional liquidity.

Using DMA to bypass market makers may offer tighter spreads and more accurate pricing. With Level 2, the order book is transparent to the investor and puts them in control of their trading. DMA orders are immediately executed, so there is no lag between inputting an order and getting the best price available.

Level 2 is an advanced trading mechanism to better understand the markets, get better prices when issuing buy or sell orders, as well as to manage market risks. Understanding the order book can help investors avoid the problem of “trading blind”. Level 2 gives investors full transparency and puts them on an equal footing with all other market participants in the order queue.