Level 2 and time & sales are the key to reading and interpreting price action in the stock market! The stock market actually moves solely based on supply and demand, which may come as a surprise to some traders. Many people think things like news, charts, and earnings cause a stock to go up or down. Instead, these things affect the supply and demand of the stock, which then directly affects the stock's price. More demand (buyers) = prices rise and more supply (sellers) = prices fall.

The level 2 and time & sales (together often referred to as "the tape") can tell us a lot about a stock's current supply and demand, which can give us insight into which direction the stock's price is likely to move. Before getting into some tape reading techniques... let's start with the basics!

What is level 2?

Level 2 is essentially an order book for stocks, showing us the best bids (buyers) and asks (sellers) in realtime for any given stock, along with the number of shares and the route used to place the order. Assuming you're not using any fancy broker with special order routes... every order you place will be shown in realtime on the level 2 for yourself and other traders to see.

The left side of the level 2 is made up of the bids. The "bids" are orders placed to buy the stock and are arranged from the highest bid to the lowest bid on the level 2. Since these are orders waiting to buy the stock, the left side of the level 2 can help us get an idea of how much demand there currently is for the stock.

On the other side of the level 2 we have the asks. The "asks" are orders placed to sell the stock and arranged from the lowest ask to the highest ask on the level 2. Since these are orders waiting to sell the stock, the right side of the level 2 can help us get an idea of how much supply there currently is for the stock.

One way to look for potential trade opportunities and to get an idea of where the price is likely to move next is to look for major imbalances on the level 2. For example, a stock with a stacked bid and thin ask is likely to go up because of the stronger demand than supply. We can often use this data to enter into the stock to profit off of the supply and demand imbalance and price rise. If it happens to be the other way around and we see a major imbalance on the side of the ask, we can potentially open a short position to profit from the stock's decline that is likely to follow.

Now, because the level 2 goes hand in hand with the time & sales when it comes to tape reading, let's move on to the basics of the time & sales now.

What is the time & sales?

The time & sales shows us every transaction in the market along with the price, volume (number of shares), and time that the transaction went through. In short, every time anyone buys or sells in the live market, that transaction is visible on the time & sales!

Depending on the trading platform you're using, the transactions shown on the time & sales may show up as red or green. Most traders see this and wonder why, since it takes both a buyer and a seller for every transaction. The reason is because these transaction are red when they executed at or below the best bid on level 2. If they executed at or above the best ask, they will be green on the time & sales.

We can use these colors to see where there is urgency in the market! For example, if a majority of the recent transactions on the time and sales are green, we know that the buyers are urgent to get into stock since they're buying at the ask or higher. This can tell us that there is a lot of demand for the stock. If a majority of the transactions happen to be red, the urgency is then on the sellers side, which means there is a lot of supply.

On their own, the level 2 and time & sales are useful trading tools. However, when they're paired together they can really tell us the full story of the market's price action. Using the two together is known as "reading the tape." The tape is one of the most valuable tools used my some of the most successful traders of all time. Being able to properly analyze it can give you a serious edge over your competition in the market.

One of the uses of pairing the level 2 and time & sales together is to interpret where there is hidden buying and hidden selling. Hidden buying and selling refers to the use of special order routes, which allow some traders to hide their orders from being shown on the level 2.

Even though they may not appear on level 2, they will be on the time & sales once the order is executed. Because of that, we can spot these hidden buyers and sellers by reading the tape.

For example, if you saw a buyer on level 2 at $5.00 for 100 shares, but on the time and sales you see 5,000+ shares traded at $5.00... you can safely assume that there may be some hidden buyers located at $5.00.

Of course, this is just one of the many insights that the tape can give us, but I want to end this post with that since this is a guide geared more toward beginners. Stay tuned for a future post where I'll go further into detail about some of the slightly more advanced tape reading tactics, or get started as a Market Master at the button below!

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