Overview

Level 1 and 2 market data in financial markets refer to the type of price data traders expose themselves to. The simplest form of the two is level 1, which only displays the basic prices. In contrast, level 2 is also commonly referred to as the order book as it reflects all the pending orders that exist within a financial instrument.

Level 1 and 2 market data

Level 1 and 2 market data

Level 1 data is simply the bid and ask prices of an instrument (lowest and highest prices buyers and sellers are willing to trade). In any instrument, traders can view each bid and ask at every price level.

Level 2 market data

Level 2 data is a lot more advanced, seeing that it reflects an order book used by the exchange a trader is executing their trades on. Level 2 data provides more granular information, which analysts usually refer to as depth of price or depth of market. This kind of data shows the number of traders who have bid and ask prices at each price point. In addition to the current bid and ask prices, level 2 shows the highest and lowest 5 to 15 prices (depending on the market) where traders have placed an order.

Traders use the order book to forecast the power dynamics between orders. For example, if one sees there are significantly more buy than sell orders at a particular price, that may be an indication of bullishness. The same is true for the inverse.

The significance of level 1 and 2 in different financial markets

All financial markets, at the very least, provide level 1 market data, which should be available with any recognized trading platform such as MetaTrader4 and cTrader. Level 2 market data is not available for all financial markets (in fact, very few). Stocks have been the most associated market for this sort of market data since this instrument is a lot more centralized than a market such as forex that’s primarily decentralized. 

With forex, there are very few brokers who provide an order book, though this is only limited to the orders made by their clients. Therefore, with this market, obtaining more accurate level 2 data that gives a trader a real edge would be very difficult, if not impossible.

Famous stock exchanges such as the NASDAQ and the New York Stock Exchange are known to provide both datasets to brokers. In most countries, level 1 market data is free and comes with the chosen trading platform. Level 2 data is usually not free and comes with a monthly subscription normally ranging from $15 to $40. Traders can receive this subscription directly from their brokers or through specialist data providers, the latter of which is thought to be a better choice.

Manipulation and limitations with level 2 market data

Despite the advantages of level 2 data, it is usually subject to price manipulation through spoofing and layering. With spoofing, a trader or group of traders place fake orders that give the impression to influence the price of an instrument, later only placing orders in the other direction while canceling their original ones. 

Layering involves the process of placing a stack of small orders at different prices to create the illusion of wide interest in the instrument. Similar to spoofing, those performing this manipulation cancel the original orders and take the opposite positions. In both cases, there may be times where it is intentional manipulation or that the participants have changed their mind. The decision-making of trading can result in anyone re-evaluating and taking on new ideas.

Naturally, the purpose of level 2 data is to identify buyers and sellers who trade on an individual exchange. However, this information doesn’t reflect all participants as some operate in what is known as ‘dark pools.’ Dark pools are trades hidden from the order book. This fact reinforces the point that level 2 data is not always necessarily a leading indicator of price 

Traders who can benefit from level 2 market data

As we saw the limitations of this data, we can conclude it’s not a 100% accurate reflection of the actual trading activity since the order book only shows pending orders rather than active ones. Due to the consistently erratic nature of financial markets, these orders change rapidly. 

Therefore, arguments exist over which camp of traders should bother about this feature. Naturally, a vast number of traders only really need level 1 data. For all its wonders, level 2 data presents two problems: extra cost and extra analysis. Regarding the latter, level 2 data is better suited towards scalpers and day traders as their entries need to be a lot more precise because they hold positions for concise periods. The scalper or day trader needs to have intricate knowledge of how best to use this data to make it worthwhile.

Conclusion

Traders have the luxury of seeing different aspects of price through level 1 and 2, the latter of which is more advanced. As with anything in the markets, we should thoroughly scrutinize any tool on its merit. In most markets, level 1 data suffices for the majority. Level 2 may be beneficial for scalpers and day traders.