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April 2006
Market Depth, which is also commonly referred to as Level II, provides an investor with the ability to see the highest bid and highest ask of each market maker/ECN (US) or brokerage house (CAN) that has publicly posted an order for a chosen security. A Level I quote consists of much less information, normally:
• The opening price of the security
• The closing/last traded price
• The change for the day
• The highest/lowest sale for the day
• The highest bid
• The highest ask
• The volume of shares traded for that particular day
The data provided by Level II is most accurate when viewed during regular trading hours (6:30 a.m. – 4:00 p.m. EST, Monday to Friday). This data will consist of the bid, ask and board lot (most commonly 100 shares) for every limit order that has been placed for the chosen security. Most market depth views will also indicate the market maker/ECN (US) or brokerage house (CAN) that the order has been placed through. As per US market regulations, bid prices will be shown on the left and ask prices will be shown on the right.
Below is an illustration of what a typical Level II quote looks like vs. a Level I quote.
As you can see on the above illustration, there are two columns; all bid orders are on the left and all ask orders are on the right. The number of board lots for each order is indicated to the right of each column, prices are in the middle and the market maker/ECN (US) or brokerage house (CAN) is listed on the left. There are many benefits of having market depth information available, including knowing who is buying/selling the security and what are the support and resistance price levels for the given security.
Being aware of support and resistance levels, which are ultimately a reflection of supply and demand, is very important when locating entry and exit points for your position. Demand will be a factor of the bid prices and supply will be a factor of the ask prices. Support levels are usually below the current price and resistance levels are usually above the current price. If there is a lot of demand for a particular security, it will create enough support to prevent a price from declining below the price that is being supported. If there happens to be a great deal of supply of a particular security, it will create resistance and therefore prevent the price from rising above the price being resisted.
You can identify the potential support and resistance levels in Level II because you are able to see all of the orders and the number of board lots that have been placed for a given security. If there is a very high number of board lots being bid at a certain price compared to all of the other prices within the market depth, this would be an indication of support for that given price. The opposite would be resistance, where you would see a very high number of board lots being asked at a certain price compared to all of the other prices.
By looking at the number of board lots in the above example, you can easily identify that there is much support for the security at $6.97 and a lot of resistance at $7.05. The reason this can be helpful is that you would know that many shares would have to be purchased before reaching the next price level of $7.06, and many shares would have to be sold before reaching the next price level for the ask side.
Many technical analysts will establish what are called “Trading Ranges.” A trading range will be applied to a chart and there will be a period of time that prices for the security will move within the range. The upper part of the range will be the resistance range and the lower part will be the support range. If the price of the security happens to break through the support or resistance trading range, this would usually indicate a buying or selling signal, depending on the range the price passed through.
There is a similar system that can be used for options* as well. This is known as montage. Montage is market depth or Level II for a particular option chain (the various options available from a company).
Market depth is available through a wide array of providers, and usually for a monthly fee. A direct access brokerage like DisnatDirect may offer their clients the ability to receive market depth information in an integrated trading platform.
Authored by: Brandon Larson, Business Development Specialist, DisnatDirect**
This is the first in a series of articles for investors provided by DisnatDirect, a wholly owned subsidiary of Desjardins Online Brokerage. For more information, go to www.disnatdirect.com or call Brandon Larson, Business Development Specialist at 1-866-894-2172.
* Investors should review the document that describes the risks inherent in negotiating options.
** DisnatDirect is a product of Disnat. Disnat is a division of Desjardins Securities. Desjardins Securities is a member of the Canadian Investor Protection Fund.
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