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Level II and ECN can be invaluable weapons in your day trading career

Day Trading is kind of like any other business. If you are going to make money trading, you need to understand it from the inside out. You need to be familiar with advanced day trading concepts such as level II, ECN, who and what Market Makers are, how to use technical analysis such as Moving Averages, reversals and other technical indicators.

Level I allows you to see the best bid and ask for any particular security at any particular time. Level II goes beyond this by showing you all the bids and asks available for a particular stock in a great long list, sorted by price. As you can imagine, the value of this information can't really be overstated. Success in day trading relies on having sufficient information to make a relevant trading decision, and Level II gives you ALL the information - where EVERYBODY has their prices, however big or important they are.. Level II also helps you guage the market's momentum (the rate of change in price) of a stock - i.e. is it accelerating upwards, or is the strength of a move 'slackening off'?. Level II gives you not only the bid and ask for each participant, but also the number of shares they want to trade, and how they want to route the order. With this information, you have almost as much knowledge as the 'big players'.

Level II screen are usually pretty simple, with a couple of columns (one for bids, one for asks). Each column is split into 3 other columns, the NAME of the participant, the SIZE of the order, and what PRICE they are willing to trade at.

On the left you can see "open buy limit orders" (Bids) starting with the highest (best) price. On the right you can see ASK prices, which are "open sell limit orders" arranged starting with the lowest. "Name" is the standard 4 letter symbol of the participant who placed the order (eg: Goldman Sachs has an open order to buy 400 shares of VOD at 24.5 or lower). Sometimes the participant is an electronic system (eg: ISLD has an open sell order above for 100 shares of VOD at 24.39. In the above example, the best bid is 24.5 and the best ask is 24.39 - the difference between these is called the 'spread'. Traders using ordinary online brokers such as Ameritrade usually only get to see the best bid and ask, and can have no real feel for how 'strong' or 'deep' the market is beneath the best price - this is why they often get caught with their pants down. It looks strong, then WHAM! all orders have vanished and its in free fall..

Level II shows market participants that have "open orders" for a security. An ECN matches orders for any buyers and sellers for a stock. Since ECNs are computer systems, an ECN execution usually takes less than a second to find a matching bargain and do the trade. A direct-access broker gives day traders access to ECNs through their trading software. The best-known ECN is Instinet (symbol INCA on Level II) although they seem to have been having some problems of recent times, losing business to faster, cheaper, hungrier ECNs like ISLAND. According to the National Association of Securities Dealers (NASD), Island traded more Nasdaq securities than any other ECN (about 10% of the total trade volume). If you insist on using an online broker or even worse, phoning your full-service broker, day trading will be very difficult for you.

The other participants you will see on Level II are generally "market makers." These are the giant corporations like Goldmans, Morgans, Bear Stearns etc. Market makers provide liquidity in any market because in return for certain exchange privileges, they guarantee to 'make a market' (i.e. quote a price) no matter WHAT is happening, even if the price is in free fall. Market makers trade on their own account (eating the tiny spread between the bid and ask ) and they execute orders for their larger clients (ranging from small individual investors to enormous institutional investors such as the mutual funds). Most online brokers send a lot of their orders to only one market maker with whom they have a good relationship. If you use direct access trading, you easily avoid this problem.

Order routing is how you choose to send your order to the market (via an ECN or market maker). If you day trade through an online broker (eg Datek) or a full-service broker (shivers!), your order will be routed however the broker wants to route it, NOT for your best benefit. If you use direct access trading, however, YOU decide which ECN or market maker to trade thru. It may seem confusing at first compared to the simplicity of standard online broking, but once you get used to routing your own orders, you will startv to understand the overwhelming benefits, which are not only monetary.

Technical Analysis (and particularly support and resistance) are THE most important weapon in your day trading arsenal. Even with the best order routing and day trading information, if you can't decide whether to trade or not, you are dead in the water. Technical Analysis uses past price movements to predict future price movements, and takes a large variety of forms. Major banks employ so-called 'quants' - day trading maths jocks who create incredibly complicated mathematical day trading models of the markets. Frankly, this is a waste of time, and you should KISS - Keep it simple. If you know where the day's support and resistance are, you can be on the right side of the market most of the time, and that is how you make money. But how do you calculate support and resistance? These range from 'home spun' methods, such as "floor traders" pivots all the way up to the "Camarilla Equation". You should understand that support and resistance levels are never absolute - they are always effectively 'zones' of variable size within which you need to be alert, and if you understand what is likely to happen should certain trading events occur, you can place your trade with confidence, sure that the weight of the entire market is behind you.

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