On the Level
Stockscores.com Perspectives for the week ending November 4, 2005
In this week's issue:
Active traders tend to rely on the Level 2 screen when monitoring the market on their computer. This window allows traders to see the balance of buyers and sellers and should provide valuable information for where a stock is going in the short term.
In reality, the Level 2 screen is a tool for Market Makers to deceive small investors, tricking them in to believing a stock is headed in an opposite direction from where it is really going. By painting a picture with the stack of buy and sell orders, the Level 2 screen can do a lot to fool investors not familiar with the games that get played.
First, here are the basics.
On the left side of a level 2 screen you find the orders to buy the stock. They are organized by price, with the highest price anyone is willing to pay found at the top. On the right, are the orders to sell, this time organized by price from lowest to highest. Each seller is designated by a four letter symbol, representing the brokerage house or electronic market that the order is routed through.
When you enter an order to buy a Nasdaq stock, it is posted to the Level 2 screen at the price you indicate you are willing to pay. The same happens when you want to sell. This allows other market participants the ability to see what is being offered to buy and sell by other traders.
Now, imagine that you are a large investor with 100,000 shares of a stock to sell. If you post an order to sell 100,000 shares on the Level 2 screen, you will almost certainly drive the price down because the simple showing of this order is likely to spook buyers and cause them to pull back their bids to purchase.
As a result, most big investors rarely show their true intentions when posting orders to the Level 2 screen. The person looking to sell 100,000 shares of a stock may only post 1000 shares to sell and continue to do so until all of the position is sold. But this is only the start of the games that get played.
If a large investor is short a stock and looking to see it go lower, they may post a very large sell order just outside the inside bid and ask. Doing so will give buyers second thoughts about buying and may make other sellers get more aggressive with their orders. Both actions have the effect of taking the stock lower, helping out the short seller.
Therefore, as a basic rule, don't trust what you see in the Level 2 screen. But you can gain valuable insight by watching how the Level 2 screen relates to the tape and to the chart.
When I say tape, what I mean is the actual trades that go through between buyers and sellers (called the tape because before computers trades were printed on a ticker tape that came out of a machine that was monitored by traders). Here is an example.
This week, I was trading the stock symbol MRGE. I was buying the stock, expecting it to go higher, but the picture on the Level 2 screen implied that this stock was actually likely to go lower. There were way more sellers showing orders that buyers, and the size of the sellers (the number of shares that they had to sell) was much higher than what the buyers were showing to buy. In fact, the highest bidder for the stock appeared to only want to buy 100 shares!
Watching the tape, however, revealed a different story. There were lots of buy orders being executed at the bid price, which meant that the buyer who was showing a willingness to buy 100 shares was actually buying a lot more. They were hiding their true intentions by only showing 100 shares.
I would guess that this buyer was looking to accumulate 100,000 shares or more, and was quietly letting nervous sellers hit the bid as he (or she) accumulated the stock at the cheapest price possible. Soon, the sellers figured out what was going on and the stock started to rise. But not before the apparently weak buyer accumulated a good size position cheaply.
If I had looked solely at the Level 2 screen, I might have been tempted to exit my position at a loss because the supply/demand balance seemed to heavily favor the supply side. However, by also considering what was actually trading, I was able to hang in and even buy more shares when I realized that there were some strong buyers at work in the market.
When I teach a class, I am often asked about Level 2 screens and whether they are important. The answer is that they are, but you have to be sophisticated in how you use them. Don't take what you see for face value, but instead, try to figure out what is really going on in the market. When in doubt, trust the chart more than anything. What actually trades is far more important than what is shown in the Level 2 screen.
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Information affects stock price. The more important the information, the greater the effect on price. Recognizing that there are market participants who act on information that has not yet been made public, we can often predict the arrival of significant news by monitoring market activity. Statistically significant abnormal activity is often an indication that positive new information is becoming a factor in the market. The Abnormal Up Market Scan and Strategy seeks out the abnormal behavior that can telegraph the future.
For this strategy, it is key to look for abnormal price and volume action out of a good chart pattern. Essentially, a good chart pattern is one where there is low price volatility and a resistance level is broken by the abnormal activity.
This week, I ran this scan and found a few charts that seem to be telling us that higher prices are probable.
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1. HBIO
HBIO has broken the pessimistic cycle with a break today from a short term rising bottom. Notice how the Sentiment Stockscore has come up through the 60 level and volume is spiking up to support the breakout. Support at $3.15.
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2. T.OIL
T.OIL is breaking out from low volatility today, it is risky entering here because the stock has already come up a lot. However, with important fundamental news expected soon, the market seems to be telling us that higher prices may be coming. If you can handle the risk, then check it out. However, if support at $3.90 is violated, be very cautious.
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3. ARXX
A big gap up for ARXX on very abnormal volume, the market is pretty excited about this stock. I would not be surprised to see a short term pull back as the breakout came out of a period where there was a little bit of pessimism. Still, there is decent potential to see the stock go to $13 provided it can hold above support at $8.75.
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References
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Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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