I have owned a car for many decades and I have even had to change it a few times. My car's engine was almost unchanged each time I changed it, but its features and aesthetics changed every time. Power steering, air conditioner, and power windows were luxury features that I had in my car, but they are no longer essential. Parking assist was the real game-changer. Parking assist was a little camera that I could see from the back of my car. It allowed me to see every available parking spot. I didn't have to twist my head and struggle to park my car. I also no longer had to ask my passenger to help me find a spot. I was able to park in a parallel manner thanks to the parking assist feature. Parking assist was my advantage for the hassle-free car park.
The same feeling of edge I get when trading the markets using the level 3 data is what I experience.
The unique level 3 market depth or 20 market depth feature has many uses. If you've ever traded at an institution desk, then you will probably appreciate the level-3 market window. This feature is not something a regular retail trader would understand. It was inaccessible for so many years before we introduced it to Indian retail traders.
This chapter aims to explain how this feature works and help you start building trading strategies around it.
This chapter, assuming you already know what it is. It will help you to understand its multiple uses.
Options traders will appreciate the 20-depth order book. It provides great visibility into available contracts and helps to identify the best price points to execute those trades. Illiquid contracts can be difficult to trade without this visibility. Although I am referring to options, this can also be extended to Futures contracts, particularly the illiquid ones.
This is the market depth, i.e. The top 5 bid-asks of the 13000 CE expiring Jan 2020.
You can see narrow offers on the right and a slightly better offer on the left. If you're looking to trade a few Nifty lots, this contract would be a good one to avoid.
However, you can see what is underneath the hood by looking at the level 3 data.
You can see that there are many available contracts, but they are not visible at the regular market depth. The bid and offer quantities are concentrated below the 8 rows.
The availability of these contracts means that the trading perspective will change. Your trading strategy will also be affected.
Level 3 data provides full visibility into the estimated execution price of your trade. This information is especially useful when you want to scalp the market. You can scalp the market
You trade large quantities, i.e. You can buy and sell large quantities in rapid succession in order to make a profit from the stock's small tick movements
These are fast trades so you can only place market orders
Let's say that you wish to purchase and sell 5000 shares of Hindustan Zinc. The regular market depth window will give you the following information:
As you can see there is no way to know how these 5000 shares are going to be filled. Take a look at this 20-depth window.
The depth window of 20 inches paints a completely different picture. It tells me not only that I will get the 5000 shares but also the approximate price at which to buy them. I would place a market order to purchase 5000 shares. The price range for this order book is 210.5 to 209.25. I also see at 215. There are 2425 shares, so I can assume the average price to be around 211.
My decision to scalp the stock will depend on how much pop I expect above and beyond 211. Perhaps 211.5. If you use a brokerage calculator, you will get the exact breakeven (post costs) calculation.
The Level 3 market window is crucial in estimating the number of shares that will trade, given the stock's liquidity. We will assume that capital availability is not an issue for the purposes of this discussion.
Take a look at the market depth.
Siemens is expected to move between 1675 and 1690 in the next hour. Given that your capital is unlimited, how many shares can you purchase for this intraday trade to make Siemens move from 1675 to 1690 in the next hour?
You can purchase close to 175 shares in the regular market depth window. The 20 depth offers a completely different perspective.
The stock's liquidity is actually below the top five ask and bid, and the impact cost of the stock is reasonable. This information is not captured by the regular market depth window. If you plan to purchase approximately 1500 shares, the buy prices will be between 1675.5 and 1678. This spread is 0.149%.
If you're certain about the target price (1690), then you can buy whatever is currently available.
To limit or stop loss, you can use the 20 depth watch and extend the position size concept. Let's say you have an intraday position to buy VST Tillers at 1313.8.
Now the question is: Where would you place your stop loss for this trade. This is what the 20 market depth can do for us.
Yes. Take a look at VST Tillers' depth window of 20. You can see that there is a high concentration of bids for 1290. The best part is that there is a high order count of 35 in 1290.
This means that many traders placed orders at 1290, which indicates that there has been some price action at this level. This could be a reason to place the stop-loss.
A prudent trader would place a stop loss at 1290 but perhaps at a price below.
This is very interesting to me. We used the above example to identify 1290 as the stop loss pricing, simply because there were more bids. We expect 1290 to be the support price.
If true, it should also appear on the charts. Let's see the below-given chart:
There is clearly some price action around 1296. Remember that support and resistance are not a single price point but a range. This stock has an intraday support of 1290 to 1300 marks.
This is an excellent example of price action in the market.
We can also view this by identifying the S & R level first and then the depth at 20 to determine if there are any bids/offers concentrated in that area.
You should now be able to see the immense value that 20 depth order books bring to your trading.
It doesn't matter what technique you use for developing a point-of-view (technical analysis or quantitative analysis), it all boils down to price and the actions that trades take at that price.
You can validate this price action by using the 20 depth market window. Use your card responsibly!
Please leave your comments and let us know how you would use the depth window of 20 to identify trading opportunities.
Best of luck!