Level II Trading and Penny Stocks

In penny stock trading as well as regular stock trading there is normal basic level stock buying and selling, and then there is Level II trading. This approach involves an entirely different perspective on how a stock behaves as well as its trading potential for an investor. The unique side of this approach doesn’t just focus on the stock itself, it spotlights the type of traders going into a stock versus exiting it.

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Background

Level II is another name for what is technically known as the ordering book for Nasdaq-listed stocks. For penny stocks this at first doesn’t seem to apply too much since many penny stocks are not listed on the Nasdaq, having a market cap that does not meet Nasdaq minimum threshold requirements. However, there’s more than meets the eye.

The ordering list shows which market movers are in play and what they are purchasing or selling. Because the market movers tend to have the best information at their fingertips, there’s a high probability that their movement can signal buying or selling opportunities on affected stocks. This feature becomes extremely handy in a day-trading environment.

The market players listed fall into specific groups:

• Market makers move the majority of the stock market, creating demand when it doesn’t even exist. These are typically large brokerages or large mega-traders moving millions of dollars at a time.
• Electronic communication network activity shows were computer orders are moving. While anyone’s order, from Uncle Joe to a professional trader in a brokerage can each put in electronic orders, these computer driven transactions do show patterns of overall demand. This can signal general trend movement for long-term investment.
• Wholesale movers work with online discount brokers, moving multiple trades at the same time in bulk. This cuts down on individual transaction trades, making the process cheaper. However, wholesalers also send off signals as to what kind of stock demand they carry in aggregate.

One of the above players at a given time tends to be the one calling the shots. It isn’t always the market maker by default. However, the player causing direction doesn’t have a neon sign sitting above his activity. The direction gets seen over time. By watching the Nasdaq order list as it updates, patterns can begin to be seen on which player is causing movements consistently. When that happens, the others follow. This particular player is referred to in Level II trading as “the Ax.”

If nothing else, day traders tend to follow who they think is the Ax, figuring that player knows what he’s doing and there are far less chance of losing than winning doing so. Level II trading platforms frequently depend on the Nasdaq order list to identify the Ax, individual or brokerage, to then follow that trader religiously.

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The Risk

There is a possibility of level II traders getting duped. Ax players understand there are other traders following them and their moves. Many times they can use this to their advantage, causing extreme buying or selling when they have an ulterior motive such as shorting a stock. Followers won’t know this is occurring because they will have no idea of the player’s strategy until well after the fact. So traders watching and following while using a Level II approach need to keep this potential duping risk in mind.

Application to Penny Stocks

Obviously, there’s not a Level II penny stock alerts system to find “Ax” players in the penny arena. However, there are ways to find these market movers by the size of their trades as other reports show their transactions as well. That said, because of the far smaller value, it is far easier to play the “duping” game on unsuspecting followers just chasing large trades to emulate assumed profits. These investors get stung in “pump and dump” schemes using penny stocks as the bait.

The above said, a number of different software tools exist now that can track over-the-counter penny stock movement the same way Nasdaq stocks are tracked. These software programs will list and show the major movers, and the same big market strategies of Level II trading can be practiced with penny stocks.

Conclusion

Like any investment, those moving into penny stocks should always research their choices before putting money down. Level II and other approaches to trading have benefits, but they also have risks. No method should be trusted 100 percent or blindly. As P.T. Barnum once said, “there’s a sucker born every minute.” Don’t be that sucker.

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