• How to spot the ax using Level 2

Please enjoy this free sample lesson; it is one of over 20 pages that is available to our DTU Traders in Module 2; over 6 complete modules will be available to you during your time with us at DTU.

In this lesson you will learn how to spot who the "ax" is using a Level 2 screen. The "ax" is the market maker who, at this particular moment (eg for this 3- to 15-minute timeframe) is either buying or selling the most stock. We'll look at how to trade with the ax in the next lesson; this lesson shows you how to spot who the ax is.

• MM ECN Routing headfake: MMs will frequently disguise their intentions by routing their orders through INCA or ISLD. See through this ruse by determining how strong the buy/sell action is on the inside bid/ask w/INCA or ISLD...eg if you see the inside ask stay firm w/INCA or ISLD you know some market maker is working a large order and that the situation is "indeterminate" or low-percentage to enter a trade. Wait until a clearer signal is available to enter the trade.

• Spotting the ax on Level 2: As we've learned already, First always keep an eye on MSCO MLCO SBSH and GSCO; these are your "first picks" to see which of them are the ax at a given point in time. The second indicator is the "number of times at best" inside bid/ask AND (more importantly) the refresh rate or 'depth' of their buying or selling when they are at the inside (that's what T&S is for). A third indicator is the "trade box" they are playing, eg where is their bid/ask spread on level 2. A final indicator is the # of times they are at the first outside (green) band on level 2. This lesson covers these four areas.

• Following the MM Axe to Daytrade: Even with the ECN routing that mm's use to hide their order flow, there's still plenty of profitable trading to be had by correctly: #1) Avoiding buying when a major mm/ax is selling (eg if you see MSCO and MLCO both sitting on the inside ask you probably shouldn't buy if their bid is 3 levels outside the market) and #2) "Shadowing" a the ax's buying/selling behavior, if you see that all else looks okay, eg no suspiciously strong ECN buying/selling on INCA/ISLD.

When the stock is not being moved around primarily by daytraders on ECNs (like DCLK is) or a mm routing order flow through ECNs, consider following one of these four main mms as one of your primary indicators.

Let's study an example of NETA from Thursday, January 6th, where MSCO is the ax:

Noticing unusual volume at lunchtime, we see a trend reversal at 12pm...BUY signal generated at 23 1/2 here on volume pivot.

In the first box, I highlighted MLCO, thinking he might be the ax. He dropped out entirely though, leaving MSCO on the bid (2nd).

Third box, we see our initial scalp SELL signal as a volume spike at 24 3/8 followed by a lower high/lower low.

P/L = +7/8 points profit in an hour trade. NETA went on to close at 24 1/2. Nice ride.

MSCO is the ax on this, we saw him stay on the inside (or 1 level outside/green) bid all the way up.

Ok, now we know who to look for, now let's look at how to interpret their position in the level 2 box.

This indicator is simply looking at the ratio of times the market maker you believe is the 'ax' is buying vs selling stock visibly on the inside bid or ask in a given time period.

Let's say in the box to the right that I've been watching this stock for the last hour or so and SBSH keeps popping up on the inside bid. Further, I see in Time and Sales that he buys at least 5000 shares of stock in 200-1K trade sizes every time he's there.

Sure, he fades to an outside bid level now and then, but overall he's buying and let's say the stock is holding it's own (or even a slight uptrend) in a down market. I'd look to buy the stock when the market starts to head back up if SBSH is still on the inside bid.

Also, as a mental 'checklist' item, at least do not go against one of the four major mm's who is refreshing his bid/ask repeatedly. Example: I don't short SPLS when MSCO is on the inside or green band, as he tends to hold SPLS up, and SPLS has up days whenever he's on the inside (at least the last 6 months of '99 to present).

We look at the Number of Times at Best (some software will calculate/display this for you), to try and determine if this mm is a net buyer or seller.

The caution, of course, is that they may try to appear to be buyers when they're really selling thru INCA or ISLD.

One tip for this: Trade stocks with less skilled market makers on them. In choosing stocks to play, find ones that trade on lower average daily volume (let's say 700K-2M, $25-$40 share price range), as they are likely to have a market maker dividing his attention trading it and 4-5 other issues simultaneously. Headfakes are more common with popular stocks, as the major firms put their best traders on them.

Looking at our NETA example again, you can see MSCO's "trade box" is:

Bid 24 3/16 x Ask 24 1/2

for the moment. This is a 5-spread trade box, telling you he's not particularly bullish or bearish on this stock publicly (again, watch ECN order flow for disguised order routing).

FYI, trade boxes of 2-5 spreads are common; what you want to watch for is both the width of the ax mm's trade box (does he suddenly go from 3 spreads wide to 6?), and the bid/ask direction of where he's parking his trade volume. That is, is he 4 spreads wide but on the inside (say at 24 1/4 bid NETA x 24 7/8 ask). This can clue you in as to the direction that this mm thinks the stock will go in.

The first outside level in your L2 window is important to follow, it's kind of a 'leading indicator' within the micro-world of the L2 box alone. Again, T&S and market / sector direction are the most important indicators, the L2 box is for closely timing your trade entries and exits only (not overall trend determination).

Think of the green band on the bid as your "escape hatch" for and the "wall of sellers to get through" on the ask.

What do the two different examples here (to the right and below) tell you about relative buying and selling in these two stocks, DELL and VRTY?

Can you exit a trade more safely in DELL or VRTY, based on what the L2 green bands alone are telling you?

Answer is DELL of course, you have 7 mms on the green bid, only an ISLD 2 green on VRTY.

Hopefully, these tips will help you become more comfortable using Level 2 screens correctly. All of these subtleties are necessary to daytrade for a living, yet no website or book I've seen tells you these important tips.

They should all make sense, there is much more to tell you about, let's press on to the next lesson... >>

We hope you enjoyed this free sample lesson: each Module gives you over 25 pages; you will have access to over 100 pages of practical daytrading examples as a DTU trader during your 4-month session with us. Click here to enroll! See you in class. Good trading!

Here's a 3rd free sample lesson How to Use Time & Sales to daytrade