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The Traders Wheel
11/07/99 by Alan Farley

Level II and the Chart

The Level II screen provides the important interface between general knowledge of stock charts and execution of specific trading strategies. Consistent market profits require insight and skill into both disciplines. Many excellent technical analysts lose money due to tape reading incompetence. On the other hand, expert screen readers often disregard input from their technical labors and succeed by trading the tale of the tape.

Numbers are the fuel of the markets. In fact, stock action is nothing more than numbers and their rate of change over time. Watching price pulses on time/sales logs offers the most accurate method available for very short-term price prediction. Emotions of fear and greed reveal themselves quickly through these rapid bursts of trading activity.

Turning a profit or loss on any trade results from four decisions: picking a market, choosing to go long or short, finding a point of entry and exiting the position. For the short-term trader, correctly reading the message of the Level II screen is critical to the success of each of these decisions.

While initial stock picking results from effective market scanning and detailed technical analysis, no two markets trade alike. After you choose your stocks, periods of passive LII observation before trading them is highly recommended and well worth the effort. A popular chart pattern may generate great excitement but have tape action so undesirable that the choice must be abandoned.

 

You can read Level II by uncovering answers to a series of questions: How do the spreads move? Who is moving them? How do they widen and contract? What times of day do the issues tend to act and react? When do they make their highs or lows? How easily do they violate the first hour’s range? What happens during the first and last 15 minutes of the market day? What happens during lunch hour? How easily do they gap from close to open?

Th

Level II will cross-verify stock chart observations, improve risk: reward profile significantly and add to profits. Swing traders must watch for price change momentum that is countertrend to the direction of intended entry. The opposite is true for breakout traders who must see evidence of synchronization with their position setups. Bulls must see underlying strength even through countertrend pivots while bears look for distribution interrupted by feeble rallies or sharp short squeezes.

The most common use of Level II seeks to pinpoint entry and exit. Of course this is where most traders fail. Prior research generates wishful or fearful thinking and results in highly flawed decision making. Instead of waiting for legitimate signals, they focus on meaningless price movements that support the bias of the trader. More than any other market skill, tape reading requires detachment that must overcome common emotional obstacles and barriers to clear vision.

Many technical traders ignore time/sales logs and prefer the graphics of short-term bar charts. But for intense study of very short-term price volatility, this flow of buying and selling pressure offers important information. Bar charts contain little data on a market's changing spread. Level II and time/sales highlight spread movement that provides clues to the intentions of the market makers, how they interact with each other and the ultimate direction of price.

 

 
Alan Farley is a full-time trader and author residing in Denver, CO. He publishes The Hard Right Edge premier web site for trader education, technical analysis and trader resources featuring both Morning Trader and Traders Workshop. The site provides traders with comprehensive resources including original tactics and strategies on multi-trend technical analysis and short-term trading .

  Alan also authors on-line training technical analysis in association with independent sites. His most recent publications include the Mastering The Trade on-line workshop, Momentum: Riding The Tiger, and Time of Day. In addition to writing, he is an outstanding speaker and lecturer on short term trading strategies.

 He has been featured in Barrons, Smart Money magazine, Tech Week, MoneyCentral and TheStreet.com.

 

 

 

 
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Last modified: April 02, 2001

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