Level 2 data

Level 2 data

Paul Alexander Bilokon, PhD

Thalesians Ltd
Level39, One Canada Square, Canary Wharf, London E14 5AB

2023.02.07
Level 2 data

Trading venues, mechanisms, and models

I The diversity in trading venues, mechanisms, and models leads to the
corresponding diversity in market data.
I The market data that we typically encounter is in the Open, High, Low, Close,
Volume (OHLCV) form.
I For stocks, sometimes the Adjusted Close is added to these.
I This is the data that one downloads, e.g., from Yahoo! Finance.
I The opening price (Open) is the price at which a security first trades upon the opening of an
exchange on a trading day; for example, the New York Stock Exchange (NYSE) opens at
precisely 9:30 a.m. Eastern time. The price of the first trade for any listed stock is its daily
opening price. The NASDAQ uses an approach called the opening cross to decide the best
opening price considering the orders that accumulated overnight.
I The closing price (Close) is the final price at which a security trades during regular market
hours on any given day. The closing price is considered the most accurate valuation of a
security until trading resumes on the next trading day. The NASDAQ uses an approach called
the closing cross at 4:00 p.m. Eastern time to decide the best closing price considering the
imbalance information accummulated from 3:50 p.m. Eastern time. See
http://www.nasdaqtrader.com/Trader.aspx?id=OpenClose for detail.
I Adjusted close is the closing price after adjustments for all applicable splits and dividend
distributions. Data is adjusted using appropriate split and dividend multipliers, adhering to
Center for Research in Security Prices (CRSP) standards.
I The Low and High prices are, respectively, the lowest and highest trade prices during
regular hours on any given day.
Level 2 data

Multipliers

I Split multipliers are determined by the split ratio. For example:

I In a 2 for 1 split, the pre-split data is multiplied by 0.5.
I In a 4 for 1 split, the pre-split data is multiplied by 0.25.
I In a 1 for 5 reverse split, the pre-split data is multiplied by 5.
I Dividend multipliers are calculated based on dividend as a percentage of the price,
primarily to avoid negative historical pricing. For example:
I If a $0.08 cash dividend is distributed on Feb 19 (ex- date), and the Feb 18 closing price is
$24.96, the pre-dividend data is multiplied by (1 − 0.08/24.96) = 0.9968.
I If a $2.40 cash dividend is distributed on May 12 (ex- date), and the May 11 closing price is
$16.51, the pre-dividend data is multiplied by (1 − 2.40/16.51) = 0.8546.
I If a $1.25 cash dividend is distributed on Jan 25 (ex- date), and the Jan 24 closing price is
$51.20, the pre-dividend data is multiplied by (1 − 1.25/51.20) = 0.9756.
I For details, see https://help.yahoo.com/kb/SLN28256.html
Level 2 data

Yahoo! Finance data, ticker: GOOG

Yahoo! Finance data for ticker GOOG (Alphabet Inc.)

Level 2 data

Daily versus intraday

I The data we have considered so far was daily.
I It is possible to look at quote and trade data on a finer timescale — intraday.
I Intraday data presents its own challenges. This data may be updated on an
hour-by-hour, minute-by-minute, second-by-second, or even finer timescale, where
every update to the price(s) — every tick — is reflected, at which point it becomes
high-frequency data.
I The nature of the intraday data is affected by the specific trading mechanisms and
models employed by the trading venue — market microstructure.
Level 2 data

Market microstructure

I Market microstructure is a branch of finance concerned with the details of how

exchange occurs in markets.
I It is now an established academic field.
I For more information on market microstructure, see
I [O’H95] Maureen O’Hara. Market Microstructure Theory. Blackwell Publishing, 1995.
I [Har02] Larry Harris. Trading & Exchanges: Market Microstructure for Practitioners. Oxford
University Press, 2002.
I [Has07] Joel Hasbrouck. Empirical Market Microstructure: The Institutions, Economics, and
Econometrics of Securities Trading. Oxford University Press, 2007.
I [dJR09] Frank de Jong and Barbara Rindi. The Microstructure of Financial Markets.
Cambridge University Press, 2009.
I [ABF+ 12] Frédéric Abergel, Jean-Philippe Bouchaud, Thierry Foucault, Charles-Albert
Lehalle, and Mathieu Rosenbaum. Market Microstructure: Confronting Many Viewpoints.
Wiley, 2012.
I [LL18] Charles-Albert Lehalle and Sophie Laruelle. Market Microstructure in Practice,
second edition. World Scientific, 2014.
Level 2 data

Example: CME Group

CME Group — A CME/Chicago Board of Trade/NYMEX Company

Level 2 data

Example: Deutsche Börse Xetra

Deutsche Börse Xetra

Level 2 data

Trading mechanisms: degree of continuity

I The degree of continuity describes whether trading is realised by means of a

continuous or a periodic mechanism.
I In a continuous market, orders are executed upon submission enabling sequences of
bilateral transactions at (possibly) different prices.
I In contrast, periodic systems (so-called auctions or batch markets) execute
multilateral transactions at one price as orders and quotes are accumulated for
simultaneous execution at a pre-determined time.
I Periodic auction markets organise liquidity at a certain point in time; they do not
provide liquidity at any other time.
I Thus only a continuous market can provide liquidity for immediacy demanding traders
that intend to trade at other times than the periodic call.
I Trading venues, such as Xetra, often combine these two trading forms as the basis for
their trading models.
Level 2 data

Quote-driven, order-driven, and brokered markets (i)

I In quote-driven markets, market makers provide firm bid-ask prices to traders prior to
order submission. Traders can trade at the posted prices immediately.
I The term market maker reflects an obligation to ensure a fair and orderly market
based on a contractual commitment. In contrast, dealers as intermediaries also
supply liquidity to the market but they are not obliged to do so.
I In order-driven markets, the orders of all traders are accumulated and matched in
accordance with order precedence rules.
I In particular, in price/time priority, orders are first ranked according to their price;
orders of the same price are then ranked depending on when they were entered. In
pro-rata model, orders go to specialists first, whereas in a price/time priority model,
dealers have few special privileges.
Level 2 data

Quote-driven, order-driven, and brokered markets (ii)

I Order-driven systems are either periodic auctions or continuous auction systems.

I In periodic auctions, orders are stored for execution at a single clearing price; i.e. the
auction mechanism follows a uniform pricing rule.
I As order-driven markets use order precedence rules to arrange their trades, traders do
not have a choice as to their counterparty.
I In continuous auctions, traders submit orders for immediate execution against existing
limit orders submitted by liquidity providers; the formal term is continuous double
auction — double as buyers and sellers can simultaneously attempt to arrange their
trades.
I There is no intermediary determining the market clearing price, but order precedence
and trade price rules determine the price for a trade.
I In pure order-driven markets, market makers trade on an equal basis with all other
traders. There is no obligation for any market participant to submit limit orders, thus no
liquidity provider of last resort.
I The basic tradeoff is between higher liquidity in quote-driven dealer markets versus
lower transaction costs and higher transparency in order-driven markets.
Level 2 data

Request for Quote (RFQ) scenario

Level 2 data

Request for Stream (RFS) scenario

Level 2 data

Classification of trading mechanisms and Xetra trading models

Source: [Hac07]
Level 2 data

Trading on Xetra

I For instruments with a low liquidity, one or multiple auctions are conducted.
I For highly liquid instruments, continuous trading with opening, intraday, and closing
auctions is implemented.
I For medium liquidity instruments, trading is supported by so-called designated
sponsors, which are obliged to provide a minimum liquidity determined through a
minimum volume, maximum bid-ask spread, and a minimum percentage of quoting in
auctions and continuous trading by simultaneously providing limit buy and sell orders,
defined as quotes.
Level 2 data

Market orders and limit orders

I Market orders (MO) are sent by participants that are willing to either buy or sell the
asset immediately, at the best available price.
I Limit orders (LO) show the interest of the participant to buy or sell the asset at a
particular price.
I Therefore limit orders are not generally executed immediately; they have to wait until
some other participant is willing to fill the order at the price given by the LO/MO if such
a participant ever arrives.
I The participant that sent the LO can decide to amend or cancel it.
Level 2 data

Limit order book

I Therefore, the price of a traded security is not given by a unique price.

I It is actually a collection of prices, which are given by all the available limit orders.
I These prices for the limit order book (LOB).
I If there are many limit orders in the LOB, arriving MOs will be more likely to be fully
matched by these LOs at a good price.
I Therefore, issuing limit orders increases the liquidity of the asset — they make liquidity.
I MOs, however, have the opposite effect: since they are matched with LOs, they
effectively take liquidity from the market.
Level 2 data

Graphical representation of limit order book

Level 2 data

Limit orders versus market orders

Level 2 data

Limit order book in time

Level 2 data

Bid and ask

I At a given time t,
I the bid price is defined to be the price of the best available buying limit order,
I the ask (offer) price is defined to be the price of the best available selling limit order.
I The bid and ask prices are denoted by Ptb and Pta , respectively.
I We can refer to the other bid and ask prices as level 2 bid, level 3 bid, level 4 bid, ...,
and level 2 ask, level 3 ask, level 4 ask, ..., the level 1 bid being the best bid and
level 1 ask being the best ask.
I We refer to the corresponding volumes as level 1 bid size, level 2 bid size, level 3
bid size, ..., and level 1 ask size, level 2 ask size, level 3 ask size, ....
Level 2 data

The quoted spread

I The difference between the bid and ask prices is called the quoted spread or the
bid-ask (bid-offer) spread:

Quoted Spreadt = Pta − Ptb .

I Generally, the size of the quoted spread depends on how liquid the security is:
securities with high liquidity tend to have small quoted spreads, since the large number
of LOs in the LOB tend to decrease the quoted spread. Illiquid assets, however, will
usually have larger spreads.
I In some sense, the size of the quoted spread will determine the cost of trading, since
the quoted spread is the price a trader will have to pay if he or she immediately buys
and sells an asset at the best available price, assuming there are no other trading
costs.
Level 2 data

Prices
I It is often useful to try to give a single number as a representative of the price of the
traded security.
I The midprice is the average of the best bid and best ask prices:

Pta + Ptb
Midpricet = .
2
I This price may be unrealistic when the volume of limit orders at the best bid and ask
prices differ significantly.
I The microprice is often more useful, since it weights the best bid and best ask prices
with the volumes posted at the best bid and best ask prices:

Vtb Pta + Vta Ptb

Micropricet = ,
Vtb + Vta

where Vtb and Vta represent the volumes posted at the best bid and best ask prices,
respectively.
I For example, if the volume of limit orders posted at the best bid price is significantly
larger than the volume of limit orders at the best ask price, the microprice will be
pushed towards the ask price.
Level 2 data

Metrics
I Auction dislocation — the price change between the end of the continuous trading
period and the end of the closing auction.
I Order resting time — the minimum and mean resting times that an order placed at a
given price level stays on the book before it is filled or cancelled.
I Fill probability — the probability that an order will be filled within 60 seconds at a
particular price level.
I Order imbalance — the imbalance of the number of buy and sell orders for a security
at a given time.
I Quote-to-trade ratio — the ratio of order book messages to aggressive executions.
I Volume imbalance — the imbalance of buy and sell order sizes for a security at a
given time.
I Order Book Imbalance — the difference between the best bid size and best ask size
divided by their sum.
I Sweep to fill — the depth of the book required to fill an order of a given dollar volume.
I Market impact — the average price impact of a trade.
I OTC volume — volume traded over-the-counter.
I OHLCV — Open, High, Low, Close, Volume.
I VWAP — Volume-Weighted Average Price.
I Volatility — historical volatility of returns over a given period.
Level 2 data
Bibliography

Frédéric Abergel, Jean-Philippe Bouchaud, Thierry Foucault, Charles-Albert Lehalle,

and Mathieu Rosenbaum, editors.
Market Microstructure: Confronting Many Viewpoints.
Wiley, 2012.
Frank de Jong and Barbara Rindi.
The Microstructure of Financial Markets.
Cambridge University Press, 2009.
Alexandra Hachmeister.
Informed Traders as Liquidity Providers: Evidence from the German Equity Market.
Springer, 2007.
Larry Harris.
Trading & Exchanges: Market Microstructure for Practitioners.
Oxford University Press, 2002.
Joel Hasbrouck.
Empirical Market Microstructure: The Institutions, Economics, and Econometrics of
Securities Trading.
Oxford University Press, 2007.
Charles-Albert Lehalle and Sophie Laruelle, editors.
Market Microstructure in Practice.
World Scientific, 2 edition, 2018.
Maureen O’Hara.
Level 2 data
Bibliography

Market Microstructure Theory.

Blackwell Publishing, 1995.