Level 3 or 20 market depth is a unique feature. It has many uses. If you have traded sitting at the Institutional Desk of an organization, then you will understand the importance of Level 3 Market Window. It is not very easy for the common retail trader to understand this feature as till now this feature was not available anywhere. Zerodha recently made this feature available for Indian retail traders.
In this chapter, we will talk about this feature and show you how you can build your trading strategy based on it.
Contract Availability
The 20 market depth order book gives the option trader a better understanding of contract yields and helps in choosing the right price for these deals. Without this help, trading illiquid contracts is a difficult task. Even though I am only talking about options contracts here, you can use it in futures contracts as well, especially futures contracts that have low liquidity.
To understand this better, 13000 CE which is about to expire in January 2020.
A general look at the market depth in which the top 5 bids and asks are shown.
In the column on the left we can see that very close bids are visible while on the right side, the offers are slightly better. If you want to trade a few lots of Nifty then you might be a little hesitant to trade in this contract.
Now let’s open the level 3 data and see what information is available there-
You can see that there are many more contracts out there that are not visible in normal market depth. In fact the volume of bids and offers is quite high in the 8th row.
Your decision to trade or not to trade can completely change after looking at the available contracts on this strike. Now it will completely depend on your trading strategy what you decide.
Execution Control (Full control over the decision to trade or not)
Level 3 data also tells you at what price your trade will be completed. This is especially useful when you want to scalp the market. When you scalp the market
You trade in large quantities, meaning you buy and sell in large quantities and do these things very quickly
so that you can get the benefit of even small changes in the price.
Since it involves very frequent trades, you usually place a market order.
Suppose you want to buy and sell 5000 shares of Hindustan Zinc. The Simple Market Depth window gives you the following information:
You can see that here you do not know from where you will get 5000 shares. Now just look at the 20 depth window-
The 20-depth window paints a different picture. It not only tells that I will get 5000 shares, but it also tells how much will be the cost of buying them for me. If I want to buy 5000 shares then I have to buy in this order book between ₹ 210.5 to ₹ 211.25. I can also see that there are 2425 shares available at ₹ 211. This means that I can expect my average price to be around 211.
Now if I want to scalp the stock then for me the stock price should be above 211. Maybe 211.5 or above. What will be the right price for you and at what price you will make a profit (after paying all the charges) you can know from the brokerage calculator.
Position sizing (how big to keep the position)
The Level 3 market window can also give you an idea of how many shares you should trade given the liquidity of the stock. To further our discussion, we assume that there is no shortage of money or capital for this trade.
Let’s have a look at the simple market depth of the market-
You expect Siemens to go from 1675 to 1690 in the next hour. Since you are not short of capital, how many shares will you buy?
The simple market depth window for this trade indicates that you can buy around 175 shares. But 20 depth paints a different picture –
In fact, the liquidity in this stock is low and the best bid and ask and the impact cost is also decent. The Simple Market Depth window was not showing this. Suppose you want to buy about 1500 shares, then for this you will have to pay a price between 1675.5 to 1678. That is, its spread is 0.149
Now if you are sure that the stock will reach your target price of 1690, then you can buy all the shares present in the market at that time.
Order Placement – Order Placement
Continuing with the same principle of position sizing, you can also use 20 depth to find stop losses and limit orders. Suppose you have to take an intraday position in VST Tillers at 1313.8.
The question is where will you place your stop loss for this trade, can 20 market depth help you with this?
Yes, just look at the 20 market depth window for VST tillers. As you can see there are a lot of bids on 1290. The good thing is that the number of Asks is also highest at the same price.
This means that a lot of traders have placed orders at 1290 and expect price action at this point. This tells us that a stop loss can be placed here.
A sensible trader would probably not place a stop loss at 1290, just a little below that.
If I am a trader, I would probably place my stoploss at 1290 or below looking at 20 depths. Maybe on 1287. Using the same logic, I will keep my target at 1340 or 1338.8.
Validate the support and resistance levels
In the above example, we considered 1290 as the stop-loss price because there were too many bids. In other words, we have considered 1290 as a support price.
I found it very interesting to find out if this is true then it should appear in the chart as well. Let’s have a look at the chart –
It is clearly visible that the price action is happening around 1296. You must remember that support and resistance are not a fixed price but a range or range of prices. Hence there is an intraday support for this stock from 1290 to 1300.
This is a perfect example of how the price action principle works in the market.
Another way of looking at this might be to first look at the support and resistance levels and then go 20 depths to see if there are more bids and offers.
Hopefully, by now you have understood the benefits of a 20 depth order book in trading.
Remember that whatever technique you use (technical or quantitative analysis) to form your opinion on the market, the decision, in the end, is the price. Every trade is made on the basis of price.
So the 20 depth window is your biggest key to understanding price action. Make good use of it.
Write us your comments about how you will use this window and how you will find opportunities to trade through it.
Happy Trading!
Gaurav Heera is a well known name in the field of stock market analysis and education. His distinguished career, which spans more than ten years, has cemented his reputation as an expert with unparalleled knowledge and innovative strategies for navigating the intricate landscape of the financial markets.