Things are not always what they seem on the Level II screen — professional traders constantly engage in sleight of hand to fool unwary traders. But there are a few signs you can look for to avoid becoming another victim — and you can profit from this information, too.
The Level II quote display allows you to see beyond the nearest bid and ask prices of a Nasdaq stock to the entire list of bids and offers, including firm and size. Although Level II (officially called the “TotalView” quote display) provides a great deal of market information, it can also be deceptive — especially for new traders who are unfamiliar with the sleight-of-hand practices of Nasdaq market makers. The market-maker “trap” is a mirage conjured by professional traders to entice you into buying or selling a stock precisely at the wrong moment. However, if you know what to look for, you can position yourself to take advantage of these setups rather than fall victim to them.
TotalView: The LevelII quote display Figure 1 shows a Level II screen for Glenayre Technology (GEMS), along with a time and sales window (right), from May 10, 2005. The Level II window has two sides — the left shows bids and the right contains offers . The bid and offer columns list the market maker ID (MMID), price, and size for each order. 
For example, the first entry on the bid list is “SIZE,” which means it is an order placed through the Nasdaq Market Center. The bid price is $2.65 and the order size is 5, which represents 500 shares. The next three listings are ARCA#, ISLD#, and BRUT#, which are the IDs for the Archipelago, Island, and Brut electronic communications networks (ECNs). Next listed is UBSS, which is the market maker UBS Securities. (Market makers also sometimes use ECNs to place trades without showing their ID.) The right side of the window lists the same information, except the orders are offers to sell.
The various price levels for bids and offers are delineated by different colors. On the offer side, some of the colored bands are “tall” — spanning several entries — indicating a large number of offers at the same price; the bid side has many colors, indicating a wide range of bids below the highest bid. When there are many colors, as is the case with the bids in Figure 1, the quote is said to be “rainbowed.” In the time and sales window, executed trades are colored green if someone pays the offered price or red if someone hits the bid.
Head Fakes: Marker maker traps 
When market makers want to buy shares, they try to create the illusion the market is about to go down so they can purchase at a low price. To accomplish this, they place offers very close to the last price while showing bids (if any) well below it. This leads uninformed traders to believe market makers are looking for lower prices — the so-called “head fake.” Although the Level II screen offers a detailed view of the market, market makers create misleading pictures of supply and demand to trick inexperienced traders. Novice traders will often sell out any long positions in such circumstances because they do not want to be caught long because of the size being offered. The novice may even attempt to “front-run” the market makers and go short — to get a jump on what they perceive to be an imminent downtrend . Let’s look at this scenario in detail. 
Figure 1 shows the last price was 2.65 and there are twelve market makers and ECNs offering shares between 2.66 and 2.69. On the other hand, there is only one market maker showing a bid at 2.65. There are two ECNs bidding 2.63, one ECN bidding 2.61, and two market markets bidding 2.57. The time is 10:18:57. Looking at this Level II screen, you might think the market is vulnerable to a drop.
If any of the traders on the offer side decide to hit the 2.65 bid, the market could trade down to 2.50 in a heartbeat. Figure 2, a daily chart GEMS, shows the stock was trading higher for the second consecutive day on May 10 and was trading just above its February highs. Traders could easily think the stock has run its course, given the number of offers appearing so close to the last trade in the Level II window. 
In addition, the time and sales window from Figure 1 shows the trades are being executed on the bid — that is, traders are selling into the bid. The last seven trades were at 2.65 — market makers are being hit at 2.65 and are “refreshing” their bids (i.e., they keep coming back). Still, to the untrained eye, it appears that there are plenty of shares for sale and traders are hitting bids. This is precisely what market makers want you to conclude — the basis of their trap. Figure 3 is the one-minute chart of the stock roughly three minutes later (around 10:21), and Figure 4 is the Level II window around the same time. Figure 1 was the Level II window at 10:18:57, at which point the stock had just been down to 2.56 and then recovered. Figure 3 shows that following the quick break, the price action immediately ran to a new high (2.72) for the day, despite all of the offers shown at 10:18:57.
Web-based trading vs. direct access and payment for order flow
When hen you use a standard discount online broker, your order is often rerouted to another source for execution — your broker is essentially functioning as a “middle man.” You are essentially sending your brokerage an order via e-mail, and the brokerage executes the order in the way that offers it the greatest benefit. Many discount brokers rely on “payment for order flow” to generate income. This is part of their business model and is one of the reasons discount brokers can offer low rates, especially for market orders. As a way to attract orders from brokers, some exchanges or market-makers pay your broker for routing orders to them — perhaps a penny or more per share. Payment for order flow is one of the ways your broker’s firm can make money from executing your trade. The firm can also make money by “internalizing” your order — i.e., executing it within its own internal order book. Payment for order flow is discussed at the U.S. Securities and Exchange Commission’s (SEC) Web site (www.sec.gov/answers/payordf.htm).
Upon opening a new account and on an annual basis, firms must inform their customers in writing whether they receive payment for order flow and, if they do, a detailed description of the type of the payments. Firms must also disclose on trade confirmations whether they receive payment for order flow; customers can make written requests to find out the source and type of the payment for a particular transaction. To learn more about the basics of trade execution — including order routing, payment for order flow, and internalization — read “Trade Execution: What Every Investor Should Know” at www.sec.gov/answers/payordf.htm. By contrast, direct-access order routing is what its name implies: Instead of being sent to a middle man, your order is entered directly into the electronic marketplace for execution. If you choose to lift someone’s offer, you are instantly filled. Or, just like a market maker, you can place bids and offers, be in the queue and wait for someone to take the other side of your order. Figure 4 shows there are more offers listed close to the last trade price (2.69), while the bid prices fall away quickly from last price. The colored bands highlight the trap. On the offer side, the colored bands are taller than the bid side, and the bid side is rainbowed. Two minutes later, as shown in Figure 5, the market has again made new highs, despite the number of offers displayed in Figure 4.
These examples illustrate how market makers will set up the appearance of more supply than demand so they can attempt to buy at lower prices — in anticipation of a rally. Finally, the ECNs cannot be ignored because the market makers use them as well. For example, a market maker may offer stock at one price in the Level II window using the company’s ID, and at the same time place a bid through the ECN Island with the goal of actually getting shares.
Bearish traps When market makers are expecting the market to go lower they use the same kind of trap to entice traders into buying. Figure 6 is a daily chart of eCOST.com (ECST) showing the stock had fallen to new lows in a downtrend that began in late 2004. Figure 7 shows the stock’s Level II window. Although there appears to be plenty of buyers from 3.11 down to 3.00, this is simply an illusion created by market makers. The bid colors are tall while the offer side is rainbowed; the offers are tight up to 3.15, then start expanding in 5- and 10-cent increments. Finally, the time and sales window shows most trades are being executed on the offer (green prices). An inexperienced trader might look at this screen and think, “If the traders on the bid get impatient, they will start to lift offers and the stock could easily leap to 3.40 or higher.” This trader could believe the risk is around 10 cents while the potential reward is 30 to 40 cents. Or, traders who are already long from a higher price might decide there is no reason to take a loss at this point. They can see how deep the bid is, down to 3.00, and any buying will rally the stock, which could lead to more buying because the market is obviously oversold. Figure 8 is the Level II screen less than two minutes later. The bid is building. The last price is now 3.10 and some new bids have come in at 3.07.
The bid appears to be very deep and the offers are thin. The offer side of the market is rainbowed. The stock should rally. The time and sales window shows more trading on the offer side than the bid side. The trap is set. Figure 9 shows the market 13 minutes later. The last price is down to 3.07 and the offer is at 3.06. Still, to the untrained eye, the bid appears deep down to 3.00, and many novice traders will conclude that the stock could still rally. Figure 10 shows the market less than 13 minutes later. The stock has broken down through 3.00, the best bid is now 2.82, and the stock is offered at 2.86. Throughout this example, the trap was the illusion that a good bid for the stock was here for everyone to see, while the offers were thin. While traders appeared to be paying the offered price in the time and sales window, the offer was being refreshed. The false impression is that if the players decided to start paying up, the price could rally. This is exactly what the market makers need you to believe so they can unload their shares on you.
The world of illusion Although the Level II screen offers a detailed view of the market, market makers create misleading pictures of supply and demand to trick inexperienced traders. The Level II screen should be thought of as a tool that requires experience and skill to produce useful results. If you are looking to trade a stock from the long side, look for the trap that gives the appearance the market is for sale. In such situations, the market makers want to buy stock in anticipation of an up move, so you want to be on the same side. Similarly, short sellers and traders who are already long should watch for traps that make it look as if the market is strongly bid. The scenarios are set ups for declines. For most traders, taking advantage of the trap is best accomplished in stocks trading below $30. Also, it is not a strategy to attempt in “brand-name” stocks such as Cisco and Intel, which have the best traders in the world. The trap occurs in these stocks, but it happens very fast — too fast for less-experienced traders.
