Market Makers - Level 2

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Patryk Jalmuzna

Hallo traders

I always hear that market makers have the advantage of being able to see all the sell orders as they arrive, and see all the buy orders as they come in. That of course is a advantage, but I have not yet understood what difference is there on their market book and the market book as we know it; Level 2?

With the level 2 (e.g TotalView for nasdaq) data, we are also able to see that information?
 
If you have TotalView, you have the best feed Nasdaq offers -- there is no better feed available to market makers. At least that's what I'm told by people inside Nasdaq itself.

TotalView is not technically the same as Level 2 -- TotalView is full depth (i.e. the best), and Level 2 is something else (best quote from each market maker, plus/minus some other stuff, browse the docs yourself if you want to know more). Level 2 was the best thing in the 1990's, and it is fairly "Nasdaq-specific" (although Pinks also have one), even though the term gets used (loosely) today to refer to any feed that gives depth better than top-of-book.
 
Perfect. Thank you for that understanding. Than is it right to asesum that in today nasdaq market the only advantage market makers have is "experience", "MONEY" and"skill". And that power STILL gives them the edgde witch is the ability to sometimes manipulate the market?
 
Patryk Jalmuzna said:
Perfect. Thank you for that understanding. Than is it right to asesum that in today nasdaq market the only advantage market makers have is "experience", "MONEY" and"skill". And that power STILL gives them the edgde witch is the ability to sometimes manipulate the market?
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Many of those who hold market maker rights do have much bigger advantages than that, but it's not the market maker rights themselves that help them so much.

Here are three roles that big trading firms may take on in the US equities markets:

1. market makers (as defined by each exchange)
2. "wholesalers" who pay for order flow from brokers
3. HFT's

Much, if not most, of the order flow in the US passes through firms that occupy all three of these roles. In other words, Citadel, Knight/GETCO, and a handful of other big firms are able to act as market makers, wholesalers, and HFT's, all at the same time.

Being a "wholesaler", in particular, is a huge advantage, as it allows you to jump ahead of others in the queue in exchange for a very small payment to the broker. This has particular value because they may have yet additional information that it's "dumb money" at the other end of the trade, and they want to trade against them, while also getting to jump in line. On top of that, this market is very uncompetitive (at least in market microstructure terms) since it's dominated by an oligopoly of 5 firms, and in some subsegments it appears to be dominated by just 1 or 2 firms.

This "line jumping advantage" is very significant. IEX, whose team was portrayed as the "heroes" by Michael Lewis's book, tried to "pull a fast one" by adding an entirely new form of queue jumping, dubbed "broker priority". Fortunately, the SEC and others were quick enough to catch this, and IEX reluctantly removed it from their exchange application..for now.

The HFT aspect also gives the big trading firms some advantages, although that advantage has faded severely over the past few years, since this is open to really strong competition. They are also forced to maintain an "HFT arms race" since vendors are always coming up with some new method to shave a few nanoseconds off of some aspect of their trading systems, and then they feel compelled to buy it as their competitors will do the same.
 
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