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In this article here, Level 2 explains its components. One component is:

Highest bid prices: The highest 5 or 10 prices (depending upon the market) that traders are willing to pay to buy a contract

Now a seller will only (1) accept the highest bid or (2) reject the highest bid in an effort to drive prices higher. So why (as a potential buyer or seller) should one be interested to know the 5 highest bids? Is it because the highest bids decides which direction things are going? What extra info is obtained from the additional highest bids in the book?

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The Level 2 data is simply showing the depth of the market. If I am trading shares with my broker I have the option of viewing only the top 10 bid/ask prices in the depth or all of the data (which sometimes can be a very long list). With another broker I get the top ten bid and ask prices and how many orders are available for each price level, or I have the option of listing each order separately for each price level (in order of when the order was placed). I get the same kind of data if trading options. I do not know about futures because I don't trade them.

Simply this data may be important to a trader because it may give an indication of whether there are more buyers or sellers in the market, which in turn may (but not always) give an indication of which way the market may be moving.

As an example the price depth below shows WBC before market open with sellers outweighing the buyers in both numbers and volume.

WBC - Pre-open Market Depth

This gives an indication that prices may drop when the market opens. Of course there could be some good news coming out prior to market open or just after, causing a flood of buyers into the market and sellers to cancel their orders. This would change everything around with more buyers than sellers and indicate that prices may now be going up.

The market depth is an important aspect to look at before putting an order in, as it can give an indication of which way the market is moving, especially in a very liquid security or market.

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  • Just as the market depth suggested above, WBC is down 1.6% this morning, 1 and 1/2 hours after market open.
    – Victor
    May 24, 2013 at 1:28
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My broker collates the order book by price and marketplace, displaying the number of shares available at each level, sorted as in Victor's screencap. You can glean information from not just a snapshot of the order book but also by watching how it changes over time. Although it's not always a complete picture -- many brokers hold limit orders internally until the market is close, at which point they'll route to an exchange or trade internally. And of course skilled market participants know that there's people out there looking to glean information from the order book and will act to confuse the picture.

The order book can show you:

  • if there's a lot of investors with orders nearby, or if it's mostly market makers
  • if there's a lot of stops just across a price point, which can indicate that price movement across the line will be difficult
  • how heavily trading is weighted to institutional or retail
  • if there's heavy retail Limit action, vs Market action
  • how deep support and resistance are
  • if someone is trying to hide a large order

Combined with a list of trades (price & size, and whether it was a buy or sell), you can get a much more complete picture of what's going on with a stock than by looking at charts alone.

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