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I'm new to automated trading. I'm in the process of coding the methodology I've been using manually for a few weeks into a quantitative algorithm using IBKR and Python.

I read everywhere I should backtest my strategy before betting money it. Sounds like a great idea, of course.

Just a slight problem. My alogo depends on Level 2 market data to make the best guess on when to enter a position.

With IBKR, I can get historical tick-by-tick data, but no historical level 2.

Has anyone encountered a similar challenge? Should I build my own database of L2 data? Or should I just run my algo live with paper trading, make adjustments if necessary, and then go live?

Should I look for historical L2 data (I need CME/Globex equity index futures) elsewhere? Seems like the data is out there, but it's expensive.

Has anyone gone through a similar decision process? What recommendation do you guys have?

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  • $\begingroup$ You can try paper trading, but if your strategy requires a full order book, then you are likely sensitive to latency and slippage. These are hard to gauge in simulation. $\endgroup$
    – chrisaycock
    Commented May 24, 2020 at 21:52

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You should forfeit developing any sort of trading strategy based on level 2 data if its purely based on the belief that the level 2 book contains additional information of value over level 1.

First of all, your initial backtest design will, without a doubt, be highly susceptible to being flawed, making you think you accomplished something when in fact it's an artifact,

but on top of this, your strategy will likely only work for a highly-liquid asset and other assets with similar distribution to that asset, but will fall flat when confronted with low-liquidity assets and others like it that have a completely different genetic make-up than the assets for which your strategy was going a-ok. The distributions of level 2 features are known to be either elliptical and bell-shaped on one extreme, and pin-pointy on the other, where values are causing sharp, abrupt bimodality.

the fact that you are scavenging for level 2 books also points out how impractical data acquisition would be for a real-time trader in the market who wants to replicate your strategy. even if they had access to that market depth, it would still not be timely enough for high frequency trading.

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  • $\begingroup$ I agree with some of the points you make - however, L2 does contain material information that is missing in L1 (for example advertised orders, cancellations, modifications etc.), all of which are components of order flow. $\endgroup$
    – Homunculus Reticulli
    Commented Jun 15 at 7:28

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