Q&A

Since You Asked

with Don Bright

Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions.

MYSTERIOUS NUMBERS
I started using a prominent retail brokerage firm a few months ago and using their depth of market (Dom) to place trades. On the Dom, when a bid or offer is lifted, it displays for example “1 @ 34.35” or “4 @ 34.32” and such to indicate the 100-share lots at that price. Most of the time, this matches the L2 and the time & sales prints, but often I see “100 @” or “800 @” and there is nothing even close to that kind of size on the L2 or T&S, even if you add a stream of prints together at a given price. Do you know where those numbers come from and why they are not reflected elsewhere? — NoDoji

Hard to say without actually seeing the monitors. However, we teach our traders to monitor the bid size and ask size and watch the numbers change quickly, often with no trades taking place. These numbers change because many automated programs use “if–then” orders. If Xyz trades at 20.40, then place a bid for Abc of 20.10. Cancel if Xyz trades at 20.35. These automated order entries and cancels make the bid-ask size bounce around like crazy.

Right next to those columns, we show “last trade size” — this is where the actual trades are shown. These trades can vary greatly from the shares shown in the bid and ask. These actual trades may be for 10,000 shares or more due to hidden liquidity pools and so forth. The Level 2 screen (Dom), and the Nyob (New York Open Book) are of value to see where shares consolidate in pricing levels. However, they are not necessarily reflecting all the real action that takes place. Hope this helps.

ADJUSTING PRICE DATA
My understanding is that technical analysis is about psychological behavior. Measuring the effects of demand and supply in a pictorial form of charts is undoubtedly one of the most useful tools for identifying trends.

So why do many chartists adjust price data for payouts? Since this adjustment removes historical data to adjust for the current price, how does it become a valid point to adjust price data? All that market players have in mind are the previous price levels achieved by a stock. No one goes around with a calculator trying to find out if the current price is preadjustment or whether a current adjusted price has moved above a previous peak. I speak in terms of classical price charting and do not include the discrepancy that arises in indicators. — Syed Rehan Ali

The most valid part of technical analysis is the self-fulfilling prophecy aspect (or psychological behavior, as you call it). Another valid part is based on return on interest (Roi) numbers from dividend-paying stocks (when you see range trading). Stocks pay a specified amount of dividend, which may be a great return when the stock price is $25 but not so good when the stock price reaches $35. This chart action is easily defined by the Roi.

I’m not sure of your actual follow-up question, but I will offer this: Adjusting for dividends and stock splits and so on is required to maintain proper linear charting. If a stock was trading at $100 and has a 2-for-1 stock split, then the 50% drop in price would throw off any type of charting — basic “apples to apples” type of reference points. So my answer is that “we do” always adjust for price action due to dividends, stock splits, and so forth — any change other than the actual supply and demand price moves. Hope this helps.

PAIRS TRADING
I know you and your company are experts in pairs trading, so I was wondering if you give me some answers to these questions: First, are your pairs traders using cointegration to do pairs trading? Second, how do you like intraday pairs trading? And third, I tried intraday pairs trading a couple of times, and found that pairs can move more smoothly than the stock in the pairs. Is this just a random thing I observed, or can I take advantage of this? Thanks. — minoritywin

Good pairs trading requires having some valuable tools to ascertain entry/exit points and then to split order-type automation (initiate with limit/parked orders to capture rebates and so on). We do a bit of intraday trading as well, which is nice when done automatically.

Some prefer to flatten risk curves with multiple pairs (again, made easier with automated spreadsheets). All in all, pairs take out market risk and offer high-probability reversion to mean-type trading.

TRADER TRAITS
What do you think is the most important character trait of a trader? Is there any ideal environment in which such a trait is developed? — Alex S

I’ve been asked this question many times, and I’ve never felt there really is a good answer. I’ve seen Ivy League professors who haven’t lasted three months. I’ve seen traders who you might think couldn’t tie their shoelaces by themselves but end up making millions. Obvious things like money management always come to mind, but more important is the understanding of risk–reward, as well as understanding gaming theory, at least to the point of knowing when and what not to play. If you cannot determine what an edge is and feel comfortable exploiting it, then perhaps you should rethink a career in trading.

An environment of activity versus passivity nurtures vision, and I prefer to see someone try a new idea than analyze it to death. If something makes sense, then try it. No paralysis via analysis — a death knell for any trader.

E-mail your questions for Don Bright to Editor@Traders.com, with the subject line
direct to “Don Bright Question.”

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