Since You Asked
Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions.
Don Bright of Bright Trading
With regard to arbitrage, I think I understand the reasons why someone trading from a retail account cannot realistically (or should I say consistently) capture arbitrage opportunities. Based on what I can gather, the barriers to entry for "the little guy" are:1. Cost. This includes commissions but also includes the effects of the bid/ask spread for retail customers.Based on your experience, is this correct? Which of these two is the biggest obstacle? I'm sure there are other barriers, and I would certainly appreciate your thoughts on what the other (potential) obstacles are. Thanks -- Marcus
2. Speed of execution. This includes not only the ability to spot the opportunity quickly, but also the speed with which you get filled.
Arbitrage takes many forms, and most of them have little or nothing to do with "speed of execution." I realize that there are a few people who try to play the minor disparities between markets like a video game, but in my opinion, this is way too difficult for such a small amount of gain. The more sophisticated arbitrage guys execute larger orders based on research and market conditions, using all the tools available to professional traders. Yes, carrying positions can be costly at times, but if you are making significant money based on capital usage, it is simply an understood cost of doing business. As far as execution costs go, the rates are so low now, if a trader cannot make money, it is not because of commissions. Most seasoned traders can get in and out for a penny or so.
I think research is key to most arbitrage efforts. You must undertand the initial "deal" between two firms (for example, Bank One (ONE) and JP Morgan (JPM)). It's important to be aware of the ratio, and you must keep the spread numbers posted prominently on your screen at all times for reference. I say "for reference" because these numbers, though announced to the world, do not necessarily reflect the trading range. Traders must consider regulatory issues, shareholder voting and approval, cost of carry, and so on before trading. We suggest determining a trading range and then implementing pair trading-type strategies for both daily trading and longer-term portfolio management of the position. The daily disparities in pricing help bring profits while the deal is under scrutiny. This can sometimes take months or years.
It's been a long time since I traded stocks, and I am quite rusty on the mechanics of short selling. Assuming your broker has the stock you would like to short, what is the easiest way to get short in a falling market without incurring horrible slippage? My thought was to place a limit sell order just below the bid at my desired entry point. Your thoughts and comments will be appreciated -- Backwardation
Your method would work as long as the stock actually bounced back up to your price. The whole idea of the uptick rule is to keep institutions and traders from hammering a stock down by hitting increasingly lower price bids. By forcing the uptick, you actually have someone else initiate the order (they will be buying from you, as opposed to you selling to them).
The risk to a trader is obviously that by the time the uptick occurs, the market may have turned around. We rarely advise using short sells; it is counterintuitive to immediate market direction.
You may want to consider derivatives such as single-stock futures or options when trying to get short in a hurry. We are always concerned about not going against momentum for (extremely) short-term trading, but you may find these products useful in your particular strategy.
TRADING FROM HOME
I have recently started trading from home and have a question about setting up my computer screen. There are so many things to look at, charts, prices, and so on, that I can't seem to get to all of them. What do you think are the most important screens to have on my monitor?
We use a horizontal row with stock symbol, last price, change (for the day), bid price, ask price, and share size of bid/ask. So far, this is pretty basic. From there I like to look at the last trade size (I focus on this so that I can see if the bid/ask is reflecting the changes based on actual trades). I then have the last trade before that (by price), and the previous price as well. This way I can see the current trade and the previous two for help with directional movement. I keep a VWAP (volume-weighted average price) column close, and a column to reflect imbalances (which come out 20 minutes prior to the close each day).
Columns for open, high, low, and close are helpful, especially when I am trading opening orders at the outset of trading each day.
We link our quote windows to full quote montages as well. I can click on any symbol and have the NYOB (New York open book) or Level II screen pop up in the dedicated montage. This helps in determining the depth of the market for each stock.
This should help get you started. Be sure to keep your open position window handy to keep track of your profits!
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the June 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
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