Q&A
Don Bright of Bright Trading
ARBITRAGE
What is the difference between agency trading and market making?
Also, is it possible to arb a large-cap Canadian stock such as Nortel
(NT) for price discrepancies between the New York (NYSE) and the Toronto
stock exchanges (TSE), or the Nasdaq and the TSE? A lot of times, I notice
that they close at different prices after you factor in the exchange rate.
Would it be possible to set this up at Bright Trading? I assume you would
have to access two different accounts -- one in Canadian funds that gives
you professional access to the TSE, and one in US funds that has access
to SuperDOT. -- C.A.V., via e-mail
Agency traders (proprietary traders) are not required to make a market
in any given security, and usually trade without order flow (orders from
customers). Market-making firms usually rely on their customers' orders
to make money. For example, they may buy from a customer's market order
at $51, and then sell to another customer's market order at $51-1/2.
Regarding your second question, many traders take advantage of certain
arbitrage opportunities between markets. The more common practice involves
electronic commission networks (ECNS) versus exchanges. When I trade the
QQQs, I keep two windows open -- one for the AMEX, and one for Island and
other ECNS. Quite often, there is a good eighth- or quarter-point profit
opportunity by doing this. It is more difficult to arb using regional exchanges,
since the regional specialists rely heavily on the primary market and their
customer orders are few and far between.
TRADING LOW-PRICED STOCKS
You confused me and somewhat cleared things up both in the January
2001 Q&A. If you buy a $10 stock, you can buy 10 times as much as a
$100 stock; 1,000 shares of a $100 stock are worth $100,000. I would never
even dream of trading such a large amount! I'd be happy with $10,000 worth.
But at the $100,000 level of trading, you are probably right about liquidity.
How can you talk about a 1% increase? Who cares about that? ALLR
at $5.78 lost 59 cents today. That is more than 10%, and still seems of
no real importance. Lots of stocks in the $10, $20, or $30 range may move
$2 in a day. In other words, you are dealing with an entirely different
kind of stock than Nasdaq stocks.
Please be more specific about the kind of trades and philosophy you
are discussing. -- Bob, via e-mail
Sorry I confused you. Your examples speak volumes for what I was trying
to explain. ALLR, for example, has traded as high as $92 and, as you know,
is now around $5. The average volume for that stock is around a dismal
20,000 shares per day. The day it had its last hurrah on the downside (September
18, 2000), going down 50% or $10, it traded 160,000 shares. Stocks that
have no value, and no real interest, move for all the wrong reasons.
Just because a stock moves doesn't mean you can profit from it. Say
you buy something at $6. If it trades $7, that doesn't mean you can sell
it at $7. You might try to sell at the market and get $5. When trading
stocks that are so thin, you have to be extremely cautious about exit strategies.
In addition, check articles at www.stocktrading.com to see what concerns
the regulators about executions on the Nasdaq. Another point to consider
is the higher execution costs when trading more shares of a lower-priced
stock.
We teach our traders to not even think about the money, only the risk.
Many of our traders use $1 million or more, intraday, of my firm's capital.
We monitor their actual risk very closely. We are more concerned about
liquidity than price.
Most professional traders do better trading (not investing, necessarily)
listed stocks where there is an actual market via the specialist system.
The specialist is required to make a fair and orderly market, cannot initiate
upticks or downticks, and is not trying to take your money. Market-making
firms are in the business of making money from their trading, and have
even bragged about how they use their customers' orders for their own gains.
A specialist on the NYSE is not going to risk his or her high-dollar job
by trying to cheat you out of a couple thousand shares of stock. They are
subject to extreme scrutiny. But OTC versus listed is another topic.
Essentially, I want to be sure that I can always buy or sell a few thousand
shares within an eighth or quarter point, not dollars. Very soon, we won't
have to be concerned about any fraction, since we are converting to decimals.
MORE ON LOW-PRICED STOCKS
I don't follow your comment about low-priced stocks in the January
2001 Q&A. You said that "a major percentage move is required to
make any significant money." If a stock is $5 per share and there
is a 2% move up, if a trader has invested $10,000 (or 2,000 shares), he
will gain 2%, or $200. If a stock is worth $100 per share and there is
a 2% move up, if a trader has invested $10,000 (or 100 shares), he will
gain 2%, or $200. Percentages are percentages, and the results are the
same from that perspective.
It is true that low-priced stocks can be more volatile, and therefore
more risky, but also they may have more potential for profit -- if you
know what you are doing. Your comments about the liquidity of lower-priced
stocks, however, are accurate. -- Don Kraska, via e-mail
Let me try to clarify this again. Professional traders don't invest
money in each trade, and do not try for return on investment. They generally
trade 2,000 shares at a time, and do not care if they are buying or selling
a $5 stock or a $100 stock. Knowing that they will not have to pay any
interest or hold the position very long, our traders don't think about
how much money is being utilized. When you are making 20, 50, or 200 trades
a day, you would go nuts if you thought about how much money is being utilized.
The traders are watching the stocks, not the money, knowing full well
that they can close the trade within a quarter point (at worst) in most
issues. These traders want the stock to move a half point or so, or until
the market tells them to close. Therefore, they prefer the higher-priced
stocks. Thanks for asking the question; I guess I was not clear.
LICENSE TO TRADE
I recently attended a seminar where people talked about daytraders
who needed licenses to trade, even if they traded at home. What is the
difference between licensed and unlicensed? I also spoke to people who
traded NYSE, not Nasdaq. I thought all the action was on the Nasdaq. While
I use many indicators like CCI, relative strength, and moving average convergence/divergence
(MACD), several of the people at the seminar were against indicators like
these if I wanted to daytrade, not position trade. -- G.T., Cleveland,
OH
A couple of years ago, all the major exchanges started requiring professional
traders to be licensed (series 7 at minimum). The firms that allow their
traders to trade without licenses are simply brokers with clients. There
are many restrictions to margin and market access. The fee structures are
often cost-prohibitive to an active trader as well.
There is nothing wrong with using the indicators you mentioned in combination
with tape reading and other tactics. The reasons our people trade the listed
securities more than the Nasdaq are many, but basically it is because we
are not the true professionals in the Nasdaq market; the market makers
are. I often suggest that those who want to trade Nasdaq join a market-making
firm such as Knight-Trimark. The OTC market is fine for investing, but
we have the numbers to show that the listed market is better for our traders.
(See my article elsewhere in this issue for more details about the difference
between professional and retail trading.)
EDUCATION
I live in Atlanta and would like to take some trading courses. Do
you know of some good ones? How about within universities? I go to Georgia
Tech, but cannot find any there. Any advice would be great.
I'm also wondering why trading the S&P 500 has gained so much
popularity. Do you know of a good book on the subject? What is a good way
to get started learning to trade the S&P?
And what do you think of some of these systems that are advertised
on the Internet? Their backtesting results are sometimes impressive. Do
you know of a website that reviews these systems? -- Michael McClellan,
Atlanta, GA
It so happens that my brother Bob and I are teaching a college course
in Las Vegas, but I have not really seen any other trading courses. There
are many finance classes, but those are always notoriously out of date.
Active trading is necessary to keep up with the market. Academics generally
do not, and have not, traded actively with their own money. You might see
if Georgia Tech will authorize the Bright Trading internship program in
Atlanta. We have credit programs at several universities and colleges.
Keep your interest up; trading is a great profession!
Trading the S&P futures and their derivatives has gained a lot of
popularity for several reasons. Primarily, the mergers and arbitrage houses
(trading firms) use the products to hedge their stock positions, and by
doing so they create liquidity in the product. Whenever there is good liquidity,
there is usually room for some momentum trading. Most of the money made
trading futures is made by the floor traders and the arbitrage firms. Generally,
we use the futures as a primary indicator of short-term (one- to three-minute)
moves in the market. We actually pay to have an audio squawk box piped
into our offices.
The best way to learn how to trade the S&P futures is probably to
go to the Chicago Mercantile Exchange website at www.cme.com and take the
course they offer. I would prefer to do what my brother did when they listed
the S&Ps on the mercantile exchange; actually trade in the pit. Many
people out there claim to have a system, but, as always, be very cautious.
This brings me to your second question. I would not rely on any system
-- even those that have been backtested. The problem with backtesting is
that it cannot take into account current market conditions. (No letters;
I know some people claim that they can.) We have never seen a system
that can come close to matching what an experienced, trained trader can
achieve money-wise. The most important computer is the one under your scalp!
Don Bright is a principal with Bright Trading (www.stocktrading.com),
a professional equity trading corporation with offices around the United
States. E-mail your questions for Bright to Editor@traders.com, with the
subject line directed to "Don Bright Question."
Excerpted from an article originally published in the
March 2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2001, Technical Analysis, Inc.
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