Q&A
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 |
SPECIALISTS
Assuming specialists make money and trading with them provides an edge, how do you feel about jumping in when the specialist is getting steamrolled? What tricks are in the specialist's playbook for a situation like that? Is he able to go short and cover lower, or is he getting longer and longer as the day drags on? - kztd
When a stock (or specialist) is "getting steamrolled" (which is rare), you will still see minor offset moves. For example, suppose that a stock opens for the day down a few dollars, but it still upticks a full 20 cents before heading south again. The specialist would be able to trade both sides of the market, participating in prints (larger blocks of stocks) on both sides. It is doubtful that the specialist will continue to get "longer and longer" during any sustained move. It happens, but not often.
Remember, the idea of trading with the specialist is to have high-probability trade entries and exits, which is what you will likely have... not perfect, but high probability.
THE SPECIALIST GAME
I recently started daytrading NYSE stocks and would like to get some detailed information about something very specific: I heard that one possible way of trading for small (a few cents) profits is to "play the specialist game." Apparently, by watching the bid/ask, the uptick/downtick (something about the specialist being only able to buy on the downtick and sell on the uptick), and time and sales (the tape), you can tell what specialist is doing and draw some tradable conclusions based on this. 1) Would it be possible to get some detailed information about this particular subject? 2) Do you know of some books, Internet sites, or people I can contact to get detailed information on how to go about trading Nyse stocks and their specialists? 3) Is there a book or manual that goes into relative detail about this very specific subject? Thank you very much in advance - Greg, Montreal, Canada
What great questions! Very similar to asking how the poker players who win the World Series of Poker in Las Vegas every year play the game. (Actually, one of our traders won $1.5 million at the event in 2001, but that's another story.) We spend a good portion of our week-long training covering a lot of this information, but let me give you some insights.
The specialist acts as a "participating clearing house" where individuals, brokers, and institutions send their buy and sell orders on particular stocks. The specialist system differs from the market maker system (OTC/Nasdaq) in that there is a single marketplace and a "national best bid or offer" quotation method. The specialist is responsible to see that all orders are handled correctly, meaning that they are treated to a fair and orderly market, and given the best possible price at the time the order is filled.
Let's start with the preopening combination of buy and sell orders that end up in front of the specialist. He or she may have a million buy orders at various limits and/or with market prices. He may also have half a million sell orders at varying prices. Now, the specialist must "go to the book" (established orders at higher prices already logged in the electronic book) to find enough shares to fulfill the million-share order. Since NYSE has a single price opening (and close), these orders must be matched up. The specialist can only accommodate, not participate, in the order. He cannot "go along" with the excess buy orders, only help on the sell side by selling shares of his own. Knowing this, we can place orders, based on fair value calculations and other assumptions, to be sure that we have orders that are on the same side as the specialist. This works well for the opening play.
Buy and sell orders will keep coming in all during the trading day, and the specialist must do basically the same thing. He will again accommodate orders when needed to maintain the fair and orderly market. He cannot initiate upticks or downticks (as you mentioned), only participate with existing orders as they are being traded.
Bid and offer quantities are constantly changing along with the prices reflected. This is what tape-reading is all about. Tape-reading is all-encompassing, not just watching the running (dedicated) tape for each stock. You must look at the Nyse "open book" to get a good idea of where the "size" orders are placed. When Level II became available to the public a few years back,it became pretty much useless to professional traders (except to bluff from time to time using Ecns? and so on). So we try to teach our traders to focus on a very few items while trading: the open book and the bid/ask/size. The running tape is important to see the type of traders involved (institutions, individuals, fund managers, the company itself, and so on). We learn to see which side the specialist is taking at various times during the day, and act upon this information.
At the end of the day, 20 minutes before the market closes, we look for the published "imbalances" (they show up on RediPlus and the Dow Jones newswires) so we can see which stocks have "excess" buy or sell orders coming into the last trade of the day. This is especially important to the professional trader who focuses on only a handful of stocks every day.
Specialists make their money from transaction fees, billed orders, and from trading. So it is important to understand how the whole game is played. I have not seen a book written to date that goes into any detail about how all this is done. I may write one someday (after we're done making money from trading!).
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the July 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
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