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

A SERIES OF QUESTIONS

Why are you so sure you will be on the same side as the specialist when using envelope orders? Would you please explain the basics about how you select your stocks (criteria)? When do you enter a trade (and when do you pull the order to avoid getting filled)? Finally, you say you have this automated. Does that mean you trade only the price movements of the particular stock?

When you "envelope" the bid and offer, you are looking to take advantage of what we call trade-throughs. This is when the stock drops or rises an unusual amount to accommodate a large order and trades through the existing bid or offer price. Note that the existing orders are entitled to the block trade, or improved, price when they print. The specialist usually participates in this accommodation.

We primarily use high-cap NYSE stocks for this technique. We understand that as traders we must help the markets by providing liquidity, and sometimes we get rewarded for it.

Your third question would take too much explanation to address fully here. ... I can tell you that we keep orders in constantly throughout the day. We tend to move orders away from the last sale when stocks drive toward our price, awaiting the gap movement.

Some traders use automated systems, while many do it manually. I teach my "boot campers" to do this manually long before they begin to automate. We always include the rest of our market indicators in our decisions.

OPENING PLAY

You say that one of the advantages (maybe the biggest) of the opening play is to be on the same side as the specialist. However, on days when the market is indicating to gap up in a big way (as on Monday, December 15, 2003, the first trading day after former Iraqi president Saddam Hussein was apprehended), your buy sides of the opening orders will be above the previous close. Therefore, you're no longer guaranteed you'll be on the same side as the specialist when your buys get filled. (The specialist could be shorting the stock to you, since it's on an uptick.) All you're sure of is that you've just bought the stock below its opening fair value. How do you adjust for losing this edge, if at all? -NJGrinder

Good point! Even though we will put in standard opening prices initially, we will be looking very carefully at the opening indications. We will adjust the sell only to be in the top third of that indication, leaving the buy order away (much lower, out of range). When there is no indication, we feel that if we do buy stock, it may be a "berry" right along with the specialist. This would mean that if we were to buy stock, there were shares available for sale, and therefore we are right back on the side of the specialist.

ENVELOPING FOLLOWUP

Regarding your response on the subject of enveloping as detailed in the S&C January 2004 column, please elaborate on the term crutch pair trading. Your insights continue to be valued and appreciated -Ken Kautz

We teach our traders a method of pairs trading that allows for single-stock momentum entry and exit. This entails the use of correlated and noncorrelated stocks, generally within the same sector/group, in a long/short relationship to take advantage of pricing disparities. For example, if we are trading the Merck/Eli Lilly (MRK/LLY) pair, we may see a large bid for LLY and a small offer in MRK. When the market starts moving in an upward trend (momentum), we can simply buy the MRK, knowing that if MRK does not participate in the upward move, we can sell the stronger bid in LLY, using LLY as a "crutch." If MRK moves up as we expect, then we simply take our profits on that upward move. This eliminates the need for two additional trades, and of course removes all risk when we close the MRK position.

Pairs trading can take on many forms for advanced traders. Check out www.pairtrader.com for additional information about these strategies.

OPENING ORDERS

What have you heard about opening orders for NASDAQ stocks on the AMEX? How many stocks are going to be trading there, when is it going to start, and so on? -freeyourmind

I have some information on the AMEX program to trade NASDAQ securities right in front of me. The AMEX will use the 74 NASDAQ stocks that are in the Standard & Poor's 500 to begin with. Benefits (per AMEX) include:

All of this sounds greatÉ we'll have to see how soon it takes place, and how well the program is executed. As you know, we have covered the opening-only strategy many times here in STOCKS & COMMODITIES, and we continue to use it daily at Bright Trading. Since the strategy can only work on listed securities, we hope that by adding these Nasdaq stocks to the mix (via the AMEX listings), we will be able to expand our profitability. By the time you read this, I certainly hope we are trading the opens on the AMEX!

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

Originally published in the March 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.


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