Q&A
Since You Asked
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.
The Shape Of Things To Come
I have been studying for my Series 7. So I’m studying up and learning as much as possible. What’s your personal opinion for, say, the next five years in regards to the industry? Do you see any major changes coming that would affect the entire trading community? How do you feel about the future for pair strategies, open orders, and all that? I am seriously dedicating my life and future to this path, and I am curious what someone of your knowledge thinks will be happening in the next five to 10 years in the industry. Thanks — Shane
Hi Shane, good luck with your studies! The naysayers have been predicting the end of trading as we know it for decades. The way I look at it is this: The global marketplace needs providers of liquidity, and by definition, risk-takers. Many have been lobbying for the “perfect markets,” which is really an oxymoron. Capitalism (or “markets”) require buyers and sellers. I have often said “Be careful what you wish for” to those suggesting total transparency. Imagine going to your local warehouse store to buy shares in GE at a specific price — not much incentive to buy, right? So philosophically, I think the markets will continue for some time.
As far as specific strategies go, we have always needed to adapt to the changes in the functionality of the various instruments we trade. I remember when options were first listed for trading back in the 1970s. The exchanges added liquidity and a way for smaller speculators/investors to get into the markets with limited risk. This opened the door to multitudes of strategies that we implemented back then — things like straddles, strangles, conversions (and reverse conversions), butterflies, condors, and all the rest. (Yes, all that goes back to the 1970s.)
Then in 1982, the listing of the S&P futures contracts in Chicago ignited the marketplace to levels never seen before, both in volume and rising index levels. For the first time, major institutions had a way to hedge themselves while providing shares to their customers, and vice versa. My brother Bob was one of the first to move to Chicago to join in all the fun! I believe that was one of his best trading years.
My point is that, sure, the opening-only strategy will continue to work well. It accounts for about 25% of all the money made by Bright traders. Pairs trading has developed into a great way for traders to make money while staying market-neutral. Directional players seem to be constantly fighting the markets, the government, and the economy, which is obviously difficult. You might like to read what I have to say about this at stocktrading.com/adaptingx.html to get an idea of what I mean by adapting to the marketplace. (This is an earlier version of a column I wrote for Stocks & Commodities)
So if doors to opportunity close, I’m confident that others will open. We just need to be on the lookout and not let ourselves stagnate.
Order Routing And Dark Pools
I’m confused about order routing. Why is there such a big emphasis placed on where you send your stock orders? If I use limit orders or market orders, won’t I get the same price regardless of where the orders are executed? Doesn’t my broker charge the same price? And what the heck are “dark pools”? Why are they called by that? It sounds illegal or something. Thanks —execsus
Good questions. First off, order routing can be very important to some traders and not such a big deal to others. The basics are these: There are primary marketplaces for each listed security, like Nyse, Amex, Nasdaq, and so on.
In addition, there are electronic communications networks (Ecns) that allow for online executions of the same stocks. A trader who has a direct order turnaround (Dot) machine can choose where he or she would like to send the order. The exchanges charge varying fees for this service. Our traders pay a small fee to hit a bid or take an offer on the Nyse, but pay much more if they hit a bid or take an offer on an Ecn. However, the same Ecns will pay the traders for providing liquidity vs. taking liquidity. When you “rest” your order on an Ecn and someone else hits you, you get paid for that.
This “taking” vs. “providing” can get a little sticky. If I place a bid on Arca to buy GE at x.32 cents and it trades at x.32 cents on the Nyse, I may or may not get filled. If I do get filled, I would collect some money, but not a full penny’s worth. In other words, the primary marketplace will likely complete its orders before others start paying to hit Ecn bids or offers. This varies from stock to stock, based on overall liquidity and share volume. You can try putting bids on each to see how they trade.
Now, dark pools are nothing nefarious. They are simply nondisplayed orders to buy or sell shares placed by institutions and some traders. If the displayed market is 42.20 bid, offered at 42.30, there may very well be a 42.25 bid that is hidden. We can use our “smart router” to locate these shares. You can read more at www.redi.com/forms/algo720.pdf. Good luck!
