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.
Stocks over options and futures?
I’ve noticed over the years of reading your column in Stocks & Commodities that you and your firm focus on equities. I have limited capital and have been trying to learn options and futures for the leverage. Is there a reason you prefer stocks? I read somewhere that you used to trade options and futures.—Chad in Florida
Good question! You actually gave one of the reasons I cite for not trading options these days. In general, retail options and futures trading is done because of limited capital. Please note, however, I have respect for my many floor trader friends who engage in options and futures. Even though they have plenty of capital, they choose to trade those instruments.
Here’s a walk down memory lane to respond to your point. When my brother and I were members of the various options exchanges and the Chicago Mercantile Exchange (Cme) for futures in the 1980s and 1990s, we felt we had a very calculable edge.
We were engaging in many of the same strategies in use today (straddles, strangles, synthetics, condors, calendar and money spreads, and so on), except we were trading in quarter- and half-dollar increments. Attempting those same strategies while trading for pennies, as today, just seems so much less appealing. Floor traders still have an edge and aren’t giving away any money to the retail public. That doesn’t mean you can’t place bets by buying calls, put, or futures in an attempt to profit from market movements; it just means that the floor traders have access to more information and available hedges that you may not.
When my brother joined the Cme in the early 1980s, we weren’t even able to cross-margin our futures and options. We had to pay full margin for the futures on the Standard & Poor’s 500 and pay full margin for offsetting Oex options, for example, and still made good money. Even today, with full cross-margining available, the edges have declined significantly.
To recap, we enjoyed options when we found a good edge (1970s and 1980s), futures when we could hedge properly (1980s), and felt that things went full circle in the 1990s, back to equities trading. Our traders can make markets without having to make markets. Our traders can use our capital to engage in strategies in equities that retail traders cannot (opening-only order, pairs trading, mergers, and so on).
So to sum up, in the case of Bright Trading, we feel that we have a better edge engaging in the various lower-risk, higher-reward, but capital-intensive equities strategies at this point in time. When things change, we’ll adapt.
You might find my January 2003 S&C article “Survival Of The Fittest” of interest in this regard as well.
Etfs and ultras
Don, do you and your traders trade exchange traded funds (Etfs) much? What do you think about the ultra long or short Etfs? Their appeal seems to be having a diverse portfolio, thereby being less risky than individual stocks.—nyscalper
I have mixed feelings on the actual trading of Etfs, but have stronger feelings about the ultras. First off, I have long been an advocate of using Spy and Dia (for example) versus paying a mutual fund manager to risk your investment capital for you. If you’re going to be in the market, it makes sense to do it yourself vs. paying someone else. For the longest time, most retail brokerages wouldn’t even tell their clients about Etfs for fear that the customer would simply buy and hold and they wouldn’t be able to generate enough commissions.
As far as trading vs. investing in these instruments, it depends on your overall trading plan. If you feel you can pick a daily or short-term direction of the market, or a segment thereof, then sure, go ahead and use an Etf. I’m not that good, I don’t like trying to predict market direction, so I rely on other strategies. I have seen so many stubborn traders (not a good trait for a professional trader) hold on too long, both intraday and over a time frame, and lose a lot of money. If you’re flexible and can take a loss quickly when wrong, then it’s not so bad.
Now, as far as the ultras are concerned, there has been much controversy, some even detailed in Barron’s, about the lack of tracking between the ultras and their components. This is like buying 10 stocks and “ultra shorting” the 10 stock index, expecting to be hedged, and losing money — which is what can and does happen. To me it’s like playing roulette, not a good move in the first place, and then adding a multiplier to it. Again, most professional traders I know prefer more predictable strategies than expanded, directional, ultra-Etf trading.
Trailing stops
have a pretty accurate trading system, but I tend to get emotional when it comes to exiting the profitable trades. Do you use trailing stops? I was wondering what your thoughts were about them — do you think they are successful in the long run, or is it better to just watch the market and manually put stock in?—Joseph Klar
I personally don’t recommend any hard stops, only alerts. I want to see what the overall market, peers, sectors and so on are doing when a stop price target is hit. For investing purposes, stops are probably a good idea, but when trading for a living, watching the market is a must, in my opinion.