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. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.
EXIT STRATEGIES
Could you shed some light on the subject of exit strategies? I’m not concerned about whether the entry or the exit is the most important; I’m more concerned about how to determine a good exit point. I seem to be able to get into a trade at a good price, but my exits tend to plague me, either too soon or way too late. Any suggestions?
— TMstock
Thanks for not asking me to respond to which is more important, the entry or the exit — we all know both are equally important.
Basically, entries and exits are determined the same way — only in reverse. Since we enter a trade either long or short (be sure to get past the “buy first” retail mentality), we look at an exit as simply a point where we see a good entry in the opposite direction. We don’t necessarily flip from long to short when exiting, because in general, we are happy taking profits at any time. As far as specifics are concerned, we look at the pivot points to see if we should expect an overall stall in the market direction. We look at price and volume points for the particular stock. Since most of my trades engage the same stocks every day, whether as a “child” stock or within a pair, we have a pretty good idea about average daily movement in price. And naturally, we see more volume at certain price levels.
As I’ve mentioned here before, we also use what we refer to as “Bright bands,” based on the volatility of each stock. This way, we know the range for one standard deviation should occur two-thirds of the time. And also naturally, we look at overall market ticks to signal a likely reversal in direction (whenever we see 900 or more ticks, long or short, we are pretty sure to see a directional reversal).
Time of day is always important, even among swing traders, since various time frames cause a different view of the overall market. You tend to see things like short-covering near the end of a trading session. You expect lower volume between 11 am and 2 pm Eastern time each day, with a “new day” at 2 pm. We always look at the market on close (Moc) imbalances each day at 3:45 to see the overall strength or weakness of the overall market and our particular stocks. If you aren’t privy to this information, check with your data vendor.
Hope this helps.
TECHNICAL PAIRS
From what I’ve read, it seems that your pairs trading strategies focus on the fundamental analysis of each stock instead of watching the technicals involved. I think of myself as a pretty good technician and can’t imagine trying to enter the market, long or short, without focusing on technical analysis.
— equtrdr22
In our pairs trading, we must first determine a long vs. short bias in the individual stocks — basically determine which stock is the one we would want to own for months or years. To this end we subject their fundamentals to heavy scrutiny. We tear apart everything we can find, from basic balance sheets and income statements to the notes on Sec filings. You would be surprised how much valuable information is available these days. Before determining the bias, we must be sure that the two companies are not only within the same sector, but they also derive their income from the same or similar sources, and how much is related to currency exchange, which is funding growth with borrowed money vs. earnings — all these things can make a big difference. Pepsi and Coke might seem like a no-brainer, but which one is more involved overseas? Which is more involved in bottling? Transportation? Branding? All this matters in the long run.
Now, after we have determined what to trade and in which direction, we must decide when to enter the trades. This is where the technical analysis comes into play. We overlay chart patterns of each stock to overall market performance (Standard & Poor’s 500, for example) to see which more closely correlates with general market movement. We determine pricing levels, support and resistance, moving averages, and so on.
Picking the right stock to be long doesn’t mean squat if our market timing and entry are way off. So I have to cop out and say we depend on both schools of analysis, and can’t benefit from one without the other!