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.
Late on the
trends
I have a bad habit of getting into trends too late. I
try to keep an eye on stocks with strong correlation to the Standard
& Poor’s 500 with no outstanding news on them about earnings
and so on. The indicators I mainly use are the S&P 500 and the
futures tick chart. I also refer to the duck list frequently and look
for at least five of the seven ducks to line up in addition to the other
indicators.
I also try to watch for resistance, but I still seem to take a position right before the stock changes direction. What am I doing wrong? —Jordan
I gather you’ve already been to our classes, so let me explain to the readers what a “duck list” is. Basically, a duck list is getting several indicators in the same place at the same time — for example, premium or discount to (futures) fair value intraday, strong stock in a strong group and so on (for immediate directional plays). In addition, be sure the engine of the day is in alignment with your chosen directional entry.
That said, your question shows one major flaw that happens to many traders, and that is waiting for too much confirmation before entering the trade. We say to only expect five of seven ducks at any time due to the fact that this is a constantly changing market.
I would also advise you use the pivot points from the futures contracts — eminis, for example. You can find these at www.stocktrading.com/Tradinginfo.htm. You can certainly use the individual stock’s support/resistance points as well, but be sure to use the futures first (especially for daytrading). For longer-term trading, you should look at the price action for the individual stock.
Pairs and VIX
I’ve got a few questions, if you don’t mind. First, when
you’re getting into a pair, does it matter which side you get into
at the beginning, buy or short?
First of all, we recommend you enter the hard side first. The definition of “hard side” varies. It used to be we would wait for the uptick to enter the short sale first. That was the hard side for years. Now that the uptick rule has been eliminated, we look at other factors. Check the bid/ask spread first. If it’s a wide spread, then that would affect your getting into the other side. In that case, enter the wide spread order first. When that’s filled, then you have little risk entering the side with the narrower bid/ask spread, and thus lower risk.
Second, when you are in a pair and the spread goes in your favor and goes to your exit points, does that mean you close out positions on both stocks?
Consider your first entry with two layers (each layer can be 100 x 100 shares, or 500 x 500 shares, whatever your risk tolerance dictates). The reason for this is that when a pair goes against us, we will add more layers (three to five, depending on various factors), which leads to more layers when things are going against us. If we only have one layer on and then take it off for a profit, the price continues to go in our favor, we have no position and no more profits. So by keeping at least one layer on, we can take advantage of trending pair prices.
Third, if one stock of the pair stays flat and one moves in your favor to your exit point, would you take profit on that and leave the flat position open, and then try to retrace on the one you exited with profit on it? Or does exiting a position in a pair trade mean you should close out both sides so you enter and exit together?
You can enter with what we call a “crutch” pair trade. You can buy the long side when the market is heading up, and either close that same side or “lean on” (crutch) the other side, completing the pair. But when you’re exiting at the “pairs price profit target” (vs. individual stock price), I suggest you close both sides with a profit. As mentioned, you may have a few layers on, taking profits, adding pairs back, taking profits, over and over. This is what we call “production” — and so much of your profits are made this way versus waiting for a longer-term profit target.
And last question: What is the Vix? I know it’s the volatility index, but what does it mean when it moves? How would I use it as an indicator? How is the Vix calculated? Does it measure volatility of the market as a whole or do different sectors have different volatility indexes? Or is it weighted to a certain part of the market? Thanks, Don. —Emanuel
The Cboe Volatility Index is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, Vix has been considered to be the world’s top barometer of investor sentiment and market volatility.
So this index moves up and down, from a “standard” number of 12 to 15, and up as high at around 80 back in 2008. Volatility is defined as how much a stock (or index) is likely to move in a 12-month period. A $30 stock, with a 30 volatility, for example, is expected to move up or down $9 during the next 12 months. So when the Vix is lower, more traders/investors are buying stock and selling calls (covered writes) compared with speculating by buying calls and/or puts (thus running their prices up, causing a higher Vix). Basically, expect more movement in the market with a higher Vix. Traders will be selling volatility (options and so forth) and hedging with stocks and exchange traded funds. Hope this helps.