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.
MARK TO MARKET ACCOUNTING
You have written about the tax advantages of being a professional trader versus a retail trader. You also mentioned something about mark to market accounting. Could you expand on these points? —JBelliott
Sure, glad to shed some light on this. If you were to buy 1,000 shares of GE at $20, yet it is now trading at $21, you have a mark to market profit of $1,000, even though you haven’t sold the shares yet. In my mind, this gives a better and truer reflection of where you really stand. On the other end, if you bought 1,000 shares of Google [Goog] a few months back at $640, and it’s now trading at $575, you have a mark to market loss, but not a capital gain loss. Some retail traders tend to almost kid themselves by saying, “I haven’t really lost any money because I haven’t sold the stock yet.” Well, as cute as that sounds, you really have lost money, no doubt about it.
We don’t have to match up trades, which is a total nightmare. We simply buy and sell as needed, and whatever our net gain is, we pay K-1 type taxes on it (distribution of partnership income). We are also exempt from Fica (self-employment tax). We see on a daily and even minute-by-minute basis exactly where we stand in real time. Another big benefit is if we do suffer a loss, it can offset other income rather than being carried forward at only about $3,000 per year.
DEFINING NEWS STOCKS
I have wondered about what your traders do when some major global event happens — for example, hurricane Katrina, the BP oil spill, and now this massive earthquake and tsunami in Japan. I sometimes think it might be safer to just daytrade instead of doing longer-term trading. You have mentioned that you like to avoid “news stocks” — and that makes sense, but I’m not sure how you define a news stock. Can you give me some insight, please? —Yelpmaster
Really good questions. Let me try to explain our thought process. First off, let me address “news stocks.” Remember, our traders tend to trade the same stocks (our “children”), much like a surrogate specialist or market maker and/or build up a portfolio of correlated pairs. All of these stocks are researched heavily, and we have excellent software to update our information daily. I mention this because there are many traders who like the idea of filtering for the latest big-mover company on a daily basis.
A fundamentally solid stock in a good trading range can be moved by rumors or actual news.We’ve found that if one of our “children” is constantly in the spotlight, it takes away from our overall comfort level in the fundamentals and technicals. A fundamentally solid stock in a good trading range can be moved by rumors or actual news. There is a difference, of course. Rumors tend to have some truth to them, but more important, rumors bring in overzealous speculators. They might start buying options or even the actual stock, simply based on one thing or another. For most rumor-type news items, we usually prosper because we are up to date with what is going on in the company. We have generally done our homework, and anticipate such news items.
Second, we have a plan in place for specific stock price movements. If we see a gap up, premarket, we have a plan for it, the same thing at the end of the day when we see major market on close (Moc) imbalances published. So basically, keep up to date, prepare a plan for price movements, and keep your share size appropriate for your account size.
Now to global events that we simply have no way of anticipating. A lot boils down to simple common sense. After the horrific BP spill in the Gulf of Mexico, we had dozens of traders with positions. Some closed out immediately (good move), some cut their overall exposure to oil stocks (another good move), and yes, some just sat there like deer in headlights (not a good move). “When in doubt, get out” is a good motto.
But let’s take this a step further. Many of our traders have dozens of pairs of stocks in many sectors, and some of these traders are really smart. The BP spill would have an effect on many sectors for months after the initial report was made — fishing and canneries, hotels on beaches, restaurants (tourism in general), and so on. So naturally, many of our people made some major changes to their portfolios — a good thing.
Remember, we are in a global financial marketplace, so plan for an exchange rate impact within various sectors as well. You’ll be able to see the effect of the quake on the Japanese currency, for example.
So keep share sizes appropriate to account size. Have a contingency plan for adjustments. Use common sense to follow the trail of secondary sector impact. Prepare for currency effects. Hope this helps.