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.
Breakout/breakdown
I’ve been analyzing breakouts from consolidation and wanted to get your feedback about the viability of a strategy I was considering. I posted this on an Internet thread a while back and got no response, leading me to believe perhaps no one actually trades this way.
Yesterday, Pru started hitting the high ticker as it broke through the Hod and rallied to $22, where it then ranged between $21.75 and $21.99 for almost two hours before breaking through $22 and rapidly hitting $22.59 on the breakout.
When a stock consolidates midday and trades within a tight range, it will either break out of consolidation in the same direction as the earlier trend, or it will break down to reverse the trend. Have you any experience with placing two limit orders outside the trading range, assuming the one that gets filled places you in the direction of the breakout? So with Pru, you would place a short order at $21.70 and a long order at $22.05 and catch the ride when the big boys come out to play late in the day. Thanks in advance!—Donna
Hi, Donna! Well, your thoughts are not new, and also haven’t really worked for the last decade or so. Playing breakouts on the upside or breakdowns on the downside by themselves are recipes for disaster. You need to qualify your strategy with such things as where the overall market is trading, premium or discount to fair value, pivot points for the S&P spot price, and so on. I would be willing to bet that the breakout above $22 on Pru was either news-related (as so much has been lately) or something to do with the financial sector. Since the stock gapped down about $4.00 the next day, I’m guessing news-related factors were involved.
Most of the money that professional traders make is from engaging in the simplicity of trading — like trading gaps on the opens, picking one or two stocks to trade day in and day out like the Nyse specialists, playing the market on close (Moc) imbalance numbers at the end of the day, and not so much in diving into the “trade du jour” based on a breakout. I would wait for the breakout above $22 and watch the market to fade the stock for the downturn in price.
There are lots of ways to make money trading, but we prefer to keep it simple. Good luck!
Tape-reading: pro and con
I’ve heard that the Bright bread & butter strategy used to be tape-reading. I know that because of the fragmented marketplace, this strategy is a lot more difficult, but it is still done by a few. Do you think this would be something good for a newbie to get into? I’m talking about spotting aggressive buyers/ sellers. Is this doable for a newbie? —Brian from Phoenix
“Tape-reading” is a term that is often misconstrued. I look at tape-reading as an all-inclusive view of current market conditions to help with my entry and exit points. We use the Standard & Poor’s 500 futures pivot points to see what trading trough we’re currently in. “Trading trough” refers to the channel of support and resistance that floor traders and other professionals are looking at each day. I publish these for my traders at www.stock trading.com/Tradinginfo.htm each morning before the market opens.
At that point, we look to see if the futures are trading at a premium or discount to the day’s fair value number. This gives us a feel for the market mechanics involved when arbitrageurs will be selling futures and buying stocks, for example. When trading at a premium, the futures tend to act like a rubber band, temporarily pulling the stocks behind them. This is one of the reasons we find trading stocks easier than futures; it’s harder to trade the leading indicator.
Many of my traders focus on only a handful of stocks, which makes things a lot simpler. No need to go to someone else’s new poker game each day — bring other traders to yours. You will know the average daily trading range for each stock. You’ll know the standard deviation moves from current and historical volatility, and so on. When a stock has moved down to a certain level, just above a pivot support point, and the futures have a premium, a buy signal has occurred.
Even my correlated-pairs traders use tape-reading when entering or exiting positions. Of course, they know the spread prices they are willing to buy or sell the pair, but if the market is heading up, they will likely execute the buy-side first. Often, they will take a profit on one side in lieu of selling short the other (locking in a profit, saving costs), but if the market reverses, they’ll sell short the other side of the pair—this is “crutch pairs trading.”
We use “bid, offer, share size, depth of book” as well, but in a different way. In fact, it’s counterintuitive. Stock prices tend to “go to size,” which means that when we see a large offer, we do not short stock a few pennies below that; quite the contrary. Most new people think they can have a virtual stop-loss by shorting stock at, say, $33.99 when there are 5,000 shares offered at $34. They figure that if the stock doesn’t go down, they can simply cover at $34 with only a penny loss. But what happens is that the buyer at $33.99 has already bought the $34 offer (in their mind), so when they buy all 5,000 shares, the short-covering begins and the stock runs up quickly. That’s when we sell. And it helps knowing where the larger orders sit, either on Level 2 or the New York Open Book.
We also listen to an audio squawk box from the futures trading floor (Ben Lichtenstein at www.tradersaudio.com is excellent) so we can hear who the buyers and sellers are, what type of orders are out there, and a running commentary during the trading day. My brother Bob and I can hardly trade without this.
There is more, of course. But to sum up, tape-reading is still relevant. It’s just that many look at the wrong stuff for the wrong reasons. Hope this helps.