Since You Asked
| Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. | 
Don Bright of Bright Trading |
ARBITRAGE AND VWAP
For arbitrage (as with Bank One and JPMorgan Chase), you have said to use the "ratio" and "spread number" as a reference. What is the ratio? Is that the price difference ratio, or the spread ratio? Second, regarding VWAP (volume-weighted average price), suppose the price is $30, and the VWAP is $30.20. Does that mean the price is below the average-volume price?
The ratio refers to the number of shares in one stock that it takes to equal 100 shares of the other. In this case, the ratio is 1.32 of JPM to 1.00 of ONE. To trade it, you would buy/sell 1,300 shares of JPM, and sell/buy 1,000 shares of ONE.
Volume-weighted average price is simply that. To calculate VWAP, multiply the price by the number of shares for each trade. Add the results for all the trades and divide that by the number of shares traded. This will give you the VWAP number. The current price is either higher or lower than VWAP. VWAP is used by brokers and customers to give them a standardized price at which to buy/sell stock to each other that day.
PRICE VS. SPEED
I am a fan of yours and find most of what you say to be very helpful. However, your July 2004 "Price Vs. Speed" article, while quite interesting, totally missed addressing several frustrations that I and many others have when trading NYSE-listed stocks. Listed specialists often leave stale quotes posted, or reduce the quote size to 100 shares, and leave it there rather than take it down, when the specialist has no intention of honoring it. Often the reason given for not honoring the quote is that it was already filled by a prior order. Well, if the quote was no longer valid, why didn't they take it down? It is often very frustrating for a trader in listed stocks to try to buy at the ask (or sell at the bid) and still see the price that you are trying to buy at remain as the best offer for a while, and still not get filled. The delay (versus that of an ECN?) in reporting NYSE fills and prints is also very frustrating. This is even more of a problem on the lower-volume NYSE stocks versus the higher-volume NYSE stocks.
I think that if the NYSE truly wanted to make their system better, and more fair, they should offer true ECN-like order quoting and execution handling. When I place orders on an ECN, for either NYSE or Nasdaq stocks, the orders are always filled immediately or immediately posted as a bid or offer. Do you foresee the NYSE improving to ECN-like speed of execution? What do you think about a trade or move rule like that of the Nasdaq being proposed for the NYSE? Thanks in advance for your opinion on this issue. --Frustrated (sometimes) NYSE stock trader
Thanks for the nice words. I will try to address your concerns as I
see them:
1. Stale quotes and "sell at bid" or "buy at ask" (price). I don't encounter "stale" quotes, and I teach my traders to watch the last trade size column on their RediPlus machines, so that they can see the actual trades, not just the bid/offer quotations. When trading via the DOT (designated order turnaround) system, we must realize that the assistant to the specialist can fill all the limit orders with the best price posted, so we usually enter orders a penny or two above the offer (or below the bid), and receive the immediate price posted, or price improvement to an even better price. This price improvement more than makes up for any "videogame" execution offered by some Ecns (electronic communications networks). It is possible to hit bids or buy offers, but I don't even teach my traders to do this. I explain that it is foolish to always give up the spread amount when trading. This is what happens when trading OTC (over-the-counter) and even listed ECNs.2. Order quoting and execution handling. I partly addressed this above, but let me try to explain what may be the cause of some frustration from a different angle. Each specialist post has a couple of dozen stocks to handle, and yet they may have only two or three that trade a significant amount on any given day. The inactive stocks are generally left with wider spreads and often with live orders from the outside. The active stocks are usually handled in the best manner possible. It's important to note that each active stock will have thousands of orders placed and canceled each and every day. I know that I cancel 80% of the orders that I place. Better traders cancel because they prefer not to leave orders in the book, and if they miss an immediate opportunity, they don't chase the stock price.
3. Trade-through rules. I hope that we never modify the NYSE trade-through rules. Some of the most profitable strategies rely on being given better pricing when the specialist has to accommodate a large order. Since we trade "with" the specialists, rather than try to compete with them, we profit by these daily (hourly) abnormalities that essentially pay us for providing additional liquidity for the stocks we trade.
So much of the frustration that I have seen from some traders is simply due to a lack of understanding of the entire process. Usually after a few days of discussion, along with a few months of actually seeing the benefits (and profits) of this system, their frustration is alleviated. The purpose of the July article was not to debate the pros and cons of OTC/Ecn versus NYSE specialists, but to show the benefits of either method. If we always had to hit bids or take out offers, our traders would not make the kind of money they're used to. In this time of lower volatility and lower risk, we welcome the higher rewards offered by trading on the same side as the specialist. Be careful what you wish for!
E-mail your questions for Bright to Editor@Traders.com, with the subject line direct to "Don Bright Question."
Originally published in the October 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
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