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.
TIMING YOUR TRADES
Don, I’ve tried everywhere, but I can’t find an answer to this question and I think you’d know. If I place a limit order after 9:30 am on Pfizer (Pfe) to the Nyse, and Pfe hasn’t opened yet on the Nyse, is that order eligible to participate on the opening cross?
—Bottle4411
The Nyse accepts orders after 9:30 for the opening-only print, and of course for day orders as well. You have a slight risk in your timing in that if the order is not in for a few seconds, you may be locked out of the trade.
PIVOTS AND NUMBERS
First off, thank you for your columns over the years. I find them very informative. I go back quite often and review some of the things you have written about. A few things are still beyond my grasp, so perhaps you could address the following: For intraday order entry, you talk about “prem,” “discount to fair value.” You also mention “pivot points” and “trading troughs.” I am still unclear what you mean by these terms. I’ve seen the term “pivots” before, but where do these numbers come from? How do I use them in my trading?
—Battlescar91
Thank you for reading, and yes, it’s been about 10 years now, so I guess there is a lot to review! As with most things, we have had to adapt and change, both in the marketplace and how we perform our tasks. We have seen tape reading change and even come full circle to where we can now identify high-frequency trading in our baskets of stocks (set your price ticker to at least four decimal places; you’ll be surprised about how many trades are “sub-sub penny”).
Now to your questions. We have discussed fair value calculations over the years, and I can defer to Hank Camp for his excellent explanation and formula (www.programtrading.com/fvalue.htm). It boils down to the cost to carry stock positions in the Standard & Poor’s 500 (for our purposes) versus holding the futures contracts. If we take the spot price of the S&P 500 (Spx or similar), the real-time total for all 500 stocks, and compare it with where the “front-month” (most traded) futures contract is trading, we see a “premium” or “discount” to fair value (FV).
For example: Spx = 1158.00 minus the FV number (due to the low interest rates currently) of about 4.00, so if the futures were trading at 1154, they would be at parity. If the futures were trading at 1156, there is a two-point premium in the futures. When we see any type of premium, we as traders understand that the big players on the futures trading floor(s) will be selling futures and buying the underlying stocks. This locks in profits for these groups. The same thing happens in reverse when they can buy futures at a discount (to FV) and sell the stocks. We anticipate these buying and selling actions and have another piece to our pie for entries or exits.
Now to pivot points. These numbers are calculated from the previous day’s “high-low-close” of the futures. They provide us with a central “pivot” point and three or more support and resistance levels for the futures. This is where the self-fulfilling prophecy comes into play. When the futures get close to these levels, the traders tend to take profits and/or slow down a directional move. As the futures are the leading indicators, many traders also slow down at these levels.
The space between pivot points is what I refer to as “trading troughs”; I view them as bumpers defining a short-term trading range. As with so many things in trading, we can watch the price action come to these bumpers and retrace (in either direction) a couple of times. When the third time comes around, we tend to hold off, thinking this might be the time we break out of this range.
These indicators are combined with other aids like ticks, depth of book, and so on to help us with our order entry. The perfect storm is to have 1,000 negative ticks, a big bid to lean on, and 1.00 or more premium, all while bouncing off a support level — and then (don’t quote me on this) — close your eyes and buy something. I hope this helps!
CRUTCH PAIRS
I don’t understand the concept of crutch pairs. Aren’t pairs by definition the holding of two stocks, long and short, at the same time?
—laracnow
Yes, pairs by definition is the trading of a long and short stock at the same time. However, crutch pairs trading is a strategy we use wherein we don’t have to hold both sides. If there is a big bid for the stock we would like to short versus the long stock we would like to buy and we see that the market seems to be rallying, we simply buy the long stock first (knowing that if the market reverses we can hit the bid on the other stock). If this buy is good and the stock goes up, we can choose to simply lock up real profits in the same stock by selling it instead of holding a complete pair. Saves money on commissions too!