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.
FROM THE Q&A ARCHIVES, A QUESTION
Don, I enjoy your articles. In reference to your column in the December 2005 issue of Stocks & Commodities, I have a query in regards to capitalization requirements and possible profits referenced in a market opening strategy. The question and answer went like this:
SCALPING NYSE & ECNS
I’m trying to learn about scalping listed stock, and since you are the listed guru, I thought I’d ask you some questions. When you are trading, do you prefer to go to the specialist or to Ecns when you need fast execution? Which of the two do you think tends to post wider spreads? —liltrdr
You might want to check my article called “Price Vs. Speed” (Technical Analysis of Stocks & Commodities, July 2004). I go into depth about why I prefer trading with the specialist. Remember, we can always use the Nyse “Ecn” (the NX function) if we want quick executions — but I prefer getting the best price over the quick execution.
From this, I take it that capitalization is required in this way:
(20)(2,000) x Average share price of high-cap S&P 500 shares
I would take the average share price to be $89 from this link:
https://www.standardandpoors.com/indices/sp-500/en/eu/?indexId=spusa-500-usduf--p-us-l--
So keeping this in mind, would my argument be correct? Would average share price be unnecessarily high? I’d be interested in your thoughts on this. Thanks.
Nice to see you keep your historical Stocks & Commodities references at your fingertips! I can address both issues for you, with updates to 2011. First, here’s the opening-only strategy and capital requirement explanation. Things have changed in the last six years, but you can assume this for the opening play:
- 1,000 shares each side = 2,000 shares
- Average price closer to $50 (since you pick your own list)
- You take 2,000 x $50 = $100,000 per stock
Many traders enter 50 stocks or $5 million with $25,000 in their accounts (20 would only be $2 million). You take away half $2.5 million, since you can’t be filled on both sides.
You assume about a 10% fill rate for the other half, or $250,000. You need to use $5 million, but do not actually use that much buying power — a good reason to trade with a trading firm vs. retail.
We have, of course, modified our strategy for the openings as well. We now use pricing based on electronic communications networks (Ecns) and so forth to be sure we don’t get blindsided on the opening gap. A lot more attention is paid to news items, earnings, and so on (a bit more preparation is needed than in the past).
It’s still one of our more lucrative strategies, both standalone and in combination with our pairs trading. If we see one stock in a pair trading much higher, premarket, we can adjust our opening prices for the other stock to reflect this difference. Since we trade both sides, we often get price improvement on the second stock.
Now to intraday scalping. Since the 2005 articles were written, we have seen the high-frequency trading (Hft) take over much of the daily volume. This, along with sub-pennies (see our 2010 S&C articles regarding both Hft and subpennies), has caused a change in our behavior. We reset our price tickers (time and sales) to at least four decimal places to see if we are being undercut by a hundredth of a penny or similar. If we are, we modify our routing to take bids and offers vs. resting on a certain price. Look for stocks with either smaller bid/ask spreads, or more mid-market Ecn activity for your scalping.
Watching this price ticker has brought on an unintended positive consequence. Now we can “tape read” direction based on this ticker and destinations (some market centers now pay for us to take their liquidity, and charge us to rest there — see my upcoming article about all these changes with “reverse Ecns”). Hope this helps!
LIQUIDITY, REST, AND ROUTING
I see you have been posting about your firm’s new approach to order routing that is saving or making your traders a lot of money. I remember you used to say “take liquidity on the Nyse (or Nasdaq) and rest or leave your orders on Arca.” Could you explain the differences you see now? Could you start by explaining “take liquidity” and “rest” orders? Does any of this routing make that much of a difference? My broker advises me to use only market orders anyway, so how does this affect me?
Wow, a lot of good and timely questions. First off, thanks for reading my posts, and be sure to keep reading S&C, since I plan on doing an article on the many industry changes in this regard — about the consolidation of exchanges, the new crop of electronic communications networks (Ecns), and their competition. I arranged to interview the top people at several market centers.
Now to your questions. When we hit a bid or take out an offer immediately, that is called “taking liquidity.” In the past, we always had to pay extra to do so. However, we would also be paid to leave our orders “resting” at various market centers (like Arca). So we would take where we paid the lowest price (with good liquidity) and rest where we got paid the most. This is called “providing liquidity.” It was pretty simple.
Due to this competitiveness, some centers are now actually paying us to “take” their liquidity. We call these “inverted Ecns,” similar to inverted exchange traded funds (Etfs). So by programming our computers with smart order logic (or simply using hot keys, or even more simply just picking a route and destination), we can now get paid for orders that we had to pay for. In our testing, it appears where we once paid extra for 90% of the orders, we now get paid for more than 50%.
How much money are we talking about? It varies, but as an example, our private Jvc trading group is estimated to save about $8,000 to $12,000 per year in fees. For instance, we pay 30 mils (0.003) to take liquidity on Arca, yet now we get paid 14 mils to take liquidity on the Nasdaq Boston (Nsbq) exchange. Since our traders pay about about 30 to 50 mils per share, this difference could eliminate their overall commissions. Overall, most traders will see a major reduction.
Take note: Be careful in your selection of routing methods and designations. The sites that pay you to take liquidity may charge more to rest on that site. For example, EdgeA pays us to take, yet EdgeX charges us to take, and vice versa for resting.
As far as your broker pushing you to use market orders (likely by pricing incentives) goes, think it through, and check other retail brokers; many charge by the share versus the “all the shares you want for $19.99” or whatever when using market orders. The average retail order is less than 200 shares the last time I checked, so it’s better to pay by the share versus by the ticket. And then you can use limit orders more freely.
Two points here: 1. Beware of “all the shares” pricing for market orders; 2. By paying per share (versus ticket), you can use limit orders for better executions. Check with your broker, or look around if necessary.