Q&A

Since You Asked

with Don Bright

-----------------------------------------------------------------------------------------------------------------------------------------------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.
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SUBPENNIES AND HIGH-FREQUENCY TRADING
Don, I read your recent column about subpennies and high-frequency trading (S&C, March 2010). How have you and your traders adapted your order routing in the last few months?

Good question. For the longest time we would advise our traders to “park” on an electronic communications network (Ecn) to collect rebates when they were waiting to be hit on a bid or offer. We would advise them to hit bids or take out offers on the primary exchange (Nyse, for example), since it was cheaper overall. Currently, we feel that it makes sense to do the latter most of the time since we are finding that when we park, we are getting fewer fills due to the high-frequency trading (Hft) orders getting placed in front of our orders. Hopefully, the regulators will work with liquidity providers to fix some of this.

WHAT ARTICLE WAS THAT AGAIN?
In a 2007 article in Stocks & Commodities, you stated that there are other strategies rather than directional for trading accounts over $1 million. I can’t remember what issue that article was in. Could you tell me? I’ve been searching through the stocktrading.com articles folder and can’t find it. Much thanks. — Ed Goon

I double-checked a few of the 2007 articles and am not sure which one you’re referring to. However, the answer is still the same, and it’s probably a good time to review current working strategies.

Our traders put up the same amount of capital that they would at any brokerage, $25,000 or so. The main distinction you’re referring to is that our people actually use the company’s money to trade with. They can use (not abuse) maybe a $1 million or more of our money to engage in good, working strategies. This brings up the obvious question of, “Don, what are these good, working strategies?”

Now for some specifics. The old standard around here is the “opening-only order” strategy. I have written about this many times over the years, yet it is as viable today as it was years ago. Today [February 17, 2010] was no exception. For those of you who might be new to Technical Analysis of Stocks & Commodities, let me review. Every day, stocks have a single price only twice, once at the opening, and once at the close (end of day). Premarket, there are millions of shares entered to buy and also to sell of most Nyse stocks that are asking for the opening-only price. Many orders are entered as “market on open” — meaning that they wish to buy or sell, regardless of what the price is. Many are entered as limit orders “opening-only,” meaning that they want to open the position at predetermined limit prices or better.

So, at about five minutes before the market opens, there may be two million shares to buy and only a million and a half shares to sell at or about the previous day’s closing price. The specialist on the Nyse must go to his electronic book at higher prices to accommodate these excess buy orders. If the stock must open high enough, then the specialist is required to accommodate by selling shares himself. What we try to do is participate only when the specialist is involved — and to be on the same side of the trade as he is. How do we go about this? Pretty simple, really.

Today, I entered buy orders and sell short orders because the market was only opening up about five S&P points. On 30 stocks I placed orders to sell short based on this fair value opening range, and I placed buy orders with a wider envelope for the same 30 stocks. If I use 2,000 shares, then I have used about $5 million in an attempt to make $500 to $1,000 or so. I expected to get filled on about 10%, which is what happened — I had three fills, two short sells, and one long buy. I made money on all three orders, which I calculated in pennies (since you can do this with 100 shares or 5,000 shares), and made about 21 cents. On 2,000 shares, that would be about $420. This is an example of using versus abusing capital. It’s not margin and it’s not leverage per se. It is “use of capital.”

Now, after the market opens, many of our traders turn to our correlated-pairs trading strategy. This involves researching stocks in the same sectors that tend to parallel each other (and usually the overall market) in such a way that they trade as a spread. An example might be Rcl/Ccl or DD/Dow, and so forth. These pairs tend to diverge and converge over time and intraday. When you are capable of holding perhaps a dozen pairs overnight, again “using capital” to allow for convergence, then you have a big edge.

Leverage or margin as commonly considered is not the same as “using capital” properly. However, if you are doing something well with 200 shares, imagine how well you can do with 2,000 shares.

Overall, one step at a time — understand what you’re doing, and adjust capital usage accordingly. I hope this helps!

E-mail your questions for Don Bright to Editor@Traders.com, with the subject line
direct to “Don Bright Question.”

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