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. |
Don Bright of Bright Trading |
ON PIVOT POINTS AND DAYTRADING
Is there any relationship between pivot points and daytrading?
I believe there is, but I do not know what it is. Could you give me some
help?--robinxing
We use the pivot points of the futures in our entry/exit decisions
during the day in this way: We consider the trading troughs between
pivot and R1 or S1, S1 and S2, and so on, to be "mini"
support/resistance levels. (We use resistance levels 1, 2, 3, and 4, and
support levels 1, 2, 3, and 4.) They tend to be a self-fulfilling
prophecy, since the large futures traders on the floor (and off) tend to
stall at these levels.
We don't necessarily use the individual stock pivot points; we merely
consider the overall market trading range or level along with other
indicators.
BUY/SELL ENVELOPE PRICING
You say: "When the market is opening up four or five S&P
points, it's a good idea to have a wider buy envelope and a narrower
sell envelope. I used 0.65% buy and 0.3% sell, for example." But why?
Would it not be more logical that the sell envelope was wider and buy a
narrower envelope?--Sheik
First, since I have already adjusted the selling price to reflect a
much higher opening (FV estimated opening price already up, based on
futures prices), I don't want a wider sell envelope because it would put
the short sell price so far away it would have little chance of being
filled. The FV calculation has already moved the price up.
Second, I widen the buy side to keep it below the previous day's
closing price. I don't like to buy anything barely above yesterday's
closing price when the rest of the market is opening sharply up. If it
can't open up with the market, I don't want to be stuck long the darn
thing!
FORECASTING IMPLIED VOLATILITY
Can you tell me a way to forecast implied volatility?
--crgarcia
Forecasting implied volatility (IV) would be a wonderful tool, and
many have come up with models that attempt to do just that. However, by
definition, one cannot accurately forecast future events such as the
actual IV of options. IV is determined solely by the actual pricing
based on supply and demand.
My decade or so on the options floor was spent, in great part, trying
to get the "implied" (actual pricing) as high as the market would bear,
and then reversing back to historical volatility (or lower) based on the
Black-Scholes models.
According to Investopedia.com, the Black-Scholes model is one of the
most important concepts in modern financial theory. Developed in 1973 by
Fischer Black, Robert Merton, and Myron Scholes, it is still regarded as
one of the best ways of determining fair prices of options.
The Investopedia entry goes on to say that there are variants of the
original model. By about the mid-1980s, everyone had the same computer
programs, so most of the edges were diminished. Conversions were priced
close to fair value based on current interest rates.
The same techniques (straddles, strangles, butterflies, condors,bull
spreads, bear spreads, synthetics, and so on) were used by most traders
on the floor back then, and some are still being used -- but it all
comes down to who has the best forecast at what next month's actual
volatility will be. Selling reverse conversions (long call, short put,
and short stock) was great when we would collect 15% or so interest on
millions of dollars of short stock sales.
NEW STRATEGIES
I have been trading for six months, with a proprietary firm out
of Manhattan. I follow sectors -- gold, silver, copper, oil, and
transports, with the same stocks for each group. I buy what doesn't go
down when the market goes down; I'll buy when and if that sector turns
and sell what doesn't go up when the market goes up. So I follow these
sectors with their index or exchange traded fund.
I incorporated this strategy into a trading system I made where
I use a stock's moving average convergence/divergence (MACD), relative
strength index (RSI), and volume, so whenever all three indicators give
a buy signal (about once every two to four days) within a 20-second
period, I'll look to buy if that stock meets my strategy but not always,
because I'll often get a strong signal from a few stocks in the same
sector at the beginning of a rally. Basically, my strategy tells me when
to buy and sell, and when not to buy.
I would love to hear your thoughts on this strategy. I think it
is good, but I'm not making money because I don't have much to begin
with and that creates fear, which is affecting my trading. --Joseph
Klar
What you describe is a single part of our multipart, all-encompassing
tape reading that our traders use. You need to add prem/disc to FV (of
futures, the leading indicator), be aware of which trading trough you're
in based on daily pivot points, and be sure you're always "outside
enveloping" to ensure you get caught up in the sweeps on the hybrid
system on the NYSE. Be aware of each stock's standard deviation move
based on historical volatility (we call this "Bright Bands"), and be
aware of the "engine of the day" -- the driving force such as oil
prices, interest rate changes, mergers & acquisitions activity, and
so on. Then you should get involved in trading correlated pairs and
doing the opening-only strategy on a daily basis (you can search STOCKS
& COMMODITIES for explanations of these strategies).
You should not attempt to trade a stock within a sector without
keeping track of its pair(s) and its peers. Doing so is a recipe for
disaster. Fundamental analysis, along with technical analysis, is
required for proper pair selection and trading. Good luck and hope this
helps!
E-mail your questions for Bright to Editor@Traders.com,
with the subject line direct to "Don Bright Question."
Originally published in the August 2007 issue of Technical
Analysis of STOCKS & COMMODITIES magazine. All rights reserved. ©
Copyright 2007, Technical Analysis, Inc.
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