Q&A - February 2007
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 |
KEEPING IT CONSISTENT
When you are performing analysis on a couple of stocks for a pair
trade or some sort of relative performance, or for that matter comparing
advancing issues and declining issues of a limited basket (say the sp100
basket), is it better to do a ratio (dividing the two) or a difference
(subtract the two)? I have seen examples from different sources
including pairtrade.com when dividing and subtracting were used. When I
look at the differences between the two ways of looking at the data, I
notice they basically mirror each other most of the time and are almost
identical, but there are times when the ratio of the two shows a spike
and starts to move quicker in the opposite direction than the difference
of the two. What is your take on using these two different calculations?
Is one better than the other? Why on some occasions does the ratio
exhibit quicker and better trend movements than the other
calculation?
In a basic spread chart, when you subtract the two different
stocks or divide the two stocks so that you create a spread chart that
shows more of a range-bound or oscillating quality to find those mean
reverting signals, why do some people use a subtraction of the two
stocks while others use a ratio or division of the two to create a new
spread chart? --raker
If I understand your question, basically, we "ratio" share size to
allow for neutral long/short values (with a certain percentage long or
short, based on the fundamentals involved). These ratios change as the
price of the stocks change. Now, for the performance analysis, we use
average trading range (ATR) of the pair over a period of time. This
helps us determine entries, add-ons, and exits, along with the amount of
frequency we may seek for each pair.
Spiking pair spread prices tends to have us "let it run" after a
certain level, settle down, and begin the higher frequency again. I use
a pair trading chart where we put in, for example, 2 x CC minus 1 x BBY.
CC = 24 x 2 = $48. BBY = 54. So the ratio spread is $6.00. If we are
long BBY, we bought the spread for $6.00 in expectation that the ratio
spread will widen out to $6.50 or so. Then we close the spread at $6.50.
If we then wanted to be short BBY, we would sell the spread for $6.50,
expecting it to narrow back to a mean.
I use eSignal for that -- myTrack works well, too (only $5.00 per
month for research, no live feeds).
On REDI, we have a price difference chart that works fine, but it is
only one to one, price to price.
It depends on your parameters for working with average trading ranges
-- have to keep consistent, that's the main thing. I hope this helps --
this is so much easier to explain when discussed in person or in a
mentorship environment to assure proper understanding of everything from
terminology to general concepts.
FORMULATING TRADING PLANS
Don, I've heard you speak several times and you always mention
that every trader should develop a trading plan. I have made up business
plans before for other businesses, but nothing to do with my trading.
Can you give some advice or examples of what we should be including in
our plans? -- MichaelV
Good question. Imagine that you were going to a banker in hopes that
he would lend you $100,000 to begin your venture into stock trading.
This is quite a stretch, as you can imagine. What would you show him?
Not just projections of possible profits, right? He would want to see
several basic bits of information including, but not limited to, markets
and instruments to be traded (NYSE, NASDAQ, futures, or options, for
example), but he would then want to know your time frame (scalping or
daytrading, swing trading, portfolio management, mergers, and so on).
He will want to know why you think you're qualified to make money in
the trading arena, so you should detail your background, but more
important, outline what you're going to do to improve your future
results as time goes by. To help make some of this easier, I'm going to
offer you this modified plan and link from our training program,
available on www.stocktrading.com/TradingPlanTASC.htm.
Good luck with your trading.
E-mail your questions for Bright to Editor@Traders.com, with the
subject line direct to "Don Bright Question."
Originally published in the February 2007 issue of Technical
Analysis of STOCKS & COMMODITIES magazine. All rights reserved. ©
Copyright 2007, Technical Analysis, Inc.
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