Since You Asked - July 2006

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

ZERO-SUM GAME OR NOT?
Could one of you academics who believe the stock market (Edit: should read "futures" not stock market) is a zero-sum game explain this idea? I think if you believe the market is a zero-sum game, you don't belong in it and should probably get a job teaching theory and not reality. The way I see it, the only way it can be a zero-sum game is if every company in the market went bankrupt and became worthless, and I'm pretty sure this won't happen.-Madmummy
(Edit: The question was about futures not the stock market) Since I get the same question during my training sessions, let me offer the following. Imagine I took a company public a few years ago. Say we sold $10 million worth of stock at $1.00. We “made” $10 million. Imagine that investors bought stock at $1.00 and sold it at $3.00, so they made money. So far, $30 million has been “made.” Those who bought stock at $3.00 have lost nothing at this point. Companies generally trade for several times book value and even higher price/earnings multiples — so even if the company breaks even, their stock may “stay” at $3.00 forever. When a company makes money, “true value” goes up, closer to the $3.00 mark, so price may increase. The market then determines pricing, with buyers and sellers taking market risk. Dividends and appreciation and overall profitability add to value. Perhaps this will help the discussion (or maybe not!).
SWINGING IN THE SHORT TERM
I am a short-term swing trader. I bought Great Atlantic Pacific (GAP) two days ago. The company is issuing a $7.25 dividend on April 25 to shareholders of record on April 17. Yahoo! has the ex-dividend date as April 12, which is today. Today, the stock dropped about $7.25, yet Yahoo! and CNN Money show the stock as being positive, obviously taking the $7.25 into account. Why did it drop today and not April 17 (the shareholder of record date)? Do I have to hold until April 17 in order to collect the dividend? If I sold tomorrow morning, do I lose the dividend? -garymc
On the ex-dividend date, the stock will open down the amount of the dividend to compensate for paying the dividend. For example, if a stock had a 50-cent dividend and closed the previous day at $31, then opened unchanged, the price the next morning would show $30.50 unchanged. Any up or down movement in price would be calculated based on the previous day's closing price minus 50 cents. Record date accounts for the three-day settlement period. You shouldn't lose the dividend because your sale also has a three-day (trading days, of course) settlement (one day later). If you're trading a retail account, I would suggest checking with your brokerage firm about proper “ex” dates, as they often show different dates from different sources. Hope this helps.
ON EMINI PRICE MOVES
Everyone knows the price of a stock changes because there are more buyers than sellers or the other way around. But why and how does the price of emini futures move? I measured how many buys and sells, number of transactions on each side and volume on each side, and in a particular period, and it didn't make sense: Sometimes there were more ES buy transactions with overall buy volume higher and still price was falling, or more sell transactions (higher sell volume also) with ES climbing. Let's assume there are 50% buys and 50% sells (transactions and volume wise) in ER2; so would the price stay unchanged? -RobertM
This is a good question we cover in detail with our trainees. First, there is a buy for every sell transaction. When you see buy or sell orders reflected on your datafeed, be aware of the number of orders changing often and quickly (especially with the eminis).
Imagine an institution with billions of dollars to trade with. They may have a big portfolio of long stock positions that they wish to hedge, dollar for dollar. They start selling the futures at 1298, and continue selling down to 1297 because they need to sell such a large number of contracts. Now imagine the floor traders (and other discretionary traders and program traders) buying these contracts. They will buy some, lower their bid, buy some more, lower their bid. This causes the price of the futures to temporarily trade as theoretical value. Purchasing these contracts under theoretical value is the same as buying all 500 stocks at a discount to their current market price. These same traders will sell the stocks at over value (current market value), so they have locked in a theoretical profit with this open position. These same futures traders will do the same thing in reverse when there is an abundance of buyers. They will sell the futures over value and buy the stocks back, thus closing positions and locking in their actual profits.
Don't think for a minute that just because you see more bids than offers that the market is rising (sometimes yes, sometimes no) because of all the possible hedging opportunities that avail themselves today due to the ever-growing number of derivatives. These bids and offers change based on various criteria from various trading strategies.

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

Originally published in the July 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2006, Technical Analysis, Inc.

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