Q&A

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Since You Asked

Confused about some aspect of trading? Professionaltrader Don Bright of Bright Trading (www.stocktrading.com), an equity tradingcorporation, answers a few of your questions.

Don Bright of Bright Trading

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FACTS OF (TRADING) LIFE

I just started my second year of trading, and while I'm not makingany money yet, hopefully I will be soon. Would you say that a negativestate of mind and the psychology of trading are why so many fail?--pamjoey

As I tell all my traders, "Trading is simple, but the psychology involvedis murder." And the "trading is simple" part only applies if you have takenthe time to learn what the heck you should be doing. I can't believe thatI still get people who think that "trading" is either "picking stocks"or "choosing market direction" -- and I have to explain the facts of tradinglife to them. Most "trainers" and "book writers" want to make the massesbelieve they can run their $25,000 account into lots of money with a systemof some kind or another. The working strategies tend to be "lower risk,higher reward, but capital-intensive" for the most part. Market-neutralstrategies have been working well in recent markets, and made for hardlya hiccup on the February 27th selloff (down 400-plus points in the market).

PROPRIETARY TRADING: A CONVERSATION

I have a question about prop trading. Are they all daytrading shops?I know the goal is to make money, but do you have to churn a certain amountof shares per day? Can you go at your own pace?--magicz

"Going at your own pace" is a must in my mind. Our people do "some"daytrading, and "some" correlated pairs, "some" market making, engage in"some" automation, and so forth -- you get the idea. We have people whotrade fewer than 50,000 shares per month, and some who trade 500,000 sharesper day -- it all boils down to your style, training, and comfort level.

Thanks, Don. I was doing a little research on prop firms. Other thanthe help with greater leverage (when needed), what does a retail traderlike me have to gain from joining a prop firm, and what does a prop firmgain from me if I were a profitable trader?

I have a risk-adverse strategy and I use derivatives to hedge allmy stock positions if I own any at that time. Since I am a swing traderby trade, my horizon isn't day to day but closer to week to week. It seemsmy style of trading wouldn't be accepted at a prop firm. I am correct?--magicz

"Leverage" is misunderstood for the most part; I prefer the term "useof capital." Leverage implies that you are planning on buying more sharesin hopes of "leveraging" yourself into more profits by using more capital,and this is not the case.

By having access to a couple million dollars, you can engage in differentstrategies that work well (lower risk, higher reward) but tend to be capital-intensive(correlated pairs, opening-only orders with the Nyse specialist, mergers& acquisitions, market making, baskets, automation, and so on). Thepublic is pretty much limited to picking stocks or picking direction, orboth. We don't have to be.

As a prop firm, we also collect interest on short stock sales, around5% or so at this time, which is nice compared with using derivatives attimes (most retail accounts don't receive short stock interest, which makesit pretty foolish to engage in long/short strategies and mergers, of course).

Longer-term holdings and hedging are both part and parcel of successfultrading. As traders we shouldn't limit ourselves to any particular timeframe.

All that said, the only thing that matters is your bottom line. If you'reable to make good money trading retail, then by all means continue doingso -- prop trading is definitely not for everyone.

CORRELATED PAIRS DAYTRADING

I've had several questions about daytrading of correlated pairs. Hereis my standard response: By spreading the overall risk by adding more pairsto the mix, we have the opportunity to snag quite a bit of intraday noiseand are likely to have several daytrades each day in at least a few ofour pairs. A word of caution to retail traders: Check to see if your brokerpays you interest on short stock sales -- most don't. If not, it is normallynot profitable to hold overnight pairs. For example, our traders receivea good rate from Goldman Sachs (approximately 5%, currently).

By having predetermined entry/exit levels, this activity can be triggeredeasily with our spreadsheets. This additional activity has added greatlyto the bottom line of our pairs traders.

In addition, we tend to leave one layer on all the time so we can takeadvantage of longer-term trending of each pair that is going in the correctdirection.

Because of the profits that can be made by pairs trading, we have beenincluding pairs trading in our three-day class here in Las Vegas. By havingaccess to the database provided by Bright/PairCo, a lot of the grunt workhas been eliminated for the traders, allowing them to focus on trading.For more details, check out www.stock trading.com/training.html.

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

Originally published in the June 2007 issue of Technical Analysisof STOCKS & COMMODITIES magazine. All rights reserved. © Copyright2007, Technical Analysis, Inc.

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