Q&A

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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. To submit a question, post your question to our website at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.

Don Bright of Bright Trading

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SPECIALIST STATEGY

I am interested in your strategy for calculating fair value, mentioned in the August 2005 issue of S&C. How can I get more info on this strategy? -Joseph Staron

Two answers: You can always check out one of our training programs (www.stocktrading.com), or you can go to www.elitetrader.com (register for free), and check the forum called "Don's openings and more." You will have to weed through several nonsense posts, but a search back to the original thread from a few years ago will show you more in-depth discussions of this particular strategy.

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CRUTCH TRADING AND EASY PAIRS?

I've been reading your posts, following your S&C column, and listening to your audio files, and I have a few questions. First, regarding an easy way to put on a pair trade, you've said there are no features of the (Redi Plus or OmnP) programs that let you "do it all" at the same time. Keeping that in mind, what do you mean by "leaning" on a solid bid or offer? Please try to explain your parameters of the solid bid or offer to lean. -Kip Page

You won't find that sort of feature on such programs because you have to sell short first, then buy... that's all we do, and we have hundreds of pairs. If you sent the orders at the same time, you would always be buying, but maybe not selling.

Let me explain the concept of "crutch pairs trading." Since we execute the hard side first, generally we mean selling the short side first (stock A). If we see a big offer (5,000 shares or more) a penny or two away from the last price of the long side stock (stock B), we place our short-sale order for the first stock. After we are filled on the short side, we watch the offer on stock B while monitoring our short position. If the short stock goes down, creating a profit for us, we can take that profit at any point, thus closing that particular trade with a positive result. If, for example, the short stock starts moving to the upside, we hedge off (or pair up) by buying the B stock. Before entering the first trade, we have ascertained through analysis that it is theoretically better to have the pair on at these prices than to take a loss if the A stock goes against us - thus "crutch" pairs trading.

As for easy pairs trading, if the short goes down, just buy that back and lock in a profit for half the commission costs. Or if you do crutch pair trade, sell first and then lean on the offer of the other stock. By "lean," I mean if there is a big offer in the NYOB for the stock that you would want to go long in the pair, sell the other one first, "leaning" on the offer of the (preferred long) stock.

If the short starts going up, buy the long stock at the offer. You have predetermined that the (long) stock is a better buy than the short stock at the particular prices showing, so instead of taking a loss on the short, you hedge yourself and complete the dollar neutral pair.

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DAYTRADER VS. SHORT-TERM TRADER

Are we daytraders trading the noises? -Always a learner

Daytraders respond to the noise in the market, and they provide the liquidity necessary for the system to work at all. If you think about it, the NYSE specialists are the perfect examples of daytraders and have been making money for 200 years.

Trading is trading, and we prefer to be called "short-term traders," since we do so much more than merely daytrade. It takes a full understanding of how the markets work (and which strategies are working) to make a living month after month. Currently, some of our traders are doing correlated pairs trading, which requires holding many positions for days or even weeks.

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MORE GAMING THEORY

I was interested in the similarities you listed between poker and trading in your October 2005 column in S&C. I had some probability theory in math and minimal gaming theory in political science classes a decade or two ago, so I'd like to refresh. Could you recommend any books or other materials on gaming theory? -tango29

Gaming theory is important in trading, and we expect our traders to become familiar with at least the basics. Besides the list of these similarities in the October issue, you can find them online at www.stocktrading.com/tradingandpoker.htm.

You might start your refresher by going to http://levine.sscnet.ucla.edu/general/whatis.htm. I also suggest you check out the book selection at www.gametheory.net. You can Google "game theory, ferguson" for some more cool stuff, and "game theory, UCLA" as well. If you want to have some fun and play with real professionals (not for money, just  for fun), you can register by visiting www.stocktrading.com/pokerandhouston.htm.

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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 November 2005 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.

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