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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BASIC SKILLS FOR DAYTRADERS

Don, since you think (pure) daytrading is a limited style, thenhow do other daytraders make profits? Could you tell me some basic tradingmethods or skills for daytraders? -- Anonymous

I'm not against daytrading, but I think other strategies can augmentyour income. Our new people learn how to do "open-only orders" (OPG) onthe NYSE. We enter about 50 stocks, buys, and sell shorts, based on fairvalue calculations. Then, when a few of the stocks gap up or down, theyare filled only when the specialist is filled. Why not trade on the sameside as the guy who's been making money for 200 years? Our daytraders alwayshave "outside envelopes," the practice of having active bids a few pennieslower than the quoted national best bid or offer (NBBO) bid and activeoffers a few pennies above the sell NBBO, to take advantage of sweeps,either collecting for providing liquidity via Arca, or joining the specialistagain on hybrid overrides (exemptions and exceptions to the Nms rules).

We do a lot of "crutch" pairs trading, where we lean on a big offerin stock A while shorting stock B when the market is showing a negativepremium to S&P fair value, buying back the short if it goes our wayor buying stock A at a predetermined price within our buy zone.

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FILLS AND LIMIT ORDERS

What conditions are present where your limit orders are filledmore often? Thanks. -- ProgrammerGuy

Limit orders are just that, an order to buy or sell with a specificprice attached. When we start to see a big move and "must have" the stock,we enter bids higher than the NYSE offer, knowing that we will likely getthe offer price anyway but never anything higher than our bid price.

If you're referring to making money on the bid/ask spread, you mightrethink that -- it's not going to work in your favor. You might very wellbuy on the bid, but then the bid may go down a dime, and take the offerwith it. Even market makers rarely get filled on both sides of the bid/askspread.

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HEDGING VS DIRECTIONAL TRADING

In holding an overnight position (with your firm), does it alwaysneed to be hedged? Or can the trader have the option of holding, let'ssay, five stocks at 1,000 shares each -- low beta, diversified for a directionalplay, each stock in a different sector, regardless long/short, just a directionper se -- with risk parameters that make sense for a swing trade that iswithin the buying power allowed for overnights? If a trader can trade freelyusing common sense with good risk control, do all overnights need to behedged, regardless of the variables? I am just trying to determine howmuch flexibility you offer to your traders on overnights. Thanks. -- Mitchfrom NJ

We have some strictly "directional" types, and they can take home positions(in general with not so good results overall), but sure. Those that arehedged seem to do better overall.

This is why clearing firms and trading firms have haircut charges (haircut= risk fee for extra capital usage). For example, hedged positions aresix times equity for free. Unhedged positions have a higher cost of carry.

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TRADING VS INVESTING

Thanks for your response; it's good to see there is some freedomin trading different styles using good risk parameters from your experience.So why are there not many good directional traders in your firm? Do mosttraders lack the knowledge in understanding the markets and stocks theytrade? A stock is going up or down, choosing a direction and being profitableis not brain surgery, it's how you manage your trades with every otherstyle that determines your profit & loss. Your thoughts? -- Mitch fromNJ

In my opinion, there is a big difference between trading and investing.

If you're switching money from bank interest straight to investing,trying to beat bank interest, that's one thing. If you need to borrow capitalto invest with, then you have to overcome that percentage before beingprofitable.

Investors look for return on investment (ROI) -- mostly passive income,where traders are actively working at their trading. Sure, there is crossover.

A trader with $25,000 who makes $5,000 per week -- is he really making20% per week in ROI? Of course not, he's working really hard each day,and the money being used -- ours -- is just a tool, no different than a computer.

When you find a stock that you want to keep long for days/weeks/monthsbased on fundamentals and technicals, you can probably find an offsettingposition to sell short (collecting interest on the short-stock sales, whichis not paid to retail traders, but our people currently receive 5% perannum) -- thus, you're paying considerably less to keep the long position.Does that make sense? If you pay 6.75% naked to use money, plus some possiblehaircut, why not collect 5% interest and get to use more money withouta haircut?

As a family portfolio "hedge fund," we are almost always hedged againstgeneral market risk, and yet we don't have to use other people's moneyor borrow any -- so at times we take a shot. But in general, we're prettyhedged.

Hope that helps.

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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 2007 issue of Technical Analysisof STOCKS & COMMODITIES magazine. All rights reserved. © Copyright2007, Technical Analysis, Inc.

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