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10 Day Trading
5. Invest in technical analysis software. Automate the trading process as much as possible.
10.1 Finding a Day Trading Firm
Selecting the right trading firm is the second most important decision a trader will make-the firm must demonstrate that it is interested in your success, not in burning through your capital by encouraging excessive trading. During the evaluation period, you are assessing each firms package of technology, training, customer service, and costs. Make a checklist ofthe following items:
Investment in software and hardware technology
Training and mentoring Broad ECN access
Commission rates and seat costs
Technical analysis software Customer service Technical support
NASD member and SIPC account insurance
When investigating a firm, find out what their traders are doing: day trading, position trading, system trading, or a combination. A day trader executes trades that last from as little as a few seconds to as long as a few hours; the day trader carries no ovemight positions, i.e., is "all cash" at the end ofthe day, carrying no exposure to ovemight risk. The swing trader, or position trader, executes trades that usually last several days. The swing trader uses short-term technical analysis indicators to enter and exit positions. Finally, the system trader uses computer programs to generate automatic buy and sell signals with predefined entry and exit prices, spanning all time frames.
The second decision a trader must make is whether or not to trade on-site or remotely. The advantage of trading on a floor is that other traders can be a source ofideas (just make sure they make money). The trading floors have distinct atmospheres; either the floor is noisy with traders exchanging ideas, or it is quiet with concentration. Question whether or not you will be able to tolerate a trader looking over your shoulder and pestering you for ideas. For some, the banter is good; for others, it is irritating.
When visiting a floor, go ten minutes before the market opens. At 9:30 am on a busy day, the software vendors send out a burst ofmarket data, and some brokers are ill equipped to distribute the data fast enough. We have seen realtime quotes thathave been delayed by as much as ten seconds, an eternity in the life of a day trader.
10.1 Finding a Day Trading Firm
Access to the best technology is essential for the day trader. When evaluating a trading firm, evaluate the software features developed specifically for the day trader. Most of the direct access brokers have Level II quotes, point-and-click execution, and rudimentary charting, but offer little else. Advanced software has programmable features such as:
Universal symbol filtering to eliminate unnecessary data
Hot keys for fast execution (the mouse is too slow)
Technical alerts such as three-day highs or volume spikes
Real-time position, profit, and buying power information
Market maker movement information (level changes) Custom tickers with filtering by symbol and volume
Quote lists with custom fields
Access to all ECNs with advanced order entry (e.g., reserve orders)
Technical analysis software such as TradeStation or FirstAlert
Data feed services such as OpenBook
Assess the number and quality ofthe technical support staff. If they spend their time rebooting the server during the trading day, then their technical support is inadequate. Ifyou trade from home and they can tell you the frame relay delay in milhseconds over a DSL line, then they probably understand the technology. Finally, corner one ofthe traders to ask about delays or outages.
Service extends to other areas such as the back office, and a trader will want to ask questions such as:
How does the firm treat its clients?
What is the trading atmosphere like?
Who clears the brokers trades?
How soon are trade confirmations received?
Finally, ask about the experience ofthe traders on the floor. The truly successful day trader has been trading profitably for a minimum of several years in all kinds of markets. Many firms are populated with part-time position traders who have otherjobs. There are many traders that come and go within several months.
Although there is no substitute for learning how to trade other than from a seasoned professional, look for someone who is willing to teach you specific techniques. In the following sections, we review the basic Level 11 trading technique and then present some advanced trading techniques with a set of case studies.
10 Day Trading
10.2 Trading the Nasdaq
The trading of a Nasdaq stock is shaped by the following attributes:
Number of market makers (depth) Average Daily Volume (ADV)
Average True liange (ATR) Spread
Volatility Percentage (VP)
Table 10.1 shows the relationship between the market maker coverage and the spread. As the number of market makers, ADV, and float decreases, the value of the spread naturally increases. The trader wants the combination of a tight spread and volatility, using measures such as the VP and ADV/Float ratio. For example, trading 1000 shares of VRSN will average about $40 per round trip in slippage (1000 X 2 X .02), reducing the trading cost substantially.
Table 10.1. NasdaqTradingCharacteristics
102.1 Nasdaq Market Participants
Each Nasdaq stock is represented by a group of market makers and electronic communications networks that compete to buy and sell shares on a computerized exchange. Investment banks such as Goldman Sachs, Merrill Lynch, and Morgan Stanley are market makers Each market maker is an NASD member firm and must register to quote a security; each market maker displays both bid and offer price quotations for a certain number of shares.
10.2 Trading the Nasdaq
When a market maker "makes a market", it is providing a dual function-it fills customer orders for that stock (agency trades), and it buys and sells for its own account (principal trades). Each market maker is assigned a four-letter code, a Market Participant ID ( ). For example, the acronym GSCO represents Goldman Sachs, and MSCO is Morgan Stanley.
The strongest market maker at any given time is known as the.4x. The Ax is typically the companys lead underwriter and investment banker, but this role changes from day to day. Other traders attempt to follow the Axs lead by high-hghting certain market makers, but lack of access to order flow puts the trader at a disadvantage. Be skeptical of anyone who claims to know how to follow the Ax; however, look for a public display of affection (PDA) on the Level window, a sudden jump onto the best bid or offer.
The theory behind market maker analysis is that if a key market maker goes high bid, then a buying situation is created, and if the market maker goes low offer, then a selling situation is created. This is another myth perpetrated by the chumers and burners. The smart market maker is accumulating shares through an ECN. The perfect time to dump these shares is to pop up on the bid with a PDA and then be ready and waiting to sell to all comers on the offer through an ECN. The difficulty of day trading with Level II quotes is that the risk/reward ratio is skewed, a pursuit similar to picking up dimes in front ofbuUdozers.
The trader may feel that becoming wise to a market makers movement is a ticket to profits. Suppose in our previous example that the trader decides to fade the PDA. This time, the market maker really wants the shares, so the trader goes short Guess what happens-the market maker buys all the shares because he is filling an order, going high bid one distressing level after another. Again, this is an issue of order flow and the requirements ofthe market maker filling an order . A trader who sees a market maker as a conspirator should probably be writing the screenplay for a sequel to JFK.
Electronic communications networks, or ECNs, are trading exchanges that are directly accessible to the public through various online brokers (hence the term direct access broker). The well-known day trading firms give access to all ofthe ECNs. Note that each ECN is also assigned an MPID. For example, the MPID of Island is ISLD, and the MPID of Instinct is INCA. ECN symbols are listed along with the market maker symbols at the Nasdaq Trader Web site.
The influx ofECNs changed the basic momentum game into a comphcated puzzle of analyzing individual marketmaker movements. Marketmakers developed techniques for enticing day traders into buying stock that they wished to sell and vice versa. Consequently, software developers added features to alert trailers to market maker movements, but the result was a Pyrrhic victory in the absence of any order flow. When f rst introduced, Level II quotations gave the trader an advantage, now, thej are ] 1 a minimum requirement for day trading.
10.2.2 Level II Quotations
Together, the best bid price (highest) and the best offer price (lowest) compnse a Levellquote. The current bid and ask price are displayed in combination as the inside matiet. The other bids atlowerprices and other offers athigherprices are outside the market. For example, if a stock is quoting 17.38 X 17.39, then 17.38 is the highest bid price and 17.39 is the lowest offer price-other bids start at 17.37 and lower, with other offers at 17.40 or higher. The difference between the best offer price and best bid price is known as the spread. The spread on the sanqile quote here is 17.39 minus 17.38 equals 0.01, or one cent.
A ifi-f /display shows ah ofthe bid and ask prices for a stock, i.e., ah of the bid prices are in descending order (from highest to lowest) on the left-hend side, and the ask prices are shown in ascending order (lowest to highest) on the right-hand side. Each bid or offer price is associated with either amarket maker or an ECN in the first column The number of shares that the market maker is bidding or offering is shown in the third column in units of 100. Note how each price tier is delineated by color.
In the Level II window in Figure 10.1, Goldman Sachs (GSCO) is bidding 1000 shares of Cisco at 17.38. The Island ECN (ISLD) is bidding 2500 shares at 17.38, and Instinct (INC A) is offering 2300 sliares of Cisco at 17.39.
Figure 10.1. Level II Window
The Level II window is modeled on the Nasdaq Workstation that each market maker uses to display quotes, adjust quotes, and enter orders. Software vendors
Implemented a fecsumle ofthis display based on the online traders couM see the same information.
10.2.3 Level II Tutorial
Before understanding the details of Level II, one must appreciate the histor} of its usage. Qriginahy, the Level II quote screen was the basis of a momentum technique known as "SOESing", where a trader could profit simply by bujing out ah ofthe market makers at the best offer price and then selling backto them at a higher price, based on the illusion of upside momentum. However, market makers learned the game quickly, and trading with Level II degenerated into a game ofhead fakes, firepower, and spoofing.
Figure 10.2. Level II Snapshot 1
Figure 10.2 shows the first Leval II snapshot in the tutorial. The current quote for Cisco (Nasdaq:CSCO) is 17.38 bid X 17.39 offer-three market participants for a total of4500 sliares on the bid, and two market participants for a total of 3300 sheres at the offer. The last teade was 1000 shares 17.38, and the stock is on a down bid (denoted by the arrow).
Suppose that after several minutes, the market makerwindow in Figure 10.2 s to the display in Figure 10.3:
data feed so that
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