188 ‘9 Tools ofthe rede COVER in Figure 98, there isan order to sll short 700 shares st 26.375 This is goed chart for sever reasons First, the stock s poised to break out off sym-
metrical trimgle formed over the past several weeks Second, today’s range is cnly LOL, a fraction ofthe ATR of287, a good ristireward ratio Finiy, the stock gapped down strongly on February 8°, so fear is built into the stock, On @
fundamental nete, Overture sold offapain after the last pivet high because ofa competitive produc in the Internet advertising marketplace,
Figure 9.8 Overture Services Entry Order
‘The chan in Figure formed a triple bettom, andit is bounded by a large descending triangle, Based 9.9 is CACL The stock is in a four-day rectangle, it has ‘onthese conditions, the stock chart is bearish because the rectangle is unbiased, the triple bottom is bearish and the descending triangle js bearish Since We Ihave an Acme R entry, we can simply wail for a breakout in either direction Certainly, trader can have an opinion abou! a trade, but the epinion means thing A:market opinion never matters except forthe shameless money man- ‘ages "talking their ook Either they are stuck in a position that needs a boost, ‘or they want to sell ata higher price-to you Be skeptical ofmarket gurus who raise their equity weightings in public Ifthe gura works fora major investment bank, then alt ofhis ing this news to the public is a chance to unload short-term trading positions er her ctients have been elued in the day before, and reteas- For further information about these market gurus, read Niederbofiers hilarious
taxonomy of market forecasters Figure9.9, CACTEntry Order Update
“Today is Friday, March 1" We will now review each ofthe long and sheet tae entes ftom February 26° Fist the chast of EAST is shown in Fignse 9.10 As expected, pace broke the upper oat channel, and the trade was exited within
‘ovo days When a stock moves this quickly in two days profits should be taken (on halfofthe position Later that day, the remaining haifwas stopped out
=
Trang 2mò 9 Tools ofthe Trade Remember the chart of Business Objects? We thought that this was the weakest chart, but this signal tured out to be the best trade (Figure 9.11) a testament to
‘gure 9.1, Business Objects Peston
“The Acme N short entry never triggered for OVER, as shown in Figure 91%: however, it did break out ofits symmetrical triangle Pigaee 9.12 Os 93 A Trading Day tị
Figure 9.13 CACI Open Position
“The CACI rectangle in Figure 9.13 triggered to the short side with both an R ‘and FB signal After two days; the chart showed conviction in nether direction Although not shown hore, the following day, tho trade was stepped cut before #
Uxce-point move to the upside ducing a masket rally
Overall, the systems performed better than our chart analysis, as is usually the case, The two long trades (EAST and BOBS) were clear winners, supported bythe milly in the Nasdag The short trade (CACD stayed flat during the mar- ‘Ket reversal but was eventually @ loser Finally, the remaining steck (OVER) did not rigger a trade (Next, we show the trader some inspirational chavts in Figures 9.14 and 9.15, {mn early 2902, Rent-a-Center (RCU:Nasdaq) had sn exceptional three-month Relative Strength reading of 97 During this period, all of the Acme entries ‘were long trades InJune 2001, the Relative Strength of Corporate Executive Beard (EXBD:Nasdag) was 95 Five log signals were generated in litle ver @ ‘month Four ont offive trades were winners, and two ofthe long pesitions were ‘ereated with multiple trade entzies
‘The reason for presenting Hese charts js to bolster the claim that a trader's ‘overall profit factor can be improved by selecting high RS stocks [4] By using these measures such as RS and KPS, the trading systems presented in this book ‘can be used as a platform to build teller systems Make the systems your evi, ‘and you will have the confidence to trade ther
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10 Day Trading
Afirst be ikea modest maiden, aude eneary villepon tis door; Aferward be es swift a scurrying rabbit,
‘nthe enemy vibe too late to resstyou Sure, The An efter
‘Welcome to the highly evaved battlefield ofetectronic day trading, an arena li- {ered with the remains ofcompiters masquerading as sit machines with empty coin hoppers A confluence oftechnology and online trading created a network ‘of traders with aocess to real-time quotes, news, and instantaneous executions As atide ofliquidity looded into the macket, the techaology stocks soared, and jus as quickly the tide weat out-along with the fortunes of many trades,
‘Avast count, Amazon.com had over one hundred books on day trading, but unfortunately nobody is let to read them The world probably dees not need nother Level II tutcral, but inthe interest of completeness, every toot has its place This chapter offers some traditional technical analysis techniques for day trang and presents some actual trading examples where tools sueh as Level Il ‘quotes have proven to be extremely usefil
Before taking the first trade, follow these stops Most traders will fil, and this is not 2 "you too ean succeed in day trading” chapter
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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 firm's package of technology, training,
¢ Investment in software and hardware technology ¢ Training and mentoring
* Broad ECN access
° Commission rates and seat costs ¢ Technical analysis software
10.1 Finding a Day Trading Firm 195 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
customer service, and costs Make a checklist ofthe following items: Market | tin tion (level el
¢ Custom tickers with filtering by symbol and volume * Quote lists with custom fields
¢ Access to all ECNs with advanced order entry (¢.g., reserve orders) ¢ Technical analysis software such as TradeStation or FirstAlert
¢ 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 overnight positions, 1.¢., is "all cash" at the end ofthe day, carrying no exposure to overnight risk The swing trader, or position trader, executes trades that usually last several days The swing trader uses short-term technical analy- sis 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 dis- tinct atmospheres; either the floor is noisy with traders exchanging ideas, or it 1s 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 of market data, and some brokers are ill equipped to distribute the data fast enough We have seen real- time quotes that have been delayed by as much as ten seconds, an eternity in the life of a day trader
¢ Bloomberg terminal
¢ Data feed services such as OpenBook™
Assess the number and quality ofthe technical support staff Ifthey 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 milliseconds 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 broker's trades?
¢ How soon are trade confirmations recetved?
Finally, ask about the experience ofthe traders on the floor The truly successful day trader has been trading profitably for a minimum ofseveral years in all kinds of markets Many firms are populated with part-time position traders who have other jobs 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 1s willing to teach you specific techmques In the following sections, we review the basic Level II trading tech- nique and then present some advanced trading techniques with a set of case studies
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196 10 Day Trading
10.2 Trading the Nasdaq
The trading ofa Nasdaq stock is shaped by the following attributes: ¢ Number of market makers (depth)
ATAPI
A Ty *4 yy 4 £
° Average Vaily volume (ALY )
10.2 Trading the Nasdaq 197 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 (MPID) 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 Ax The Ax is typically the company's lead underwriter and investment banker, but this role changes from day to day Other traders attempt to follow the Ax's lead by high- e Float ¢ Average True Range (ATR) ¢ Spread ¢ Volatility Percentage (VP)
lighting certain market makers, but lack of access to order flow puts the trader
at a disadvantage Be skeptical ofanyone who claims to know how to follow the Ax; however, look for a public display of affection (PDA) on the Level II window,
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 trp in slippage (1000 X 2 X 02), reducing the trading cost substantially
Table 10.1 Nasdaq Trading Characteristics
Symbol Market ADV Float ATR &pread VP ADV Makers (millions) (millions) Float CSCO 106 79.39 7180.0 0.80 O1 5.71 111 MSFT 88 27.42 4510.0 1.89 O1 3.63 0.61 VRSN 77 18.79 195.9 1.98 02 11.00 9.59 NVDA 68 9.72 108.4 2.82 06 8.06 8.97 MERQ 63 2.90 77.6 2.29 06 6.36 3.74 HOTT 42 0.39 30.2 0.92 10 4.00 1.29 PNRA 31 0.28 123 2.44 30 3.75 2.28
10.2.1 Nasdaq Market Participants
Each Nasdaq stock is represented by a group of market makers and electronic
ized exchange Investment banks such as Goldman Sachs, Merrill Lynch, and
Morgan Stanley are market makers Each market maker 1s an NASD member
i ATI MU cơI C ƠØ QUOL© d s urity; €2 NdIT Ke AKC display DO btd
and offer price quotations for a certain number of shares
a sudden jump onto the best bid or offer
The theory behind market maker analysis is that ifa key market maker goes high bid, then a buying situation is created, and ifthe market maker goes low offer, then a selling situation is created This is another myth perpetrated by the churners 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 of bulldozers
The trader may feel that becoming wise to a market maker's 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 oforder flow and the requirements ofthe market maker filling an order [17] A trader who sees a market maker as a conspirator should probably be writing the screenplay for a sequel to /F'K
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 of the ECNs Note that each ECN is also assigned an MPID For example, the MPID ofIsland is ISLD, and the MPID of Instinet is INCA ECN symbols are listed along with the market maker symbols at the Nasdaq Trader Web site
Trang 6198 10Day Trading 1022 Level II Quotations
‘Together, the best bid price (highest) andthe best offer price (lowes!) comprise Level J quote The current bid and ask price are displayed in combination as ‘he inside market The cdher bids atlower prices and other offers a higher prices are outside the market, For example, ifa stock is queting 1738 X 1739, then 1738 isthe highest tid price and 1739 is the lowest offer price-cther bids start at 1737 and lower, with other offers ut 17410 or higher The difference between the best offer price and best bid price is known as the spread The spread on the sample quote here is 1739 minus 1738 equals 001, or one cert ‘A Level display shows all ofthe bid and ask prices fora stack ie, sll of
the bid prices are in descending onder (from highest to lowest) on the left-hend ide, and the ask prices are shown in ascending order (Jowest to highest) on the right-hand side Each bid or offer price is associated with either a market maker fr an ECN inthe first column ‘The number of shares that the market maker is bidding or offering is shovn inthe third column in units of 100 Note how each, price tier is delineated by coer
In the Level IT window in Figure 10, Goldman Sachs (GSCO) is bidding 1000 shares of Cisco at 1738, The Island ECN (ISLD) is bidding 2500 shares al 1738, and instinet (INCA) is offering 2300 shares of Cisco at 17:39 CSCO H38 CN “127 TaTs T600
Cle mesh Bd 1738 Ack 179
Open 129 High 1800 Loy - 17.07 GSCO 12338 10 |[MSCO 1739 l0 ISLD 138 25 INCA 124 23 SCHB 173 — lọ COWN 140 l0 SBSH 173 10 MLCO 14 10 REDI 123 10 SBSH 1740 10 MICO 13 10 REDI 1744 _ 10 COWN 1246 l6 NESC 174 10 MSCO 1736 16 SCO 7m 1Ó
Figure 10.1 Level Window
‘The Level Il window is modeted on the Nasdaq Workstation that each market maker uses to display quotes, adjust quotes, nd enter orders, Software vendors
102 ‘Trading the Nasdaq 199
Implemented a facsimile ofthis display based on the Nasdaq data feed so that ‘online traders could see the same information
1023 Levelt Tuteriat
‘Before understanding the details of evel Il, one must appreciate the history of its usgge Originally, the Level I quote screen was the basis of a momentum technique known as "SOESing”, where a trader could profit simply by buying ‘ut all ofthe market makers athe bes offer price and then selting backto them at ahigher price, based on the illusion of upside momentum However, market ‘makers earned the game quickly, and trading with Level II degenerated into @
game ofhead fakes, firepower, and spoofing! CSCO el Ch 1000 Coe 1861 BE 1238 Ak 1799 Open 179 High 1800 Lew 17.07 CSCO 1738 l0 MO 139 10 ISLD 138 2 INCA 13 23 SCHB 1735 10 |COWN 1740 10 SBSH 173 10 MLCO 1740 lọ RED 13 1U SBSH 140 10 MLCO 13 10 REDI 141 10 COWN 1736 l0 NFSC 1741 “10 MO 136 10 Jasco H41 lo
gure 102 Level TI Stapshot 1
Trang 7xô 10 Day Trading CCO 1m Cụ 12 THÍG 23900
Close HH BẢO Ư3M Ad 173
Open 179 Hạh I800 Low - 1767 GSCO 1238 — 10 MSCO_ 1739 — 10 ILD 138 25 ID 140 d8 SCHB 1738 — 10 COWN 1/40 l0 SBSH 1738 10 |MLCO HZÁO HÓ REDI 1738 10 SBSH 1740 10 MLCO 173710 REDL 174110 COWN 17% 10 NESC H41 10 MSCO 1736 10 GSCO H4 l0
Figure 103 Levelt Snapshot 2
Alldiough the Level I quote has remained the same (1738 x 1739), 2300 shares of Cisco have been bought at 1738, and two ether market makers have joined the best id A buying situation is created when the best bid tier expands, and the best offer tier contracts Likewise, a selling situation is created when the best ‘offer tier expands, and the best bid ter confracts In this situation, momentum traders will rush into Duy CSCO at 1739 since only one market maker remains, hoping that Morgan Stanley (MSCO) will finish selling shares at 1739 and tuise the offer to aptice of 1740 oc higher So, the momentum trader has bought shares at 1739 and is now waiting for a higher offer Before continuing with our example, we esamine the practice of Level I trading before decimatization (B.D.) and after đecimalizatien (A.D) In 1995 B.D, a trader could SOES in for 1000 shares at 17 %4, and as soon 95 the offer was rised, try to sll it immedisely for 17 378 in order ‘quick $125 (not including commissions) In 2002 A.D, a stock such as Cisco to pocket 8 Jag a penay spread which invalidates the otiginal SOES strategy As a result, some traders have adapted ty trading more size and staying inthe trade longer, in contrast to the virtually rsk-fiee trade ofthe past ‘Several minutes later, CSCO is trading up to 1745 Now, the trader can act a amarket maker and use any ofthe ECNs to sel 1000 shares ef CSCO at the offer price of 17.45 For exanple, the trader may use ISLD to display its offer as shown in Figure 104 Ifthe momentum continues, then the trader will sell the
102 Trading the Nasdaq 201
shares and make six cents in several minutes For 1000 shaves, the profit will be ‘860 minus commissions CSCO TT TC li TATad 100) Cow 1861 Bd 174 Ak 1245 Open 1792 High 1800 Low - 1707 CSCO H4 10 |JMSCO 14 1g XID HO 72 |BID 1 as SCHE 174s ã |COWN Hấp l6 SBSH 4 10 |MUCO 147 q0 REDI 14 10 [SBSH 146 q6 c ren 4 ao COWN 12 10 |NEC 146 q0 MSCO 1 10 |@GSGO 1⁄46 1Ó
Time 104 Level I Snapshot 3
‘Suppose that the momentum stalls before the trader is able to sell the shares Further, the Level Il window shows that market makers are lowering their bids ‘andlor offers [momentum i reversing, then the trader should beable to sell at ‘he best bid price, in this ease ut 1744
1024 CaseStudy: ImConeSystems
“The case of mClone Systems(IMCL:Nasdaghis an example of combining news and tracking market maker movernent to predict price direction The company was expecting the FDA to approve its cancer drug Exbitux before the end ofal-
cendar year 2001 The stock had been sliding from the seventies into the fifties near the end ofDecemier On the moming ofDecember 27, a Merrill Lynch ‘analyst issued the following comments regarding the drug's spproval
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Given that Menill Lynch is a tep market maker by volume in ImClene, the logical step was to monitor the market maker MLCO on the Level IL window ‘Most direct access software lets the trader highlight market makers or ECNs in
the Level If window The trader can team much by observing the actions of a Dighliglted ey market maker
Sự Tê TẠP ea is
Tignre10.5.ImCloneIntraday
‘AL approsimately 3:30 pm on the Friday aftemoon of December 28, Meri Lynch went low offer on IMCL For the nest thirty minutes until the closing bell, MLCO remained on the best offer AS ECNs rushed to step in frent of MLCO to sel shaves, the market maker aggressively lowered ils offer price to sell stock The price plummeted several points over the last thee bars, as shown, in Figure 105,
‘Then, with the whir of fax machine in ImClone's offices on Dee 28, the TDAS leter anived, rejecting the ballyhooed Erbitux trial and casing doubt over the drug’ future Wall SreetJournal, February 7, 2002 ‘Ac7:14 pm that evening, ImClone announced that the FDA had decided net to accept the filing forthe Erbitux application On Monday morning, January 31, IMCL opened at 4539, down 986 points from Frey's closing price (refer to Figure 106) An investor may have been inclined to listen to the analyst's posi
102 ‘Trading the Naslaq 208
tive comments for guidance and buy the stock but the astute traderlets price do the taking and typically does the opposite oft investor
Figure 104 ImCloneDally
AAs shown in the ImClone example, Level IL trading is not about plopping in front ofthe sercen and hitting hot keys, Use the technology and combine it with market knowledge to esplil unique trading opportunities Further, use other ‘data sources to refine your understanding of any given stock and understand its pattern oftrading
‘The Nasdaq Market Data Web site offers detailed data reposts such as the ‘Market Maker Price Movement Report and the Time and Sales Repott these are daily replays of Level I price movements and trade history, respectively (Order a few ofthese reports and track a stocks price movement throughout the centre trading dy
1025 Case Suly: Comverse Techreogy
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‘As the symbols pass by, certain pattems begin to emerge Focus on the ras in
ten thousand share blocks and higher, eg., 10K 20K, SOK ete Then note whether the trades are printed in green (up ticks) or red (down ticks) The usual,
large-cap suspects will appear cn the tape Newsworthy ‘well, but we wat to foc on Hove stocks with no apparent news, so review the stocks will appear rmoming news to eliminate the known ones This skill becomes second ae ‘with experience Gnluly 9 and July 108, 2001, several casual glaces a the ticker revealed some unusual activity in Comvene Techaology Large bloc of CMVT were crossing the tape, anid no news had been released about the company All ofthe trades were at Kast 10000 shares in size, and all ofthe trades were cecturing con down teks
Figure 10.7 Converse Technology
“OIhly 10°, Comverse announced that they were citing earings estimates for the next two years The stock gapped down ever twalve points that morning (Figure 10.71 In retrospect, one Wenders whether oF not anyone Kew abent hese ents aead ofthe announcement (ongue planted firmly in cheek) One ‘month ate, investment houses uperaded the toc (tongue deeply embedded) In the following sections, we show the trader hov to analyze socks based on their Mock volume, and explore how to detec unusual trading volume in small-cap stocks As with our tnding systems, we Want to analyze the market from as many perspectives as possible
102 Trading the Nasdaq 8
1026 Case Study: OSCA Ine
In easly 2002, OSCA had an average dily volume of 85000 shares Then, on
Febmary 19°, the average daily volume was exceeded at 9:55 am, in the absence
fofnens After spiking up to 22, the stock pulled back to 20 and then slowly ‘gained ground for the rest of te day on heavy volume A230 pm, the price spiked back to 2% where it closed on the day (Figure 16)
‘The various news organizations had picked up stories ofecquisition rumors tuoughout the afternoon, but an average volume filter detected this unusual ‘movement ealy in the morning The formulas easy: calculate he average daily ‘Volume ofthe stock forthe past twenty days; we want to focus on illiquid stocks with average daly volumes ofbetween fifty to two hundred thousand shares ‘Then, compare the volume ofthe current trading day to the highest volume of the past sity days to see ifvolume is tracking higher
2s Ciao Bist e203 Sean “Veto
Figure 108 OSCA Ine
Trang 10206 10Day Trading 103 Day Trading Techniques
ay trading is simply the application of technical analysis to smaller time frame To illustrate this point, consider the Money Flow Indes, or MEL The MFI formula uses the high low close, and volume of bar to calculate a value known as Money Flow, or MF Ifthe MF ofthe current bas 18 grester than the MF ofthe previous lar, then money is flowing into the stock: a declining MF implies that money is flowing out ofthe stock, Without getting into the details ‘ofthe calculation, cleaty the MFI can be calculsted on any kind oftardaily or intraday Figme 109 shows a divergence on a daily chart of Ciena,
moh ut! i th ntl!
igure 109, Dally Money Flow
(On the intraday chart shown tn Figure 10.10, Ciena gapped up on the morning, ‘of November 13°, cresting a divergence between its price and the MFI The de- lining MFI from the previous day was a signal to sel short Ciena on the open
Her, the strtegy for the trader is to locate stocks gapping in either direction before the opening bell and filter them with the MEI from the previous day 10 identify divergence patterns “The chief objective is to combine the tools provided by the direct access software (eg, gap scanning) with traditional technical analysis to identify high probability price patterns Direct sceess software makers are just beginning to ‘add other filters and built-in scans to complement their charting features, 103Day Trading Tecluiques 207 ere aa er ail ly a = | "il, nu som | tO a jo Io | a ae ia kei — ee — 1094 Gap Wang
‘As discussed “Sneecssful day trading requires mastery ofthe gap and while gaps ean result in in Chapter 2, gaps axe ential to stntegies such 8 pair trading fast profits ey are the source of major trading mistakes The first mistake is the bargain complex discussed in Chapter 6 Just a investors are attracted to fal- ling prices, traders are attracted to stocks that gup down A key to trading down ‘zaps isto distinguish between stocks that are gapping because ofnews affecting, ‘the whole market or because of news abut the eompany itself
‘The ether ey to trading gaps is to wait for confirmation The temptation is ‘always there fo scoop up a stoek before the market opens because the price ap- pears cheap Ifthe stock has bad mews and is chesp at 830 am, then it will ‘probably be cheaper st 9:30, Writ nail the last possible minute vo assess the di-
rection ofthe stock before the market opens
‘Remember that the gap price reflects al ofthe known information about the stock, The point i8 not to dwell on the fact that the price was 58 yesterday and ‘now35, The trader wants to wat for ethers to commit themselves and then take ‘a trade in whichever direction price leads him orher Let the stock establish its range and then Wait fer any breakout This technique is known as an opening
range breckout (6,
Trang 11208 10Day Trading [ 'ñ) i thin hyn ae , 28 W te | ies yr toa Gea aor ta as Sean sos gt
igure 10.11 Ciena Opening Range Breakout
“On Mant II? Ciena gapped down and exabished an opening range between 890 and 9.16, as shown in Figure 1011 At 9:55 am, the stock broke through the upper band ofthe epening range, rallying for mest ofthe day The advan- tage ofusing sn opening range breakout (ORB) is that the risk is bounded by the distance between the upper rewards defined by the trader’ choice ofesttechsique, eg, a moving average and lower band 16 ~8:90) = 0.26 points The ‘eressover or ATR-based profit target As spreads have narrowed, gaps have become increasingly imporant tothe rmarket maker When spreads were wider, the market maker made mest ofhis profits from the spread by buying the bid and selling th offer As spreads intarge-cap stocks have visually died p, the profit potential has shifted fom "3vead trading to position trading ‘A market maker trading a gp is Sinilar to the specialist on the NYSE han- dling an oxder imbalance A matket maker buying shares fom an institutional seller is taking the caer side ofthe trade and has an imerest in buying these stares as cheaply as possible Tins, the ellective jective isto crete wide as posse before the open and then wait fora counter-move to sell the a papas shes Barring aay disastrous nes, acounter-move will occur mest ofthe time in the first few minutes of trading, no matter how abbreviated ‘Ancthe effective gap strategy is gap continuation trading This sotegy is explred in Section 10.32 103DayTrading Techniques 209 1032 Continuation Trading
We define coninuation trading as the connection between the last hour of one trading day and the frst hour ofthe following trading day Stocks that move in ‘either direction the last hous ofa session tend to continue in the same direction te following momming A stock will Te dormant all day, trend ino the closing bell and then follow through the next day, barring & major gap Contimation patterns fll nto thee general categories:
@ Gap Continuation a News Continuation 2 Breakout Continuation Caps
Gap continuation isthe steategy of finding gaps in strongly tending stocks that are created by general market conditions, net by company-specific news For ‘exanple, iffutures are weak and a sock in strong up tend gaps down, Hen we ‘wan! to buy that stock before the open Similarly, ifthe futures ae strong and 8 ‘weak stock zaps up, then we want to go short (Feferto Table 102)
‘Table102, GapContinustion Strategy
‘Stock Gap Stock Trend Trade
Down Up Buy
Up |up Down Sell Short
Gap contimaton is a relative strength strategy Just as lioness hunts forthe ‘weakest prey under good conditions, the trader is looking for the weakest stock, ‘when futures are strong Examine the price percentaze gainers and losers from the previeus day in addition to stocks with strong percentage increases ox de- creases over the past few days, filtering out these stocks with light volume, Ifthe futures are up strongly, then check each ofthe price percentage losers to see if ‘any of them are gapping up Likewise, ifte futures are down strongly, check the perventage gainers for down gaps
(On Mareh 20", 2002, the Nasdaq futures opened down over twenty points ‘While the Nasdag was in a downtzend, Panera (PNRA:Nasdaq) was inan up- trend, as shownin Figure 10.12 That morning, Paneragapped down to62.76, ‘down 63 cents from the previous day's close of 63.39 My the end ofthe dey, the ‘Nasdaq Composite Index closed down over {ily points, white Panera closed almost two points above the epen at 64.70
Putas Down
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‘When a company reports camings after the bell the perception ofits eamings is altered by the tone of the market during the day If'@ company reports good ‘earings but the market was down on the day, tien people will tend to find a troubling element in the eamings report that sends the stock down afer the bel, ‘The odds are in favor ofthe stock trading even lower the fellowing morning, but its opening price is subject tothe opinion ofanalysts who will ssve uperades or downgrades Analysts being cnly uzman, their comments echo the sentiment of the market, and everyone piles on”
‘Table 103, News Continuation Strategy Martet Tone | arnings | Morning Gop | Eamings | M©mmngGap
Balls Positive | strong Up | Neestive | Down Bearish | Pesive | up | Newstive | Strong Down
Neutral Positive up | Neste | Down
103 Dey Trading Techniques 2n
‘Table 103 shows the impact of market tone upon & company’s earnings report “The issue is how the trader uses this information to establish a postion When company reports its earings, unless the stock js halted for news pending, de price develops in two stages First, the stock reacts to the earnings number The company beats meets, or misses is mamber, and within minutes the stock finds its new price evel Then, the waiting game begins for the company conference call, a game ofcorporate spin Unless the company mentions forward guidance {nts earnings report, people will be eagesly awaiting tha guidance during the call When the guidance is released, the stock find its second price level (refer to Section 10.45 on trading after the bell) Because the actions ofanalysts can be unpredictable, He news continuation, strategy should be traded only when the market tone and earnings tone mateh Ifthe market tone is bullish and eamings guidance is postive, then the stock should be bought afterchours In contrast ifthe market tone is bearish and eamines guidance is uegaive, then the stock should be shorted after-hours ‘Bearin mind thatthe stock price has absorbed most ofthe news already, so the difference in price between the after-hours cose and nest morning's open will rt be nearly as large as the gap between the regular market clese and the open ‘The trader is simply trying to wring out an extra point or two because the ‘emotional market participants will be eager to bul out or bolster their postion carly on the following morning, and there will be added pressure on the stock in the điretion efthe after-hours move Even in instances where the market tone is neutral, a bullish earnings report will generally get a sight bump up from the after-hours close the nextday
“The same principle applies to other news released after hours, such as a new ‘contract announcement or an SEC investigation On November 28, 2001, at 415 pm, the Urited States government announced a $428 miliơn cowtraet for fa smallpox vaccine to Acambis (ACAM:Nasdag) The stock closed neat 38 and traded up to the low 40% after-hours Watching the stock ise over three points ‘within minutes, we decided net to take the trade
‘The following day, Acambis opened above 48—it had traded as high a 50 before the open At the time, ifWe had known the float ofthe stock were less tan 8 million shares, then the rade Would have been more appealing Clealy, the magnitude ofthe gap is directly related tothe significance ofthe news and the capitalization ofthe stock The enterprising trader should be able to develop ‘general trading guidelines by studying the interaction between news and stock float Figure 1013 shows the intraday chat of Acambis preceding the contract announcement Notice the subtle siens of accumulation beginning en the after- noon of November 27 and the expanding session width ofthe S-minute chart
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[igure 10.13 Acambis New Continuntion
“The breckond contimuatin ix a two-day pattem On Day One, the stock must conaclidate the entire diy ual later inthe afternoon Then, one of two hours before the closing tel, the stock trends stronaly in ether dizetion ‘This is an ‘example ofa pent-up move that will protably continie on Day Two, unlike a ‘sock that trends all day cn Day One tnd continues info Day Two The strategy is asimple application ofthe alteration principle a a trending day flows 8
nontrending day, but the key is to recognize the beginning ofthe trend phase
Inte in the afternoon of predominantly fat dey The breakout contintaton is a pattern fer reabtime scanning programs such as FintAlet The breakout fllows the paltem principle ofa redangle,
where the rectangle height of the breakout period is compared to @ smaller range height for a longer time frame preceding the rectangle In this case, we
vide the trading day into half-hour intervals, so the trading day has a tel of {teen intervals Since we scan fora breakout duriag the lst two hours ofthe
trading day, we want to calculate the ratio of the range height of the last four thirty-minute intervals divided by the range height ofthe previous nine thirty-
te intevals, eg, a taio of 21 ot 31 Further, the height of te reference ‘ange must be natow, a ite a8 108-208 of the Mcek® ATR Figure 10.14 shows breakout continuation for Rambus (RMBS:Nasdaq)
Theme 1614 Rambus Breakout Continuation 1033 Block Trading,
Previously, we presented some examples ofhow block trade analysis can detect ‘unusual activity in a stock Before we esplore the mechaaics of this techaique further, les compare the average block trade with the average trade size for the ‘Nasdaq stock market, As shown in Table 104, the average block size is ewer twenty thousand shares, but remember that a trade qualifies as a bleck only in the contest ofa socks average daily volume (ADV),
For example, ifthe ADV ofone stockcis 100,000 shares, then atrade of5000 shares could be considered a block trade, For a stock with an ADV of one mil- lion shares, then trades of 25K and SOK would be considered block trades For stocks such as Cisco Systems with an ADV ofmillions ofshares blocks become ‘more difficult to interpret
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(One accepted truism of day trading is that large blocks signal a trend reversal ‘This concept has appeal because a lage block to be sold will temporarily force <dovin the price A trader whois slerted to large bleck on the tape may be able toride the momentum back up; however, this type oftrade has two problems Fins, by the time the “print occurs in Time & Sales, the stock may have already reversed because Nasdaq members have up to ninety seconds after execution to report transactions; thus, the print can be delayed Second, the trader has no idea whether ornet ancther large block is coming down the pipe ‘Without any insight as to order flow, fading a block trade may not be wrth the risk Only the participant with sceess to order flow can buy or sell head A trader of NYSE stocks subseribing to the OpenBook service (raleased January 24, 2002) can view the specialist's limit order book from 7:30 am to 4:30 pm, Here, the trader can devalop a sense ofte technical levels that maybe breached ‘and anticipate any movement towards those areas
‘The key to block trading is to measure the frequency of certain block sizes across the spectrum ofmarket capitalization Ifa large block needs to be bought fr sold for a small-cap stock, then the probability is preater thatthe block is 8 ‘one-off, and the trader may be able to participate in a reversal We recommend tat the trider set up a group ofseparte tickers, seerepated by ADV to display only these trades that meet the minimum block size, Table 105 shows sample Dlock sizes sorted by ADV
‘Table 105, Vohime Based Block Size ALY Sage 9.00 = 0 ơn - 570,000 em — umn | 7.60 wom 3,02,0 | 10m6
We caution the trader net to place too much emphasis on a single block trade People seem to get excited about seeing alarge print above the offer ifthey are long or a lange print below the bid ifthey are short The jsclated print serves only as a psychological inthat position fhe orshe is dwelling on every tick and consulting the oracle of boost to the nervous trader, who should probably not be the Yshoo board Mors importantly, many were executed on ownticks’ and how many on up ticks The trier is examine a string of block trades to see how simply trying to assess rend and possibly impending news When 2 low cap stock suddenly shows up on the ticker, then that is rign to get involved,
103Day Trading Techniques ais
1034 Spread Trading
‘When spreads were widerin the fractional days, spread trading was an activity Dest reserved forthe market maker Silla trader could "play market maker" in a liquid stock by simultaneously placing abuy onder at the best bid price and a sell ‘onder at the best offer price using an ECN such as the Island For example, if stock were trading at 40's 41, then a trader could bd the stock at 40 5/16 and offer at 40 15:16-there may have been a seller and buyer who were willing to
take advantage ofthe betterprices given by the spread trader,
Unfortunatly, for stocks with wide spreads, the trader with no knowledge fonder flow is 2 silting duck Ifa trader’ bid is hit, then it probably happened for one reason-the stock is going down, and the trader sill has an offer to sell his or her shares Now, ether market participants see that the bid was hit, and taut going low offer In an atempé to sel the shares, the trader goes low offer as well, cutting the spread and sowing the seeds ofthe stock's demise The trader will be Tucky to get out ofthe trade without ales,
‘Cumently, the spreads are as narrow as possible, so unless the practice can be ‘automated, spread trading is intense and is not the best use ofthe trader's time ‘A large-cap stock such as Cisco trades with a penny spread To make money on te spread the commission costs must be factored into both sides ofthe spread
trade For example, ifthe commission is $10, then the total cost of the trade is $820, one trade forthe bid and one trade for the offer AtTeast 2100 shares must ‘be spread @2100 X $001 = $21 ~ $20 = $1) to make any profit at all, Even with stock such 2s Cisco, a price jump could move the stock twenty or thirty cents, ‘and all ofa sudden the trader has risked several hundred dolla to make a buck, ‘converting 2 spread trade into a position trade ‘Spread trading has been subsumed zlmest entirely within the domain ofthe computer Fer the large-cap stocks, many ofthe ECNs axe lined up on either Side ofthe Level I window with thousands ofshares displayed on the screen ‘Traders that used to wateh the volatility on the Leve IT sereen are now forced to “watch as automated programs swap hundreds ofthousands ofshares before any ‘appreciable price movement The free-flowing velaility of the past has evolved
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“The sock market is expanding on either en ofthe day, 2 natural extension into roundthecock trading Assuming 22-hour trading day, we divide the day int five natural sepusenls s shown in Tate 106
‘Table 106, Trading Day Segt0edfs
ae Time Pert
Before the Bell 8:00 pm-09:30 am EST ‘The Open 0930 am- 1100 am Lunch Hous® 11:00 am = 2:00 pm The Close 62:00 pm - £00 pen Aller the Bell 04:00 pm - 08:00 pn
‘The time period in the fist row is not a typographical error The new trading day starts just after the close ofater-hours trading st 08:00 pm, putting us on the 24-hour le One may question cur designation of the Open and Close soguients with their expanded time frames, but they serve to delineste the time periods whan trades are entered New trading positions between 1:00 am and (0200 pm are rare,
1041 Before the Bell
“The posiod before the ball is divided into two phases: Research phase (68:00 pm = 0800 am)
Trading phase (0860 am - 09:30 am)
‘The research phase-the process of downlcading price data, scanning chats, and salocting socks is discussed in Chapter 9 The trader should have al ofthis ‘work done before trading Legis st (8:00 am, although some traders prefer net {otra ether before orate the bel, invshich case te trader can hitthe soaze iton Use the time before the cpening bello set up chats, enter aes and
scan for gaps The trader may also have ether research services and publications to review beforehand Finally, any remaining time can be spent laughing at the ays on Squawk Bos’
104 The Trading Day 2
Fair Vote
Its aly moming situa for some traders-the business scton, cofte, andthe futures ehace One of he fist ings to do is fip en the teens get the
Tatest SEP futures quote displayed in the lower-right hand comer ofthe screen,
“This quct, also known as the SAP bie shows the positive or nealive chmge from yesterdays SCP 500 futures contract lee “The purpose of watching the SRP farses in the moruin isto assess the senem dretion ofdocs became futures ares leading indicator of sock pices, tnles the Rdtre sự very ston (eg, greater than 1500 or les than -SC0} then the market open willbe dificult predict As trader evenuall eas, psitive Frures change doesnot imply strong epening, and negative Futures ‘hmge does not imply a weak: opening This price dssrpancy is explained by the trating concept knownasfir value
Fair value’ is an estimate of what an S&P 500 futures contract is worthy it is
fora that factors in borrowing cos ane cvidents Fir vane is compte ai the and ofeach trading day to compare withthe ata ites price, Before the market opens, the SRP ftures serve as market pry, digesting my news to trade above or below fair value, Fox example, bls ecenonie relawe st 8:0 am will send the Futures soaring beyond thes ive The ey pint st owe where fares are trading elative to fair valve Some business channels
‘such as CNBC display this value before the opening bell
Market commentators alwaya give ther perception ofa strong open cr weak pen forthe market For now, hi the mute buon to make your own dterni-
nation Firs, calculate the net change for the SP futures from yesterday's close, This value is displayed with a“ or " point value on the talevision
screen Fer example, ifthe SRP flares ae +250, then the fares ae trading two and hal pints higher in the meraing trading session Then, get the fair
value displayed on the screen; this value is also displayed as a "+" or" point value For example, if fair value is "-6,00", then futures closed six points above
fairvave yesterday the fir val 18 "6.007 then the fares eesed 8 pws lop Blue yesterday Now, compare the ceaent SGP futures quote again fairvalue to dtermine tow the market is ing to epen thin morning Simply surat the fat Vale number (From the SEP futres quote (8) A psitive mune indicates bras tothe upside; ancgative nomber indicates downside bis; and zero means that the market wil epen fist Some sample combinations offer value and f se shown in Table 10.7,
Trang 16218 10Day Trading “Table 1027 Far Value 4 Fumes (21| Foor tatu (F1| SiR) | Morte Open tú 4100 | +400 tp +200 1600 | 4.00 Down 2.00 -A00 | 1206 up 600 4200 | 1300 Down 250 240 | 0 entra ào 350 | 1800 tp
Mest ofthe time, the fair value is a small sumber, and the SAP futures quote by itselfis an indication ofhow the macket will open Do net make this assump- tion, however-always check the feir value deta (S) -(F> SH: he SAP futures ‘lose a 09:15 am, and stocks continue to trade dusing the fifteen minutes before ‘the market opens, so even this figure can be misleading
‘Once we have made an assessment of the general market, we twen to the subject ofindividual stockpicking, Ifthe market bias is up, then we focus on our Jong selections Ifthe market bias js down, then we focus on the shorts With courstock selectins in place from lat night's analysis, we want to review each of
these stocks for any news before the opening bell Che uc Cha
(Companies are revising their earings guidanee ơn anincrcseingly reghlar be<is, ‘with an attendant rise in the number of conference calls being held before and
after make! hours Depending on the severity ofthe news, the stock may or nay net be halted Companies with bad news are more likely to be hulted than ‘companies with good news, so companies with good news ereate mote opport- nity for traders “The problem with trading halts is that news does net go through the normal <issemination process, so when a stock reopens for trading, it wil gap and find its equilibrium almost immediately, similar to a specialist delaying the opening ‘ofa stock until the imbalance can be resolved (unless the stock is halted, there may be some liquidity on the ECNs for an NYSE stock) ‘One company, Ciena (CIEN: Nasdaq), has held several merning conference cal, creating oppertunity for the early bird trader On November 12, 2001, Ciena held @ conference call before the bell to update its guidance The positive nevisxaCieniain fiom 2 price of 1718 to well ever 18 atthe open, a¢ shown in
104 The Trading Day 219
Figure 1015 Trading was never halted in the stock so @ trader Fisting tothe conference eal could have gotten in immediately gt itm Sale igure 10.18 Ciena: November 12, 2001
Ciena’ contreace cal thal was held on February 3®, 2002, was warning The stock was halted forslost one hous Note the opening eountersmeve from the zap down in Figure 1016
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20 loDeyTrading
Another source of ctical data before the bell ae the govemment’s economic reports released al 0830 am, such as the fllowing:
a Non-Farm Payroll
‘8 Gross Domestic Product (GDP) a Factory Orders
‘a Consumer Price Index (CPD) 8 Producer Price Index (PPI)
(On the dates ofthese key govemment reports, either avoid trading before (8:30 ‘am or wait until after the report is Teleased, Further, do not trade off these data ‘except for # fade-the reaction to these numbers is usually unpredictable and characterized by zigzags The whole point ofprofessional trading is to eliminate ‘as much uncertainty as possible, not to place one's capital on black or red
4042 The Open
“The wort time for an investor to buy stock i at the open (once the investing pbc catches en, this wil change because conventional wisdom transltes io Tighter wallets) Conversely, the open is usally the bes time forthe trader to sell along poston and ita a short position In His Stock Traders mena, Eich plots the performance of te market by percentage each halheur ofthe ‘ay [16] Forthe pend between January 1987 and December 2000, the market ose 528% ofthe ime onthe open “The masket racy sprints from the epen because even in the eax ofescep- Lionally ood ce bad nes, the masket needs tine to digest the offsetting orders just after the opening bell Tins, the market wll spend from fifteen minutes to ‘one hour setting into @ range before committing to a certain direction’ At this Poin, either the tong signals or srt signals forthe swigg trades are going to Stat firing, giving a indication as vo the drestion ofthe market As the open develops the trader builds up his or her portflio of postions and lets price do theres When the market is spit, both ong an shor signals wil trigger This isthe opti scenario ‘The catofTfer nev sigals is 1:00 am Even 1:0) am is ite tate to tke signals because the majer trend decison ofthe market wil almost sways be made within the first hour ofthe trading day
lo Re treatment sa ten tts heron He alas he pen: Sealy, of hkl pried the Ace ‘hae Mauger uber ie day oon the 10084 BST, nh 104 The Trading Day, m 40443Lunch Hour
Forobviows reasons, the trader should focus on the open and close, while aveid- ing tuneh hour Market makers like to eat day traders for unch Stl, companies have been known to sip in news announcements with traders on siesta creating
scramble (referto the Tyco examplein Chapter )
By definition, the Iuneh heuris atime for consolidation, so many rectangles ‘and triangles setup during this period, Scan for stocks and sectors Hat trended strongly in the morning and that are poised to continue in the afternoon (c percentage gainers or losers), Use the rectangle” to predict market direction for {he afternoon
During tunch, the worst action a trader can take isto buy a stock that is up ‘on the day in anticipation that twill resume its upward move in the afternoon (Gee the Rambus example in Chapter 5) Wait for a confirmation before taking ‘any long trades because the 01:30 and 2:00 pm half-hour periods are the worst
performing market intervals [16]
4044 The Close
{general the intraday trend is persistent je the moming tend wil usally resume in te aftemoon Intraday V pattems are rare except fr certain days of the week (Chapter 6) Beginning st 2:0 pm, the trader shouldbe looking for reversal patterns fo ase whether or not the merning rend will resume If
rectangle forns, then the breakout ofthe rectangle will dstate whether or not the postion shouldbe covered or maintained “To exitong positions oriitste new short positions, lok for “MI tops To ‘it shot postions and enter long postions, look fr "Wbettoms Combine aese patterns with Bolliger Bands to maximize trading profits near highs and Jows ofthe day [I} The Greed aces in Figures 1017 and 1018 show esamples SŸM top and W'botiom pattems, respective “The reversal patter sa great tock because it serves two fimetons Fits protect the trader from giving back the bulk of ny profits stained during the ay Second, it fees the traders capital for ther strategies thất rigge towards the end ofthe day Furthermore, the reversal patter isthe oly ether decision point for determining whether cr not to stay ina positon until the rest ofthe (ay Gn ddition to the profit tat and sop ess) ‘Do sot be ansious to cove short postions for elles that occur ey ia he le period, Rallies around 0200 pm tnd tofizle.vhie alls starting closer