Day Trading

The stock market is the term we use to refer to the collective marketplace where stock securities are exchanged for agreed upon prices.  The stock market as a whole is actually a collection of loosely tied together exchanges which facilitate the actual trading.  When most people in the United States think of the stock market, they think of the New York Stock Exchange with hundreds of brokers screaming to buy and sell securities rapidly throughout the day.  While this may have been how all the stock trading was facilitated in the past, today improvements in technology have vastly changed the landscape in which buyers and sellers interact.

Today most stock volume is transacted over electronic communication networks which are publicly viewable electronic exchanges, also called ECNs, as well as in dark pools, which are another form of electronic trading where the buyers and sellers are hidden until an agreed upon price is matched.  These various exchanges and dark pools are tied together through quoting systems to form the order book of a stock.  The highest bid (coming from any exchange) and the lowest offer (also coming from any exchange) make up the national best bid and offer.  It is now illegal for most transactions to occur away from the national best bid or offer (NBBO), so even though the market is fragmented amongst various exchanges, a retail trader is still guaranteed the best price possible at any given time.  There are some exceptions where institutions may trade with each other away from the NBBO but this isn’t of much concern to any day traders.

The true purpose of the stock market is to allow corporations to access private wealth in order to make investments to grow their companies.  The benefit to private wealth is that when they invest in a company that grows, they realize the appreciation in value of that company by holding securities that increase in value.  So fundamentally if a company makes more money, and has expectations to make more money in the future, the price of the companies shares should go up.  As any market participant knows the correlation between earnings and share price is less than perfect, especially in the short term.

Of course from the way the market is structured, and the ease with which buyers and sellers can interact, traders are able to take shorter term positions in hopes of profiting from near term volatility.  The value or detriment of trading volume as compared to purely investing volume in the stock market is always being debated, but of course as long as it is legal you can count on a significant amount of total orders to be for the purposes of taking trades.

Participants in the stock market range from small “mom and pop” long term investors to high frequency trading hedge funds whose trades are directed on microsecond time frames with super powerful computers and algorithms.  Today for better or worse most volume is transacted by high frequency operations.  Some of this is a necessity to navigate the fragmented markets with large orders, while other volume is very predatory on small inefficiencies in price.  There is also a substantial amount of volume transacted in dark pools, so it would behoove any prospective trader to really understand what these are, how they operate, and how they are used.

The stock market as it exists today may be unrecognizable to past generations given technological advances, but it is none the less thriving as volume continues to generally increase year over year.

The reality is that no day trader in the world makes money every single day.  In fact, many day traders who make money over the long term actually lose money on more days than they profit.  Of course many prospective traders can not make money at all, and they rarely have profitable days.

The percentage of profitable days a trader has really depends upon the system being used by the trader.  Some systems are designed to make a small amount of money with a very high winning percentage, other systems are designed with the intent of losing small amounts of money many days, but occasionally having extremely profitable days which more than make up for the money lost.

An example of a system designed to take small profits a high percentage of the time would be a scalping system, either by hand or more commonly, using a high frequency algorithm.  Binary Options can also be used to leverage a scalping strategy.  Compare brokers here. While using high frequency trading systems was extremely profitable when it first became in vogue, fierce competition has quickly eliminated many of the inefficiencies in this niche.  Most of the profits are taken by large market making firms such as Getco and Citadel, as well as hedge funds that specialize in this arena.

A system that is designed to profit less often, but is also designed to take larger profits when correct may be an options trading strategy, or perhaps a tape reading strategy, or some combination of the two. If a trader can actually spot a large buyer or seller, or otherwise identify a time when a stock is likely to make a big move, they can take a large position with a tight stop loss, or take a position using options.  The trader can then capture a portion of the move with a leveraged position, and take a very large profit.  This recently seems to be where a high percentage of profitable hand traders are making money.

The lesson is that a trader can never believe a system that promises to make money 100% of the time, or on 100% of days.  Markets are always changing, and a system that was extremely effective yesterday could be worthless tomorrow.  The key is to always adapt, to use as many tools as you can at your disposal, and fiercely protect your account balance with a long term view in mind.  Many traders will make the bulk of their entire year’s profit in only a hand full of days, and the key is to be ready when the opportunity is present.  Find a system that works and exploit it as much as possible while it works, meanwhile always be testing new ideas and identifying future possibilities.

Risk management while trading is the practice of setting and maintaining tolerable loss levels given account size, trading technique, and personal thresh holds.   Effective risk management is put in place on every trade, and ideally is also monitored over longer time periods such as days, weeks and months.  It has been said that the biggest difference defining a professional trader from the rest is an ability to strictly follow predetermined risk guidelines.  Put simply a professional trader rarely will allow himself to lose more money on any one trade than he has decided is acceptable before entering into the trade.

Risk Management Techniques

A stop loss can be the most important risk management tool for a trader.  In its most basic form, a stop loss is simply a price at which the trader has decided to be the very largest loss he is willing to accept on a trade.  When a stop loss is reached, the position is liquidated or covered and the loss has been accepted.  A trader can accomplish this with either a stop market order or a stop limit order.  The difference is that when the stop price is reached either a market order to immediately exit the position is automatically placed, or if a stop limit has been chosen a limit order is placed and the limit order will execute if the security price reaches the limit price.  A stop limit order is not guaranteed to execute so it is best to be judicious when placing this stop order type.  The SEC gives a good description of stop limit and stop market orders as well.

A daily loss limit is another very effective risk management tool.  This sets a maximum loss level for a trader for any 1 day.  When this thresh hold is reached, the trader must either liquidate all positions immediately, or else be prevented from entering into new positions.

For profitable traders, it is also a good idea to systematically remove money from their trading account.  This can be a particular dollar amount every chosen period of time, or it can be a percentage of their account value, or it can even be anything above a particular thresh hold at which they decide that there is no benefit to holding a greater dollar amount in the account.  The point is that if money is systematically removed, the trader will never be bankrupt in a worse case scenario (think flash crash) and hopefully a declining percentage of total net worth is subject to risk in their trading account as they make money over time.

Why Manage Risk

The point of each of these techniques is limiting personal risk during a worst case downside scenario.  Every seasoned veteran knows that by nature, security price values are both unpredictable and volatile.  There are opportunities to make money consistently in the market, and there is no point in losing everything in one trade, day, or even month.  A professional will take the worst case scenario as a very real possibility, and plan accordingly so that they always live to make money another day.  A trader never knows if any one trade will make money, but if they are confident in their system they know they will make money in the long run.

A quantified loss limit also removes emotions from decisions, and for those who plan to be professional day traders it is a necessity.

In trading and investing, stock refers to a financial security that denotes ownership in an underlying corporation.  The stock is broken up into shares, which are easy to exchange over the stock market, or in private sale.  By owning shares of stock in a corporation, the holder is entitled to ownership rights of the corporation, which includes a right to participate in earnings and asset value growth of the company.  This is why investors buy stock, hoping the value and income of the underlying corporation increases.  Holders of common stock are also entitled to vote on company matters, either by attending annual and special meetings or by sending their vote by proxy, if they are a holder on the day of record.

The percentage of the corporation that one share of stock represents is different for every corporation, and depends on the total number of shares outstanding.  If there are 10 shares outstanding and a holder owns 1, he owns 10% of the corporation.  If there are 100,000,000 shares outstanding and the holder owns 1, he owns 1/100,000,000 (one one-hundred millionth) of the total corporation.

The shares that day traders exchange are in publicly traded corporations.  Day traders should be very happy that stock exists, as it makes it extremely easy to exchange small fractions of corporate ownership in thousands of corporations.  Publicly traded corporations are governed by the SEC, and holders have rights and limitations that may differ from privately held corporations.

While owners of stock are allowed to profit in the growth of a company, their liability for debts incurred by the corporation do not extend beyond their initial investment.  In the event of a bankruptcy, holders of the corporate stock are generally the last in security ownership line to receive any payment from the sale of all assets.  Some investors, and even some traders, will buy preferred stock in a corporation.  Preferred stock differs in that there are not typically voting rights associated with it, but in the event of a bankruptcy holders of preferred stock are ahead of the common stock owners in claiming a right to any value from the liquidation of the corporation.  Preferred stock may also receive a different yield in dividend payments, and are entitled to the rights to dividend payments before holders of common stock.

Traders should keep in mind that the stock they are trading represents real tangible value in the underlying corporations.  The nature of public stock and the public markets has made rapidly facilitating their exchange very easy, and without this day traders would not be able to function.

A moving average is a statistical measurement commonly used as an indicator in trading.  Moving averages measure an average price over a set period of time, commonly 10, 15, 20, 50, or 200 previous periods.  When plotted over time, a moving average can give an indicator of price trend in a security.  Multiple moving averages are often compared simultaneously, and the relationship of different time period moving averages to each other is believed by many traders to provide an indication of likely future price movement.

Often times moving averages are treated as areas of support or resistance.  When these levels break, there is sometimes a large fast push in price movement.  Generally the longer term the moving average, the larger the push created.  Sometimes traders will look for a bounce off of a moving averages as well depending on strategy and if they believe the overall trend is in tact.

Some traders use moving averages in more complex ways as technical price indicators.  An example is a moving average cross.  This occurs when two moving averages of different time periods cross each other.  Sometimes when this happens there is a large push in price movement in the direction of a cross.  A common cross seen as significant to traders is the 50 time period crossing the 200.  Some traders may find significance in different time periods however.

Another more complex use of moving averages is the MACD indicator.  This indicator uses convergence or divergence of moving averages in an attempt to predict future price direction.

Moving averages may be simple or exponential, which applies weighting factors that decrease exponentially.

Whether you are a technical trader or not, it behooves most traders to at least be aware of moving averages as many market participants believe in their ability to provide a level of support or resistance.

The advantage of entering passive orders is that the trader is not giving up the spread in price.  Over time, or with large enough shares, saving the spread can lead to a huge difference in net profits for a trader.

The drawback of entering passive orders is the lower likelihood of having the order actually filled.  This is true on both LIT and dark markets.  If you use an aggressive order to enter a position, meaning you remove liquidity posted to the order book or in the dark pools, you are guaranteed that your order will transact.  If you are putting an order in passively there is no guarantee that even part of your order will be filled.

There is also a high probability in most cases that if the order is actually filled, most likely the price will move and the order could be transacted at a better price anyway in the near future. 

This is known as the adverse selection of fills.  This is also true on both dark and LIT markets.  There are ways that a trader can avoid this to some extent, and it is understanding the nature of how different ECN and dark markets fill during different situations.

For instance, a stock may have a very thick ECN book with lots of share size on both the bid and the offer.  Sometimes an institution may be buying or selling a large quantity of shares, and may be willing to give up the spread, but does not want to move the share price. 

An alert trader may be watching the tape print, and the markets that offer traders rebates to remove liquidity may be transacting very quickly on the bid or offer, as the institution seeks to slowly enter or exit their position.  At the same time the more expensive markets may not be printing at all, and the trader can be reasonably confident that the price is not about to move in the near future. 

The trader can enter the position passively and be reasonably assured that they have a good price.

The Dark Pools

Understanding how different dark pools transact can also be critical to a trader’s ability to have the highest probability of seeking the best priced liquidity.  There are dozens of dark pools in which traders can execute orders, and each one fills differently. 

Some are managed routes, meaning the dark pool maintains their own inventory of shares, and as they balance their share holding quantity their traders or algorithm may be willing to execute a trader passively, even if the LIT markets would not offer the same fill. 

Other dark pools indicate a large buyer or seller may be moving the share price in the near future, and a passive fill will typically be a strong sign that the price is about to move against the trader.

With large enough size understanding how to be filled passively can be a huge advantage for a trader.  Even taking a one penny spread with 10,000 shares is a $100 profit for a trader.  For this reason a trader must always watch how different ECN markets and dark pool markets are filling.

What to do next? Take a look at the top brokers.

A LIT market, or light pool market, refers to ECN stock exchanges where the order book is made public for all who subscribe.  A LIT or light pool market will allow traders to see the amount of liquidity that is posted on the bid and offer of the order book for a security.  A trader will use the information that they see on the LIT markets as an indication of the stocks likely near term direction.

On the other hand, you can take a look at what dark pools are.

A majority of volume still transacts over the light pool markets.  According to a recent Wall Street Journal Article, about 70% of volume is transacted in the LIT markets.

It is easy to spot a large buyer or seller when they post orders to LIT markets, because the large order will show up on the book for all to see.  Because traders will run the price away from the large order, large buyers and sellers have become very clever about transacting on the light pools but they still are usually forced to show themselves to a large degree.

Examples of LIT ECNs are:

• BATS,
• BATS BYX
• ARCA
• EDGX
• EDGA
• NASDAQ
• NASDAQ Boston.

Each light pool has a different pricing scheme, and some will pay rebates for adding liquidity while others will pay rebates for removing liquidity.  A trader must understand pricing intricacies of each market in order to maximize his own cost efficiency, as well as to understand which markets will be the most liquid.

A trader with a longer term holding strategy who only places limit orders for profit will most likely always sit on the market that pays him the biggest rebate, and in some cases a trader can even make money from his transactions alone.  On the other hand if the trader seeks the most aggressive liquidity he will increase his trading costs, but will improve his ability to get executed at the price he wants.

Eventually when you have been trading for a consistent period of time choosing the right LIT ECN for your needs becomes second nature.

Dark Pools: The Rise of Private Exchanges

While lit pools dominate the trading landscape an increasing number of traders are turning to dark pools for their transactions.

Dark pools which are private exchanges with no transparency have been gaining popularity in recent years.

In fact they accounted for about 40% of all stock trades in 2017.

Institutional investors in particular are drawn to dark pools because they offer the ability to find buyers and sellers for large orders without revealing their intentions.

This allows them to obtain better pricing and minimize market impact.

Dark pools also offer lower transaction costs and the potential to fill trades closer to the mid-point of the bid-ask spread.

However critics argue that dark pools may result in stock prices on public exchanges not reflecting the actual market value.

Despite the controversy surrounding them dark pools continue to play a significant role in the trading world.

At InsiderFinance we provide real-time options flow sentiment analysis and trends analysis to help traders interpret both dark pool and lit pool trades bridging the information gap between retail traders and institutional investors.

Don’t forget to check out our Masterclass for trading with options flow and dark pool prints.

The consolidated tape, also referred to just as the “tape” of a stock, is a list of every transaction over 100 shares that takes place in that stock. The tape displays the time of the transaction, the exchange or ECN the transaction took place over, or if it was in the dark markets, the exact price, and the size of the transaction.

Traders use the consolidated tape to help spot large buyers or sellers, and predict future price movement. Traders do this by watching for large surges of buying or selling showing up on the tape, and by watching for abnormally large transactions (usually transactions over 10,000 shares in size). A trader who successfully spots large buyers or sellers can take a position in the same direction as the large market mover, and piggyback on the momentum created. Finding trade entries and exits based on tape prints is known as “reading the tape”.

A tape may also show that when a stock reaches a certain price, a large trader steps in and either buys or sells at that price. Sometimes, when a large institutional investor only steps in at a particular price, the pattern may repeat several times. A trader can use this information knowing that the price the large trader steps in on is an area of support or resistance, and may provide an entry or exit for a trade.

A tape is also used to understand which markets are most active for a stock, and this will give a trader a better chance of being executed at the price he wants. For instance in a stock with a thick book, a trader may notice that BATS BYX exchange is printing very rapidly on the offer, but other ECNs are not. A trader may be able to get filled very quickly on BATS BYX, and may not get filled at all on other ECNs.

Having access to the full consolidated tape, and having direct market access from a brokerage so a trader can be executed at the best possible price is crucial to being profitable. At How We Trade, we would never trade without watching the tape, and we believe all traders should enjoy the same advantages we have. To be a trader with access to the tools used by professionals, enter your information in our sign up sheet and open an account with us today.

A dark pool is a stock exchange that is not open to the public, and does not display the liquidity posted to its books to anyone.  Dark liquidity is considered any liquidity that executes away from public exchanges.  The purpose of trading in dark pools is mostly to minimize a large order’s impact on price.  Orders transacting between institutions away from public markets are considered dark liquidity as well, even if they never enter into any established “pool”.   While liquidity is not displayed, after an order transacts it prints to the public consolidated tape, and everyone can see that the order transpired.  What is not known is which dark pool exchange the order transacted in.

In a public exchange, all of the orders in the book for a stock on the bid and offer are displayed to the public.  While this is good for efficient price discovery, it is bad for institutions with large orders to be executed.  If an institution with a large order were to put their entire order on the public light pool ECNs, traders would purposely move the price away from the order in an unfavorable direction to the institution (if it is a buy order traders will move the price higher and force the institution to execute at a worse price.)  When the NYSE was the exchange executing almost all of the volume, this was a big problem for traders with large orders.  Other traders would know the big order existed and would force the price in an unfavorable direction. The market impact of large orders was even greater than the order size alone seemed to indicate.  As more volume is transacted on dark pools, it has called into question their role, as having a lot of hidden volume is not conducive to efficient markets.

When an order is entered into a dark pool and there is no contra liquidity to be matched with, it will post on the dark pools books just as if it were a light pool, except the books are hidden from everyone except the pool owners.  When another order enters into the pool it is crossed with the sitting contra-direction liquidity and is executed.  The order executing in the opposite direction of the large order will be completely filled just as if it was executed in the light pools, but unlike the light pools the trader behind the smaller order will not know the true extent of liquidity in the pool, only that it is greater than his order.

This is known as the “winners curse”.  This is because it can be assumed that if the order was filled completely, there is a good chance that it would have been more beneficial to let the larger order impact the market first because the larger order will have a bigger price impact than the smaller order.  In reality it is usually a mixed blessing because there are a lot of players transacting in most securities and new liquidity is always entering into the pools.  It should be known that there are regulations preventing most orders from executing away from the national best bid and offer, so a dark pool cannot prey on unsophisticated traders.  However, most traders acting in the dark pools are very sophisticated.

There are also different types of dark pools, and depending on the pool type it may change the participant’s idea of the quality of a fill.  For instance, some pools will only match client orders against other client’s orders.  Having an order completely executed in a pool of this nature is more likely to be viewed in the “winners curse” context.

Other dark pools are owned by broker deals, and the broker dealer will act as a counter party to the order if there is not enough other contra client liquidity to match the full order size.  A fully filled order with a broker dealer counter-party is often a high quality fill, because the broker executed the order from their own share balance simply to provide high quality execution.

This type of dark pool relationship is very important to How We Trade, and we utilize this execution very frequently to get more liquidity at better prices than would be available otherwise.  Our broker dealer dark counter-parties are one of the biggest edges we can offer a trader, and because we transact so much volume with these broker dealers our execution costs are comparably very low.

There are times where certain price levels will have vastly more liquidity available in the dark pools than on the public exchanges, and vice versa.  Volume has generally trended toward more execution in dark pools over the last few years, meaning a higher percentage of total volume executes in dark pools now than in previous years.  This means that traders need to educate themselves and trade with firms providing next generation execution like How We Trade, or risk being left with inferior tools.

Types of Dark Pools and Their Impact on Execution Quality

Dark pools come in different types and the type of dark pool can impact the quality of the trade execution.

Some dark pools only match client orders against other clients’ orders.

In these pools having an order completely executed is more likely to be viewed in the context of the “winners curse.” Other dark pools are owned by broker-dealers and if there isn’t enough client liquidity to match the full order size the broker-dealer may act as the counterparty to the order.

A fully filled order with a counterparty broker-dealer is often considered a high-quality fill because the broker executed the order from its own share balance to provide efficient execution.

How We Trade frequently utilizes this type of execution to access more liquidity at better prices.

This relationship with broker-dealer dark pools gives us a significant edge and helps keep our execution costs low.

Traders need to be aware of the different types of dark pools and work with firms that offer next-generation execution to ensure they have access to the best tools for their trades.

A professional day trader is anyone who day trades, and creates enough profits to provide for their lifestyle on a consistent basis.  There are multiple ways to do this, but the majority of professional day traders work for a company that allows them to trade firm capital, and then take a percentage of the profits as their own.

In the past this was done at large banking institutions but, the Volker rule passed in 2010 largely separated the proprietary trading desks from the banks.  In response, some of these desks were spun off into separate hedge funds and proprietary trading firms.  Today, most professional trading is done at hedge funds and proprietary trading firms, and a person need not always have past professional trading experience to land a job.  Many proprietary trading firms will allow a trader to open an account, give the trader an initial buying power, and either let them grow in the firm’s trading system, or let the trader use their own methods.

At Howwetrade, our trading group trades with a proprietary brokerage firm.  That means that we offer traders the ability to open a proprietary brokerage account and trade firm capital.  The benefit of this to traders is that they get an account with one of the largest proprietary brokerages in the industry, with all the professional resources and benefits they offer.  Traders are then allowed to keep the majority of the profits they generate, using firm capital!

We have a professional trading group with mentors that will work with traders if the person desires, and all traders have access to our chat room and squawk so everyone is keeping up with the action we are seeing in the market.  Many people in our group have years of experience, and traders usually find the chats very helpful.

We love to help people with a passion for trading expand their skill set, and hopefully help them achieve greater profits through lower transaction fees, and greater buying power than they are being offered at their current brokerage.

If you are a professional trader already, or if you have a passion for trading and are looking for a way to boost your trading career to the next level, contact us and let us know a little about your trading style and if you are interested in joining our group.