What is Stock

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.

What is a Trade Blotter and How is it Used

A trade blotter is a record of each trade that transacted for a given period of time, normally one day. 

A blotter would include the time of the trade, the ECN or dark pool market the trade occurred over, the quantity, the exact price, and if it was marked as a buy, sell, or short order.  Sometimes a blotter will include orders that were entered but were cancelled before they transacted as well.

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A trader will use a blotter as a way to review his trading day.  The blotter allows the trader to see exactly what happened over the course of a day.  It is a good idea for day traders to review their blotters at the end of every trading day, and record their observations in a trading journal.

A trader will look for places where he could have had better timing with entries or exits, or could have entered orders more efficiently, for instance by using an ECN that has a lower cost or rebate.

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A trade blotter is a valuable tool for a trader when he reviews it daily to improve his trading technique.

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The Importance of Keeping a Trading Journal

Day traders all go through a long learning curve as they transition from novice to professional abilities.  It is unavoidable that a new trader will make mistakes, and it is even an important part of the learning process.  The key to becoming consistently profitable, and reducing the time it takes to reach this level of success, is to minimize how often mistakes are repeated.  Repeating mistakes is the most common obstacle preventing traders from attaining their goals.  If you want to be a professional day trader, you must develop a strategy to avoid making the same mistakes over and over, and consistently develop your skills.

The best way to do this on a daily basis is to keep a trading journal.  What is a trading journal?  A trading journal is like a diary, it keeps a record of each trading day.  It details exactly what you did well and exactly what you did wrong.  Over time this will help you spot trends in your trading, trends in what you do well, and trends of common mistakes that you make.  A trading journal will also improve your efficiency, help you master your emotions, identify the trade setups that are most profitable for you, and give you a framework to improve your profitability.   How exactly do you develop this trading journal, and what is the best way to maximize its effectiveness?

A trading journal is not hard to develop, but you must be very honest with yourself, and you must be very consistent recording each day’s entry.  Start by bringing up your trade blotter at the end of each day.  Use this with a chart to review and remember each trade that you took throughout the day.  Start by writing what you saw that interested you in each trade in the first place.

Look at where you entered and where you exited the trade.  Could you reasonably have improved these points based upon the information you had at that time?  Be very honest here.  Sometimes the answer is no, but for new traders more often than not there was some aspect of the actual personal execution of the trade that could be improved upon.  Think back to your emotions at the time.  Did they help you?  Did they get in the way of you making a logical decision?  The vast majority of times you will find that emotions hinder your logical decision making processes.

It is very important to remember your emotions.  The most difficult part of becoming successful for most new day traders is not the learning or understanding of a strategy.  What stands in their way is allowing their emotions to influence how well they adhere to their planning and processing of information.  In your journal don’t just stop at remembering what your emotions were.  If all we know is that we were elated and it caused a decision to become more aggressive than was logical given the situation, it does very little to prevent feeling this kind of elation, and therefore mistake in the future.  Write down why you were so elated.  Did you previously have 3 profitable trades in a row, were you way up on your day, or was their some influence outside of trading such as family or personal matters affecting your emotions?

By writing down not just what your emotions were, but also the reasons underlying the emotion, it allows you to more effectively identify and short circuit potential emotional pitfalls in the future.  This is how a trader improves, and how a trader reaches consistent profitability.  Following a trading strategy is not an emotional decision.  The most successful traders think and act only based on probabilities. Be sure to include in your journal any emotions that prevented you from taking a good trade as well.  This is an opportunity cost the same way mishandling a trade is.

A trading journal is not just about emotions, however.  You also must detail the trade set ups that worked very well for you, and the trade set ups that did not.  Traders will commonly fall into a trap where they think that a trade set-up is consistently profitable for them, but in reality it is not.  Write down trade set ups that ended up being a waste of your time.  Be sure to include things in your writing such as hot key errors, technical glitches or equipment malfunction, and even reasons that you were away from your computer during profitable trading hours.  It is very easy to rationalize reasons for not making money while trading, but the reality is you are responsible for controlling and improving every variable that affects your trading.

At the end of each day right down the biggest takeaways from the day.  Remember that the journal is a record of your successes and failures.  What mistake do you most wish you could correct?  What did you do very well that you would like to continue to do?  Over time this will allow you to see common errors that you make, and it will help you identify the most probable trade set ups to deliver positive results.

A trading journal should also be reviewed each morning before trading starts.  Read the previous days entry and key points from past entries.  This will ensure that the information is fresh in your mind at all times as you trade.  Remember that you have one goal when you are trading, and that is to be as profitable as you possibly can be.  Having information at your fingertips but not utilizing it because it was not on your mind at the time it was needed most is a mistake for which a trader has no excuse to make.  The only way a journal is valuable is if you are actively making an effort to follow your own ideas for improving.

If you are bluntly honest and diligent in keeping your journal, you will never struggle to systematically develop strategies to improve your trading profitability.



Shorting a Stock

A short stock position is initiated by a trader in order to profit from a decline in the stock’s price.  A trader initiates a short by selling shares of a stock that he does not own.  If the stock’s price falls, the trader can then “cover his position” by buying the stock back from the open market and profiting from decline in price.

When a trader sells a stock that he does not own, his account is credited with the value of the sale.  At the same time, there is a debit in the account for the quantity of shares that he borrowed to sell.  If the stock does indeed fall in value and the trader wishes to realize his profit, the trader will purchase the shares from the open market and replace the borrowed shares.  This is known as covering the short.  The trader’s profit is then the difference between the amount of money he made from selling the borrowed shares, and the amount of money it costs to replace the borrowed shares.  Similarly, if the price increases in value, the trader will lose the difference between the proceeds of the sale and the cost of the purchase.

Besides expecting a decline in a securities price, a trader or firm may initiate a short position in order to hedge another position.  This will protect the trader or firm from future volatility in the hedged position.  If the hedged position performs as expected, the gains will be offset by the loss in the short position.  If the hedged position losses value, the loss should be offset by a gain in the short position.  This is a strategy used by many firms and traders to mitigate risk.

A trader can short a stock as long as he is able to borrow shares that he does not own. While this seems impossible, it is not, and in fact it is a very common practice.  Borrowing stock for shorting is facilitated by the brokerage, and in most instances the shares will be borrowed from the brokerages own inventory.  If the brokerage does not have the needed shares in their own inventory, they can borrow the shares from another brokerage or from another client’s margin account. There are firms that specialize in facilitating these transactions and they often find and borrow the shares from large institutions or pension funds.  This is known as a “stock locate” or “locating stock”.  A trader or firm must be able to locate the stock before the short is initiated, this requirement is known as Regulation SHO.  If the trader does not locate the stock and can not deliver the sold shares to the purchaser during the 3 day clearing deadline, it is known as a “naked short”.  The SEC has a great description of of the mechanics of short sales and the legal requirements here.

Traders should remember that brokerages will charge interest fees for the stock that is being borrowed, so there is a decaying value to holding a short position open over time.

Example of a Profitable Short Sale

A trader shorts 500 shares of stock ABC at $10.  The trader’s account will be credited with the proceeds of this transaction, $5,000.  The trader also has a debit to replace the 500 shares that he borrowed.  The stock falls in price to $9.00.  The trader decides to take his profit and cover his short position.  He buys 500 shares back at $9.00, for a total cost of $4,500.  The trader will make the difference between the proceeds of the sale $5,000, and the cost of the purchase $4,500 for a total profit of $500 (minus all commission and interest charges).

The ability to short a stock is important for a trader or firm to profit from declines in price.  It is important both as an opportunity to capitalize on a drop in price for profit, and to mitigate risk as part of a hedging strategy.

What is a Designated Market Maker

A designated market maker is a broker dealer firm that always maintains quotes on the bid and offer for a specific security in which they are designated as market maker.  The purpose of the market maker is to help facilitate smooth trading operations for a particular security.  A market maker will hold a certain quantity of a given security in their own inventory, and as their quotes are filled on one side they will balance their inventory by attempting to “take the spread” and re-balance their inventory on the other side of the bid-offer.  The market maker’s continuous quoting ensures that adequate liquidity is present on the books at all times for a smooth and efficient trading environment.  A designated market maker is also known as a “DMM”, and formerly was known as a “specialist”.

A market maker need not be “designated” to make a market in a given security, however.  Any person or institution adding liquidity to a stock’s books by quoting on the bid or offer is participating in market making activities.  If a person or institution adds liquidity to the books by quoting a new national best bid or offer, they are said to be “making the market”.

In today’s markets, arguably the most valuable time for a designated market maker to be present is during times of high volatility.  Ultra short term trading algorithms known as HFTs will perpetually quote liquidity during times of normal volatility.  When volatility increases based on news or other data affecting security prices, HFTs will often pull their quoted liquidity at nearly the speed of light, greatly diminishing the available liquidity in a security right at a moment when it is most needed.  The designated markets makers will step in during these times and provide much needed liquidity, and re-establish an orderly trading environment.

While in the past market makers were exclusively human, a significant amount of market making operations are now handled by computer algorithms.  Top electronic market makers for US securities include GETCO, Knight Capital, Virtu Financial, and Citadel Group.

Traders may not always be aware that market makers are present, but they should never forget that they help ensure the efficient and orderly markets they require.

What is the Series 56

The Series 56 is a designation required by the SEC for any person who wishes to participate in proprietary trading activities.  The designation is obtained by passing a 100 question comprehensive exam administered by FINRA, and allows a trader to participate in proprietary trading over many exchanges such as the Chicago Board of Options Exchange (CBOE), (CBSX), the National Stock Exchange (NSX), and the International Stock Exchange (ISE).

The Series 56 was first required in 2011, and was created by the self-regulating organizations mentioned above.  The exam covers topics such as securities markets and how they operate, trading products, fraud prevention, investment strategies, and trading and reporting practices.  Designed specifically for proprietary traders, the exam ensures that traders are educated and relatively sophisticated market participants.  This is for the healthy operation of securities markets as well as for the trader’s personal protection, as market operations have become increasingly complex as technology advances.

The series 56 exam allows a testing time of 2 ½ hours, and requires a passing score of 70.  Initially pass rates for the exam were very low as high quality study material had yet to be developed.  The materials have quickly improved, and while official statistics are not available the exam is now relatively easy to pass for those who study.  If a prospective trader fails the test, he must wait 30 days to take the test again.  If the trader fails a second time, he must wait another 30 days.  If he fails a third time, he must wait 180 days to re-take the test.

A Series 7 license is considered to supersede the Series 56, and if a trader holds an active Series 7 a waiver may be granted by the CBOE and the trader will not have to pass the Series 56 exam.

While traders might not enjoy having to pass the Series 56 exam, ultimately the information that must be known to pass the exam is for the protection of the trader and for our securities markets.

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What is a Moving Average?

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.



What Is A Passive Order or Fill

A passive order, or if the order is transacted a passive fill, happens when you add liquidity to the market.  This happens when a trader enters a bid below the offer price, or enters an offer above the bid price.

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.

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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.

passive order

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.

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Long Stock Position

A long stock position is one in which the trader has an interest in the price of the security increasing.  This means that the trader either bought actual shares of the security, bought call options for the security, sold put options for the security, holds warrants to purchase shares which would result in an increase in value of the warrants if the price rises, or holds a derivative or ETF position in which the position’s value will increase if the underlying security rises in price.

A trader may take a long position for multiple reasons.  He may believe that the company has good growth prospects and believes the price will rise, he may believe the industry or sector has good prospects and is taking a position in multiple securities, he may believe that the recent price action indicates that the price will rise in the near future, or he may be holding a position to collect the dividend or fixed income yield associated with the security, or he could even be using the security as a store of value.

A long position will always rise in value when the price of the security increases.  A long position may be held anywhere from seconds to years. Traders as diverse as high frequency algorithms to mutual fund investors take long positions.

The opposite of a long position is known as a short position.  This is a position from which the value of the position rises if the price of the security falls.

In the United States markets traders may take both long and short positions, but in some markets such as the Chinese Market, traders are only allowed to hold long positions.

Offer Price- Ask Price of a Stock

The offer price is also known as the ask price of a stock.  The offer is the lowest price at which someone is offering to sell shares of a security.  The lowest price at which shares are being offered is technically known as the national best offer.  Any shares posted for sale on an order book is technically an offer.  The offer price shows up opposite of the bid price on the stock’s order book.

When a trader posts shares to sell on a stock’s order book, they are said to be offering shares.  A stock may have offers at many different price levels, as traders have posted their offers prior to the stock executing at the current price.  All offers on the public ECN LIT markets are visible to the public.  Dark pool offers are not visible to the public, but can be found by sending test orders.

The balance of bid quantity to offer quantity is an important piece of information traders may use to help identify future price movement.  If there are more shares being offered than bid, it may be a sign that the price level will drop because the sell interest is greater than the buy interest.

Discovering dark pool offers can also be a valuable indicator of future price movement.  Even though dark pool offers are not displayed, a trader may send test orders for the purpose of trying to identify the approximate size of offers in the dark pools.  Sometimes when a LIT market is offering liquidity at a particular national best offer, there will not be any available liquidity in the dark pools at the same price.  This can be a good indication that price will rise, as dark pool volume is viewed as very “intelligent” volume.  Similarly by watching the tape of a stock a trader may identify that the dark pool prints are mostly transacting on the offer, which is an indication that there may be a large intelligent buyer.  It should be noted that dark pool transactions cannot typically occur at a price away from the national best bid and offer.

Offers, or ask prices, are quoted in increments of one penny on all stocks over $1 in price.  When a stock falls below $1 an offer or bid may be quoted in small fractions of a penny.  Even though stock prices may not be quoted in increments of less than 1 penny on stocks over $1, transactions will occur at increments of fractions of a penny between the bid-ask spread.

Understanding how offer price movement, transactions, and quantity may affect future price movement is important for a trader to master to be a successful day trader.

Aggressive Stock Market Order

An aggressive stock market order is one that removes liquidity posted to the books.  Usually an aggressive order crosses the Bid– Ask spread. In other words an aggressive buy order will be priced on the offer or higher, and an aggressive sell order will be priced on the bid or lower.

An aggressive order will always be executed assuming enough shares are posted on the books to fill the order.  A passive order, which will sit on the books, has no guarantee of being transacted.  A passive order will only transacts if an aggressive order from another trader removes the shares.  An order may transact in part aggressively and in part passively as well if the aggressive order is larger than there are posted shares to remove.  The shares that remove liquidity will execute aggressively and the remaining shares will be posted to the books to execute passively by adding liquidity.

Let’s look at a couple examples to illustrate how an aggressive order works.

Let’s say that stock ABC has a bid of $1.00, and an offer of $1.01.

If a trader wants to purchase shares, he has options.  If he feels no pressure to be executed, he can post his buy order on $1.00 and this will add liquidity on the book.  If he gets filled it will be filled passively and his price will be $1.00.

Let’s say that the trader is worried that the price will move up away from him, and he wants to be executed immediately.  Let’s also say that his order is for 100 shares, and there are 500 shares posted on the offer at $1.01 for sale.  If the trader puts his buy order in at price $1.01, his 100 share order will transact immediately at price $1.01.  This is an aggressive order.

Let’s say that instead of 100 shares, the trader has 1,000 shares he wishes to buy.  Let’s say that there are the same 500 shares on the offer at $1.01 and 200 shares posted on $1.02.  The buyer could put the full 1000 share order on price $1.02.  This order will aggressively remove the 500 shares on $1.01, and also remove the 200 shares on price $1.02.  The trader will execute a total of 700 shares at an average price of $1.013.  The remaining 300 shares of the 1000 share order will post on $1.02.  This will be the new bid of the stock, and if the order fills it will fill passively and the trader will have an average execution price of $1.015.

Clearly the benefits of an aggressive order are the speed and certainty at which the order transacts.  The drawback is that the trader will give up a price spread in order to pay for the transaction certainty.

Some ECNs will pay a small rebate to remove liquidity aggressively.  Other ECN’s will charge a high fee to remove liquidity, and pay a high rebate to add liquidity to the books.  When sending an aggressive order a trader must be very aware of which markets the order will remove liquidity from because the transaction costs can vary significantly.  Sometimes it may be beneficial for a trader to use dark pools for aggressive orders because the costs may be lower and there may be more available liquidity at better prices.

However he chooses to execute, understanding the benefits and drawbacks of using aggressive orders are important to the trader.

What is a Limit Order

A limit order is an order type which has a defined maximum or minimum execution price and must fill at the defined price or better.  This is opposed to a market order type which does not have a defined price and will seek liquidity at progressively further price levels until the whole order is executed.  A limit order has no guarantee of executing, it will only fill if the stock (or other security) price reaches the limit order price, and enough liquidity transacts to execute the order partially or entirely.

Limit orders are used to control entry and exit points precisely.  It is a way to guarantee that a fill will only occur at the price entered by the trader.  A market order can create significant price slippage if there is a lack of available posted liquidity.  A limit order takes away the risk of price slippage.  The trade-off of course is that there is a risk of the order not being executed at all.

Limit orders are commonly used as profit taking orders because they can be set ahead of the price reaching the desired level.  This can help traders take emotion out of the decision to exit a trade, and for some traders it is a way to automate their exit without watching every tick.  Also this is helpful if a stock’s price makes a fast move which executes the limit order, and there is not time to react before the price moves back toward the entry.  It usually is good practice to have an order out just in case this type of fast move happens.

Another benefit of limit orders is that there can be higher rebates from posting to certain ECNs.  Some ECNs pay a rebate to remove liquidity, but most will pay a trader to add liquidity to their books.  The rebates for adding liquidity are generally higher than the rebates for removing liquidity.  This is also known as a passive or aggressive order and an explanation of the difference is below, but a limit order will often add liquidity to a stock’s book.

An example of an ECN paying a high rebate to add liquidity to its books is the BATS Exchange, which offers a rebate of up to .0029 per share to add liquidity.  Done correctly a trader can defray a significant amount of his transaction costs from posting limit orders to the books.  This of course is dependent on the trader using a broker which passes through ECN rebates.

When used as an entry, keep in mind that a limit order may be better suited to a slower moving stock or market.  If a stock is volatile and moving very quickly, a trader could miss out on an entry completely.  It takes time for the trader to set up the order, and even if the order is entered quickly a stock may not print the order if it posts passively.  In the hopes of saving a small margin of money by placing the limit order, a trader may miss out on a very large move.  A market order would guarantee execution but the final cost is unknown.  This is something that must always be weighed and balanced when a trader makes a decision about which type of order to enter.

Keep in mind that a limit order can still be an aggressive order type, meaning it will cross the book to seek and remove liquidity. In this way limit orders can still be very effective at providing high quality execution to the trader.  If a limit order does not cross the book it is considered a passive order, and adds liquidity to the stock’s book.  When an order is passive there is no guarantee that any portion of it will be executed.  If the order is aggressive the limit order will seek liquidity up to (or down to) the limit price entered until the order is completely filled.  Assuming that there is liquidity on the book, the order will at least be partially filled.  If the order partially fills and reaches its limit price, the remaining share balance will sit passively on the books at the entered limit price, and any further execution will add liquidity to the books.  An example of this is below.

Example: Aggressive vs. Passive Limit Orders

For example, let’s say stock symbol ABC is bidding $7.00, and offering $7.01.

A limit buy order entered passively will be entered at $7.00 or lower.  This will add liquidity to the stock’s book and will only be executed if someone else’s aggressive order removes them.

Let’s say that the buy order is entered at $7.01.  Let’s say that the order is for 100 shares, and there are 200 shares posted on the offer.  This order will remove liquidity from the shares posted on $7.01 and will be fully executed at a price $7.01.

Now let’s say that the buy order is entered at $7.02, and the order is for 500 shares.  For the sake of the example, let’s say that there are the same 200 shares posted on $7.01, and 100 shares posted on $7.02.  This order would remove the 200 shares posted on $7.01, and continue on and remove the 100 shares posted on $7.02.  At this point there will be no more liquidity to remove in the range of the limit order, there will be 300 shares executed at an average price of $7.0133, and the remaining 200 shares left to be executed will post on $7.02 only to be executed if someone else comes in with an aggressive order to remove them.  If they execute the full 500 share position will have an average price of $7.016

Keep in mind that a market buy order would seek liquidity from progressively higher price levels until the order is fully executed, so execution is guaranteed, but at final cost unknown.

As is evident from the example, a trader must consider his order type carefully, balancing his urgency of execution, volatility, fee structure, and available liquidity.  Limit orders are a very beneficial tool, and are the best choice to control execution price.

How Do Day Traders Get Paid

Day trading is a bit like owning a business in that it is a career that does not normally come with a conventional salary.  Day traders get paid based on their performance, and they get paid very well if they perform very well.  If a trader does not perform, he simply does not get paid.

Most traders are paid a payout based on their month ending profit or loss (p/l).  A trader trading his own equity keeps 100% of his profit, but is subjecting 100% of his own money to loss when he takes a trade.  A trader who trades with a proprietary or other trading firm may keep less than 100% of the month end net profit, but they can be given a large buying power enabling them to make more money than they could with their own capital.

The key for a day trader to take home the most money possible is to find a firm that will give him a very high payout of profits.  Many firms will allow a trader to use the firm capital, and teach the trader a strategy, and then split the profits with the trader.  A normal profit split is 50/50 of the month end net profit, which is not a bad deal considering the trader is using firm equity to trade with.  Some firms pay out considerably less, but usually if they do they will take partial responsibility for a trader’s loss at the end of the month and let the trader start his net p/l at zero (or at a fraction of the loss) at the beginning of the next month.   Most firms do not take responsibility for a trader’s loss, and if the trader has a negative net p/l at month end it will carry over to the following month.  It is extremely rare that a firm will reduce a traders month end loss.

On another note, there once were salaried trading jobs where a trader was paid simply to execute orders, mostly in roles for mutual funds, hedge funds, and banks.  These still exist in a limited amount, but most humans have been replaced by algorithmic computer systems designed to maximize efficiency with their high processing speeds.  The salaried positions are now for the traders who design and program these systems.

Traders who are able to develop algorithms and wish to create their own automated trading strategies can also usually find a proprietary trading firm to execute through that will give them access to capital and their electronic resources and possibly lower costs.

In the end day traders create their own income.  This is a big part of what attracts people to become traders in the first place and it is a very powerful incentive to do well. Traders bear more risk than someone in a salaried position and the intent is to be compensated for taking on that risk.

LIT Markets – Light Pool Markets

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,
  • ARCA
  • EDGX
  • EDGA
  • 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.

What is the Consolidated Tape of a Stock

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.