Exchange Traded Fund (or ETF)
An exchange traded fund, abbreviated ETF, is a fund that trades like a stock, and tracks an index, an asset class, a commodity, or basket of commodities. Like a stock, an exchange traded fund will transact throughout the day, and does not necessarily trade at it’s intrinsic value, or net asset value (NAV). This is unlike a mutual fund, which only trades on market close exactly at the net asset value.
Unlike a mutual fund an ETF is not actively managed, meaning its performance is meant to mimic the underlying asset(s) tracked as closely as possible, either on an intra-day or long term period, depending on the ETF. Exchange traded funds typically have much lower expense charges than mutual funds, making them attractive to some investors. ETFs are also attractive to day traders, who can trade an index or commodity with an equities trading account, rather than a futures or commodities account.
Some exchange traded funds are meant to trade double or even triple the volatility of the underlying index or asset tracked. These funds are solely for the purpose of day trading, and never should be held long term as they have considerable decay in their net asset value. The reason for the decay is the use of leveraged products to create the extra volatility. Recently these funds have come under more regulatory scrutiny because by design, they will all eventually be worth $0. They also create extra volatility in the market as a whole as the funds must rebalance their own assets during the trading day.
While an exchange traded fund is not necessarily required to trade at a share value which would correspond exactly with the true NAV, any significant deviate would qualify as an arbitrage opportunity, and any inefficiencies in pricing are typically rooted out very quickly by high frequency traders.
ETF volume accounts for hundreds of millions of shares of market volume daily, and these products have become very popular amongst both investors and traders. The most popular ETFs include: SPY (S&P 500), EEM (emerging markets), GDX (gold miners), VXX (S&P 500 VIX), and XLF (Financials).
Sometimes an ETF may be useful to a trader acting on sector specific news, when the trader is unsure how one particular asset within the sector will be affected. An example is when the US Government decided to increase capital holding requirements of banking institutions. Without a full analysis of each bank, a trader would not know how significantly each would be affected. Instead knowing that the industry as a whole would likely decline in price on the news, the trader may have decided to short the XLF (Financial Sector)
Traders and investors alike should educate themselves on exchange traded funds as they provide a useful alternative to other assets.
A market order is an order that a trader enters that does not specify a specific price to execute. A market order will seek liquidity at progressively further prices from the current bid and offer until the order is completely filled. The purpose of the market order is to ensure that the transaction is completed instantly. This can be very useful to traders in a fast moving market because they are assured of the order executing. A market order is the opposite of a limit order, which is an order that must execute at a certain price or better.
A market order can be a buy or a sell order. If the order is a buy order, it will first remove liquidity from the offer. If this does not completely fill the order, the market order will continue to seek liquidity at progressively higher prices until the fill is complete. Conversely, if the order is a market sell order, it will remove liquidity from the bid and progressively lower prices until the order is completely filled.
The obvious benefit of the market order is the speed and surety of execution. A market order will always fill, and it will always fill almost instantly. If a stock is very quickly changing prices and it would be difficult to take the time to enter a specific price a market order can be extremely useful.
This works very well for traders if the order is small, or if there is a lot of liquidity posted in the stock. This type of order can potentially be very dangerous for traders as well. Because price is not specified, the order can legally transact at whatever price is necessary to complete the order. If a trader enters a very large market order relative to the liquidity available in the stock, he risks moving the price significantly away from the current bid and offer. Because high frequency trading programs can remove posted liquidity so quickly, there is always a risk that the programs will remove liquidity before the market order is even able to access it, resulting in an even worse execution for the trader. Traders should always be aware of how large their order size is in relation to the available posted liquidity for a particular stock. All stocks are different in this regard, and the same stock can be different during different days or even during different times of the day. This is yet another reason why traders must always watch the book of a stock while trading.
It should be noted that using a market order in the dark pools can access more liquidity than can be seen on the books. Sometimes this can result in a much better fill for a trader, other times the light pools will pull orders when a large market order is entered into the dark pools. If you have access to a sweep order that will seek both light and dark liquidity it is most beneficial to trader entering the market order.
A market order is simply one more tool in a traders toolbox. It is useful in fast moving markets with ample liquidity. Used at the right time it can be tremendously useful, used at the wrong time it can cost a trader a lot of money. Traders must always be aware of the circumstances when deciding between using a market order or a limit order.
What Is A Stocks Volume
Volume is the total quantity of shares which have transacted in a given time frame. Traders use volume as a measure of a stock’s volatility or potential volatility. Higher volume will generally signify that a lot of parties are interesting in trading the stock, and the stock is likely to move as a result. Volume measurements are also used as a signal of liquidity of a security, so a trader can judge his ability to enter or exit a position at current market values.
Higher volumes are generally favorable to traders, but may only be beneficial to a point, or may not be beneficial depending on the exact strategy. A trader may also look at average volume at a daily level, or may even break this down in smaller increments of the day to judge when he may best employ a strategy.
Volume does not double count transactions, meaning if a trader purchases 100 shares from another seller it results in 100 shares of volume, not 200.
Typically in charting software volume is displayed below the price chart. Volume is normally displayed for every price bar, so that if a chart is displaying 1 minute price bars volume will display for each minute. The chart and volume together typically will look something like this:
This is a daily chart of GE, with the volume displaying for each price bar directly below the bar. In general it can be noted that days with lower volume also have a smaller range in price.
Volume is NOT an indication of price direction by itself, it simply is a signal that traders use to judge if a stock is likely to move. Often times traders will watch screens displaying the stocks with the highest volumes, or displaying sudden spikes in volume, which is can be a sign that news was released, or at least that the stock will be moving.
Traders who are relatively new and are working on refining their strategy will be well served to watch how volume impacts trading.
What are the Stock Market’s Trading Hours
The stock market’s regular trading hours are from 9:30 a.m. to 4:00 p.m. Eastern Standard Time. There are is also a pre-market session every day from 4:00 a.m. to 9:30 a.m. EST and a post-market session from 4:00 p.m. to 8:00 p.m. EST Check the NY Stock exchange’s website for hours and holidays.
The regular trading session from 9:30 a.m. to 4:00 p.m. is the typical market session that most people refer to as the “day’s trading session”. This is when the vast majority of the day’s volume transacts and when most market participants are active. Because there is more volume posted to stock’s books during the regular session it is arguably more predictable and a safer time for day traders to be involved due to the higher likelihood of having liquidity available to execute orders. Some day traders prefer pre-market or post-market sessions however and only trade these times. Generally it is recommended that only experienced traders participate in the extended hour’s sessions however due to the possibility of extreme volatility.
Some stocks are very active in the pre-market and post-market sessions, and some have no activity at all. The spread will often widen significantly at non regular session hours and it can be very difficult to enter and exit large positions.
It is very important for a trader to understand the stock they are trading and the likelihood of liquidity being available after the closing bell. If a trader accidentally does not exit a position by 4:00 p.m. it can be very tough to exit after the close, and with a wider spread significant price slippage can occur. This can needlessly cost a trader a lot of money.
Only experience can give a trader a feel for the differences; but it is crucial to understand the differences between sessions and the differences between how particular securities trade during these times. Always trade a light position until you understand the risks and movements of the hours you are trading.
What is A Share of a Stock?
A share of a stock represents ownership in the company that the share is issued for. Share ownership entitles the investor to share in the profitability of the company (or lack thereof) as well as a say in company matters put to a vote of investors. Stock investors purchase shares issued by corporations in hopes that the company will become more valuable through increased profits and business prospects.
One share of a corporation may represent different percentages of total company ownership based on the number of shares outstanding for each particular corporation. For instance, if there are 10,000 shares outstanding for a given corporation, one share represents ownership of 1/10,000 of the company, and the shareholder has 1/10,000 of the total vote in shareholder votes on company matters. If a shareholder owns 5,000 out of 10,000 total shares, they would own 50% of the company and have 50% voting rights.
Shares bought and sold on the stock market represent true ownership of a corporation, and entitles owners to the benefits and pitfalls of ownership. A nice perk for investors of publicly traded corporations is that while they are entitled to share in the upside if company profits soar, an investor can not lose more than his or her investment if the company goes bankrupt. In other words, owners of shares are not required to pay back company debts personally if the corporation can not meet its debt obligations.
Some people think of a share as something intangible that goes up and down in price almost randomly. The reality is this is far from the truth. The price of shares is based on buying and selling, most of which is is performed by large institutions like hedge funds and mutual funds. They decide to buy and sell based on exhaustive research and financial modeling of all available information on a corporation’s current profitability, current and project future asset values, and future profitability estimates and potential. The price of a share, and the value represented by the share is no arbitrary matter.
The ability to break a corporation into many shares which can be sold to many investors has allowed owners of large companies to sell their companies, which would otherwise be too large to purchase for any single investor. It has allowed average citizens to partake in the benefits of company ownership when they otherwise would not be able to, and this investment propagates economic growth, allowing companies to use investor money to expand operations and hire additional workers. When a company first breaks itself into publicly traded shares, it is said to have an IPO or initial public offering. When a company issues additional equity to the public after an IPO this is known as a secondary offering.
A trader should never lose sight of the fact that while their ownership may be short term, the instruments they are trading represent real tangible value, often in some of the world’s largest corporations.
What Is A Stock Trade
A stock trade is actually a transfer of ownership in a publicly traded corporation. The trade refers to the exchange of money for ownership rights, which are denoted in shares of stock. In common parlance, the term trade has come to mean a shortly held position taken with the intent of capitalizing on near term volatility. Those who do this for a living are known as day traders, but many people will buy or sell stock in shortly held positions with the hopes of making a lot of money.
An example of how this is done:
A trader buys 1000 shares of stock ABC at $50. The stock price moves up to $54 dollars after a positive earnings announcement creates buying interest. The trader sells his 1000 shares at $54 and makes $4 of gain per share on the position. Total earnings are 1000 x $4 = $4000. The trader made $4000 in a short time period, or an 8% gain on his investment of $50,000. Traders will also use some tools such as margin buying power and options to create leverage, and magnify the extent of their gains. Caution must always be taken by the trader however as losses are also magnified by leveraged positions.
Generally speaking short term trading is discouraged by the government, both for the safety of the trader’s capital as well for general healthy functioning of capital markets, since trading increases volatility. Let’s not forget that the purpose of capital markets are for corporations to access public wealth so they may make investments in their businesses, and for the public to invest in corporations that they believe will make money for them, so that their personal wealth will grow. This relationship is beneficial to both parties and it is why capital markets are such positive drivers of economic growth. The value of having short term traders involved in these markets is always up for hot debate, especially with the explosion of high frequency algorithmic trading.
No matter which side of the issue you are on, you should always understand what you are doing when you place a trade. Always understand what exactly you are trading, the maximum amount of money you can lose, and how you can be most effective in placing your orders. This includes understanding how your broker works, how much you pay for commissions, the types of orders you are placing, and how you are determining that a particular moment is the best time to place the trade.
What Is A Day Trader
A day trader is someone who buys and sells securities, usually equities but possibly bonds, derivatives, futures, currencies or options, with the intent of taking advantage of short term price movements to create profits for their account. Day traders may occasionally hold securities overnight, but normally close all positions by the end of the day, hence the term “day trader”.
A day trader works to establish a trading strategy that will result in the trader either only taking trades with a higher probability of being profitable than not, or with the probability of a winning trade creating profits such that over time the profits will be greater than the losses, even if there is a higher probability of the trade ending in a loss. Once developed a trader’s goal is to adhere to the strategy as strictly as possible, gradually using greater and greater trade sizes in order to increase their profits over time.
Strategies for equity traders may including reading a stock’s tape and order book to spot large buyers or sellers, going with price momentum during times of high volume or rapid price movement, or reacting to technical or algorithmic signals. Some day traders work exclusively by writing algorithms, often times ones that operate on extremely short time frames, taking advantage of small inefficiencies in the market. The trader will then let their algorithm work throughout the day, usually monitoring it constantly and adjusting it in response to changes in market conditions. If you have the ideas but don’t have the computer skills to program your own algorithm, Cyborg Trading offers traders a fantastic resource by taking the need to know programming languages out of the equation for the trader.
Day traders may work for a proprietary trading firm, such as WTS, T3 Trading, or Bright Trading, or they may trade their own accounts with a retail brokerage such as TD Ameritrade or Interactive Brokers. A trader will work with a proprietary trading firm to get increased leverage and more professional trading tools, or a retail brokerage in order to keep 100% of their profits. A proprietary trading firm may have lower commission charges than a retail brokerage, but may require the trader to pay for some monthly costs such as software and ECN access, and will generally keep a percentage of the trader’s profits. A proprietary firm will provide a trader with firm capital, however, and may increase a trader’s total profits significantly. The right choice is an individual decision for each individual.
A day trader is a participant in the markets, always working on their strategy to predict short term price movements in order to create profits for their account.
What Is Trading On Margin
Trading on margin is the ability to buy or sell more of a security than you would normally be able to with your account equity. It is basically a loan from the brokerage provided as a service to clients. By law you cannot have more margin value loaned to you than you have in equity. Put another way, you can borrow up to 50% of the value of your purchase. You are also free to borrow less if you wish. Some brokers will require a higher percentage of account equity of the total margin purchase.
This applies to retail accounts, and accounts must be specifically given privileges as margin eligible accounts. A broker will require an affidavit from the account owner stating that they understand all risks associated with trading on margin, and are in a strong enough financial position to assume those risks. Margin accounts require a minimum deposit of $2,000, and some brokers will require a higher deposit.
Traders use margin in hopes of magnifying their gains. If they are buying a position that is twice as big as the equity in their account, the hope is that they will make twice as much money from it. This is sometimes the case, but unfortunately there are no guarantees.
Buying on margin is risky by nature. When you have twice as much equity invested in the position than equity in your account, every price increase or decrease will have double the effect on your account equity. This is very good if the position goes in your favor, and will at least double the damage if the position moves against you. A trader should only use margin if they fully appreciate the risks and rewards.
Margin is also not free. It can be thought of as a loan from the brokerage, and like all loans there is an interest rate attached. The interest rate will vary amongst brokerages but will often be indexed to an established rate, for example the rate may be libor+ standard markup, or the rate could just be a flat rate. Either way every day you are using margin, you are obligated to pay interest. The interest is deducted from your account, and it usually behooves the trader to only hold positions on margin for short time periods.
If a trader is holding a security on margin, and the value of the position declines substantially, a trader may be subject to a margin call. A margin call is a call made by the broker to add more funds to an account when the equity declines to a certain percentage of the total position value. This happens to help assure the brokerage that they will not lose their own money on the position. Different brokerages may have different standards for when a margin call is placed, but if funds are not added in time the brokerage will liquidate the position to a point where the account equity is an acceptable percentage of the position value.
Trading on margin can be beneficial for day traders as long as they have controlled risk parameters, but essential to understand the full consequences of using it.