Day trading
From Wikipedia, the free encyclopedia
Day trading most commonly refers to the practice of buying and selling stocks during the day such that at the end of the day there has been no net change in position: for every share of stock bought an equivalent share is sold. A gain or loss is made on the difference between the purchase and sales prices. A primary motivation of this style of trading is to reduce the risk of holding a position overnight (where the open price may have significantly changed from the previous day's closing price).
Day trading is not necessarily more risky than any other trading activity. However, the common use of buying on margin (i.e. using borrowed funds) amplifies gains and losses such that substantial losses or gains can occur in a very short period of time. It is commonly stated that 80-90% of day traders lose money. An analysis of the Taiwanese stock market suggests that "less than 20% of day traders earn profits net of transaction costs" [1].
Day trading used to be the preserve of financial firms and professionals and some savvy private investors and speculators, but in recent years has become notoriously common amongst casual traders taking advantage of new facilities offered via the Internet.
The NASDAQ officially defines "pattern day trading" as placing four or more round-trip orders over a five-day period.[2] A pattern day trader is treated differently from other traders: a broker may allow margin levels as low as 25% as opposed to the usual 50% e.g. a day trader can leverage the $100 in his account to buy $400 worth of stock; a broker may require the trader maintain a minimum liquidation value e.g. if the account value falls below $25,000 no day trading is allowed.
Some of the more commonly day-traded financial instruments are stocks, stock options, currencies, and a host of futures contracts such as equity index futures, interest-rate futures, and commodity futures.
History of Day trading
To understand how day trading has evolved, one must understand how stocks were traditionally bought and sold. Originally, most important US stocks were traded on the New York Stock Exchange. A trader would telephone a stockbroker, who would relay the order to a specialist on the floor of the NYSE. These specialists would each make markets in only one to five stocks. The specialist would match the purchaser with another broker's seller; write up physical tickets that, once processed, would effectively transfer the stock; and relay the information back to both brokers. Brokerage commissions were fixed at 1% of the amount of the trade, i.e. to purchase $10,000 worth of stock cost the buyer $100 in commissions.
Financial settlement periods used to be long: Before the early 1990's at the London Stock Exchange, for example, one could buy a stock one day, and only pay for it as much as ten working days later. Rather than paying for the shares one could sell before the end of the settlement period reaping the profit or suffering the loss - the difference between the purchase and sale prices. Similarly, with a cooperative broker, one could sell shares at the beginning of a settlement period only to buy them before the end of the period hoping for a fall in price. This activity then was identical to day trading now, except for the duration of the settlement period. Nowadays the settlement period is typically "same day", hence day traders.
The reason settlement periods were reduced was to reduce market risk. Safe title is only ensured upon settlement. One's counterparty is much more likely to default if the price moves significantly against the counterparty. Reducing the settlement period reduces the likelihood of default. Reducing the settlement period was impossible until electronic transfer of ownership became possible. Moving from paper share certificates and written share registers to "dematerialised" shares, computerised trading and registration required not only extensive changes to legislation but also the development of the necessary technology: Online and real time systems rather than batch; electronic communications rather than the postal service, telex or the physical shipment of computer tapes; the development of secure cryptographic algorithms etc.
One important step in facilitating day trading was, therefore, the founding in 1971 of NASDAQ -- a virtual stock exchange on which orders were transmitted electronically. Another step made day trading of shares potentially more profitable: In 1975, the Securities and Exchange Commission made fixed commissions illegal, giving rise to discount brokers offering much reduced commission rates.
Thereafter, the systems by which stocks are traded have evolved along with the home computer and the internet. A number of Electronic Communication Networks (ECN's) began to form. These were essentially large proprietary computer networks on which brokers could list a certain amount of securities to sell at a certain price (the asking price or "ask") or offer to buy a certain amount of securities at a certain price (the "bid"). The first of these was Instinet. Instinet or "inet"[3] was founded in 1969 as a way for major institutions to bypass the increasingly cumbersome and expensive NYSE, and also allowing them to trade during hours when the exchanges were closed. Ironically, early ECN's such as Instinet were very unfriendly to small investors, because they tended to give large institutions better prices than were available to the public. This resulted in a fragmented and sometimes illiquid market.
The reason for this was that "market makers" had very few obligations to the public. A market-maker is the NASDAQ equivalent of a NYSE specialist. It has an inventory of stocks to buy and sell, and simultaneously offers to buy and sell the same stock. Obviously, it will offer to sell stock at a higher price than the price at which it offers to buy. This difference is known as the "spread". A pure market-maker will not care if the price of a stock goes up or down, as it has enough stock and capital to constantly buy for less than it sells. Today there are about 500 firms who participate as market-makers on ECN's, each generally making a market in four to forty different stocks.
Without any legal obligations, market-makers were free to offer smaller spreads on ECN's than on the NASDAQ. A small investor might have to pay a $0.25 spread (e.g. he might have to pay $10.50 to buy a share of stock but could only get $10.25 to sell it), while an institution would only pay a $0.05 spread (buying at $10.40 and selling at $10.35).
In 1997, the SEC adopted "Order Handling Rules" which required market-makers to publish their best bid and ask on the NASDAQ. [4] The existing ECN's did an about-face and began to offer their services to small investors. New brokerage firms began to emerge which specialized in serving online traders who wanted to trade on the ECN's. New ECN's also arose, most importantly Archipelago (arca) and Island (isld). Archipelago eventually became a stock exchange and in 2005 was purchased by the NYSE. (At this time, the NYSE has proposed merging Archipelago with itself, although some resistance has arisen from NYSE members.) Commissions plummeted; in an extreme example (1000 shares of Google), in 2005 an online trader might buy $300,000 of stock at a commission of about $10, as opposed to the $3,000 commission he would have paid in 1974. Moreover, the trader would be able to buy the stock almost instantly and would get it at a cheaper price.
ECN's are in constant flux. New ones are formed, while existing ones are bought or merge. As of the end of 2005, the most important ECN's to the individual trader are Instinet (which bought Island in 2005), Archipelago (although technically it is now an exchange rather than an ECN), and The Brass Utility ("brut"), as well as the SuperDot electronic system now used by the NYSE.
This combination of factors has made day trading in stocks and stock derivatives (such as ETF's) possible. The low commission rates allow an individual or small firm to make a large numbers of trades during a single day. The liquidity and small spreads provided by ECN's allow an individual to make near-instantaneous trades and to get favorable pricing. High-volume issues such as Intel or Microsoft generally have a spread of only $0.01, so the price only needs to move a few pennies for the trader to cover his commission costs and show a profit.
The ability for individuals to day trade coincided with the extreme bull market in technical issues from 1997 to early 2000, known as the "dot-com bubble". From 1997 to 2000, the NASDAQ rose from 1200 to 5000. Many naive investors with little market experience made huge amounts of profits by buying these stocks in the morning and selling them in the afternoon, at 400% margin rates.
Adding to the day-trading frenzy were the enormous profits made by the "SOES bandits". (Unlike the new day traders, these individuals were highly-experienced professional traders able to exploit the arbitrage opportunity created by SOES.)
In March, 2000, this bubble burst, and a large number of less-experienced day traders began to lose money as fast, or faster, than they had made during the buying frenzy. The NASDAQ crashed from 5000 back to 1200; many of the less-experienced traders went broke. [5]
A particularly nasty incident occurred in July of 1999 when day trader Mark Barton killed his wife and two children then proceeded to visit two brokerage firms killing nine more people and wounding several others before killing himself [6][7][8].
Techniques
There are six common basic strategies by which day traders attempt to make a profit: Trend following, playing news events, range trading, scalping, technical trading, and covering spreads.
Trend following
Trend following, a strategy used in all trading time frames, assumes that stocks which have been rising steadily will continue to rise, and vice versa. The trend follower buys a stock which has been rising, or short-sells a falling stock, in the expectation that the trend will continue.
Playing news
Playing news is primarily the realm of the day trader. The basic strategy is to buy a stock which has just announced good news, or short-sell on bad news. Such events provide enormous volatility in a stock and therefore the greatest chance for quick profits (or losses).
Range trading
A range trader watches a stock that has been rising off a support price and falling off a resistance price. That is, every time the stock hits a high, it falls back to the low, and vice versa. Such a stock is said to be "trading in a range". The range trader therefore buys the stock at or near the low price, and sells (and possibly short sells) at the high.
Scalping
Scalping originally referred to spread trading. Today it has come to mean any extremely quick trade for a small profit.
Technical analysis
In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, his or her decision would be based on the patterns or activity of people going into each store.
Introduction
The methods used to analyze and predict the performance of a company's stock fall into two broad categories: fundamental and technical analysis. Those who use technical analysis look for peaks, bottoms, trends, patterns and other factors affecting a stocks, bonds, forex, futures, options, indexes, currencies and commodities price movement and then make buy/sell decisions based on those factors. It is a technique many people attempt, but few are truly successful at it.
The world of technical analysis is huge today. There are literally hundreds of different patterns and indicators that investors and traders claim to have success with. There are various technical analysis tools available to investors.
Technical Analysis - What Is Technical Analysis?
Technical analysis is a method of evaluating the markets value by analyzing statistics generated by market activity, past prices and volume. Technical analysts do not attempt to measure a vehicle's intrinsic value; instead they look at charts for patterns and indicators that will determine future performance.
Technical analysis has become increasingly popular over the past several years, as more and more people believe that the historical performance is a strong indication of future performance. The use of past performance should come as no surprise. People using fundamental analysis have always looked at the past performance of companies by comparing fiscal data from previous quarters and years to determine future growth. The difference lies in the technical analyst's belief that securities move according to very predictable trends and patterns. These trends continue until something happens to change the trend, and until this change occurs, price levels are predictable.
There are many instances of investors successfully trading a security using only their knowledge of the security's chart, without even understanding what the company does. However, although technical analysis is a terrific tool, most agree it is much more effective when used in combination with proper money management.
Technical analysis or formula traders use mathematical formulae to decide when a stock is going to rise or fall. Most traders use technical indicators, although more experienced traders tend to use fewer of them. (In fact, some very long-time veterans do not even use charts, but buy and sell just from "reading the tape", that is, watching the bid, ask, trade, and volume numbers from a Level II screen.)
Covering Spreads
Playing the spread involves buying at the Bid price and selling at the Ask price. The numerical difference between these two prices is known as the spread. The bigger the spread, the more inefficient the market for that particular stock, and the more potential for profit. This spread is the mechanism that some large Wall Street firms use to make most of their money (as opposed to trade commissions) since the advent of online discount brokerages.
To make the spread means to simply buy at the Bid price and sell at the Ask price. This procedure allows for profit even when the bid and ask don't move at all.
About 75% of all trades are to the upside -- that is, the trader buys an issue hoping its price will rise -- because of the stock market's historical tendency to rise and because there are no technical limitations on it. About 25% of equity trades, however, are short sales. The trader borrows stock from his broker and sells the borrowed stock, hoping that the price will fall and he will be able to purchase the shares at a lower price. There are several technical problems with short sales: the broker may not have shares to lend in a specific issue, some short sales can only be made if the stock price or bid has just risen (known as an "uptick"), and the broker can call for return of its shares at any time.
When the typical online investor places a market order to buy a stock, his broker submits this order to a market maker (MM), who then fulfills the order at the Ask price. In other words, the Ask price is the price the MM is asking for the stock. When the typical online investor places a market order to sell a stock, the broker submits the order to a MM and sells at the Bid price, i.e. what the MM is bidding for the stock.
Due to the liquidity of the modern market, orders are constantly flowing. Many times, a MM will buy a stock just to turn around and sell it to a particular broker. In fact, one of the primary purposes of the MM is to maintain liquidity in the market (among other things). Through this transaction, the MM will profit anywhere from a few cents to a whole dollar per share, in average circumstances. Over the course of a single day, a MM may fill orders for hundreds of thousands or millions of shares.
Day traders are able to capture some of the spread through buying access to Direct-Access Broker systems, rather than by trading through retail brokers. The average online investor uses a retail broker. (All of the brokerages that advertise $15, $10, or $5 commissions to the general public are retail brokers.) Through direct-access brokerage systems, day traders send their orders directly to the ECNs, instead of indirectly through brokers. ECNs put day traders on the same level as MMs.
Views of Day Traders
Day traders, through the use of modern technology and recent regulatory changes (within the last 15 years), have cut in on the MM's business action and taken a piece of the pie for themselves. Some see this as causing frustration amongst investment banks, who are thought to vilify day traders in the press. Day traders are sometimes portrayed as "bandits" or "gamblers" which is thought to discourage others from joining in on the activity.
On the other hand, others see the phenomenon of day traders as primarily created by the stock brokerage community, in order to get people to constantly trade more stocks, and to thereby pay more commissions. These critics see this as applying to business news and stations such as CNBC, which is seen as relevant primarily to day traders.
Lastly, some argue that day traders serve a valuable purpose by contributing liquidity to the marketplace. In the course of entering many buy and sell orders throughout the day, day traders add to the number of people who want to either buy or sell a security, and therefore increase the number of shares bid or offered. In addition, day traders might even help to move a particular security closer to market equilibrium (the point at which supply and demand are equally balanced, or the "true" price of a security) by reducing overcorrections in price. As a security moves up in price too rapidly, for example, a day trader might step in and short the security, thereby providing some downward pressure. If a security moves down in price too rapidly, a day trader might provide some support by entering a buy order.
posted by yeni novita @ 10:20 AM
0 comments
0 Comments:
Post a Comment
<< Home