we can also participate to buy at the Bid if we so choose.The Ask column is traditionally the price at which we buy our stocksfrom Market Makers and ECNs. Again, they stand ready to sell youshares that you are willing to buy at the Ask price. Additionally, we canalso function to sell our shares with an ECN or SelectNet order as well.The next two columns are Day’s High and Low. This provides uswith an intra-day range that will give us a better understanding of possible potential for traders. Stocks generally do not end the day at theirhighs or at their lows, but rather somewhere in between. This is what provides the active trader with potential as stocks move off bottoms and falloff tops of intra-day prices. The next column is volume.Volume indicates interest in a stock. The more interest that is there,the more predictable a stock generally becomes. I see many low volumestocks that offer traders less predictability for the following reason. In astock without traders’ interest, Market Makers tend to widen spreads tocompensate themselves for the added risk of providing liquidity.Whereas a few large share buys can make the stock move up in biggerincrements, a few large sell positions can do the same. This makes entering these kinds of stocks more tricky. More importantly, exiting thesestocks can be dangerous as they drop just as fast as they climb. In someinstances, low-volume stocks do offer potential, and we will discusswhen these are safe and when they are not later in the book.The Last Price column simply shows the price at which the last saleof the stock occurred. Again, prices at the Bid side are generally sellorders, whereas those at the Ask are buy orders. It is by the Last Pricecolumn that many traders can ascertain the direction of the stock by the
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number of buys and sells. The Last Price Volume column is important toshow us if any block trades are being executed. We will explain theimportance of block trades later on in the book as well. The Open andthe Close columns simply add information to get a measure for wherethe stock is trading currently relative to these two prices. We tend to usethis as the market opens to gauge potential after the first moves in themarket occur.In the morning, traders will gather their news momentum stocksand possible favorites and place them in the Level 1 screen so that theycan watch the action on several stocks at a time. I currently use two Level1 screens with about 75 to 100 stocks on them. Many of these stocks aresimple sector leader stocks that enable me with a generalization of themacro view of the market by sectors. The rest are the momentum playsthat are created by news or unusual activity that either the market or Imay not be fully aware of. The Level 1 screen is the starting point forwatching stocks and understanding basic market price action.
LEVEL 2The Level 2 screen is an important part of the process for the active trader.Level 1 quotes show the first level of the quote system, but Level 2enables traders to see the Market Maker and ECN participation at eachprice level.If a trader is going to route his or her own orders, then Level 2 is themap for how to best execute decisions. On the Level 2 screen (see Figure 3-2), a trader will find several price levels with market participants atthese levels. The market participants will show us at what price they arewilling to provide liquidity at and how much size they are willing to offeror bid at that price level. We will be discussing the functionality of theLevel 2 later on in the book. For now, realize that an active trader with anEDAT execution system will have trouble seeing the underlying strengthand weakness of a stock, as well as how to place orders to market participants without a Level 2 screen. Although traders have been withoutit in the past, the complexity of the current market participants and routing orders to them make Level 2 an essential part of an active trader’s toolbox. Many Level 2 systems have a Time of Sales Ticker built into them.
TIME OF SALESA Time of Sales Ticker is a visual representation of the trades that occurat price levels. This is the same information that a trader sees in the LastPrice column on the Level 1 screen. The last sale on a particular issue is
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reported to the tape and is listed on the Time of Sales Ticker (see Figure 3-3). This scrolling indication of buying and selling gives the activetrader a better historical visualization of how much buying and sellingis happening in the stock. The Time of Sales Ticker will post the time ofthe sale, the amount of shares transacted, and at what price the sale wasmade. Many of these software programs color-code these sales as well.Many fix buy orders as green and sell orders as red. In-between trades,which are trades that occur between the inside Bid and Ask prices, canbe seen as white or purple with some software programs.The Time of Sales Ticker is a key component to watching the paceof buying and selling to determine the strength of the trend in that stockwhen trading momentum. It is an essential part of a trader’s arsenal asit provides the actual trading prints of where stocks are trading.The Time of Sales Ticker has one drawback, however. At the openof each trading day, the enormous volume that comes down the Nasdaqinformation pipeline includes market orders and limit orders frompre-market trading, as well as newly entered orders as the trading dayopens. This event creates a funnel effect by which individual trades havea hard time making their way to our computers in a real-time manner.
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This is a bottleneck that begins at the Nasdaq and has nothing to do withindividual brokerage systems.With the huge volume each day, it is unfortunately a necessary evilthat we have delayed Time of Sales information at the open. I have foundthat within 10 to 15 minutes after the open of the trading day, my quotesseem to move in tandem of where my Time of Sales prints are showingtrades that occur. Many ask how we can trade when we can’t see thetrades that occur at the open. The answer will be explained later on inthe book when we get to our methods sections and how we approacheach individual day.
CHARTING SOFTWARECharting software is helpful for those who use intra-day charts and technical indicators to enter and exit stocks. Some are as basic as just havinga three-month chart with a 50-day moving average line and a 200 day
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moving average line. Some go as deep as a one-minute tick informationchart. The basic idea behind charting is to identify technical areas of support and resistance. Numerous charting patterns are available, rangingfrom extremely basic to extremely complex and expensive. The idea isto find charting software that does what you need it to.Most traders will use charting programs offered through MBTrading.com, ATFI.com, or Qcharts.com. Other ideas for more in-depth viewswould be programs like Metastock. These systems enable you to add filters to search for definable setups through parameters created by the user.Basically, traders are using charts to identify trends and counter-trendsin the market. They can use pivot lines, Fibonacci indicators, BollingerBands, and so on to aid themselves in doing so. Just be sure to subscribeto what you need in the beginning. Don’t sign up for information youaren’t ready for. Added bells and whistles are neat, but if you do not needthem, why pay for them? It just ties up trading capital.
NEWS SERVICESFinally, news services are beneficial for the active trader. You can collect this type of information in several ways. Many news providersare offered through your broker or at least they will give a referral tosomeone who has a reasonable cost for what is offered. Generally, accessto business wires such as Dow Jones, Reuters, PR Newswire, and Comtexis enough for news momentum candidates. Real-time news is obviouslythe optimal situation as fresh news generally provides the best momentum moves. However, as we have seen many times, even old news canmove a stock if it is under a different headline. A trader can subscribe tothese news services for a monthly fee (see Figure 3-4).
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I see many rooms that either present false information or hype astock a lot by the continuous reposting of the same information, tryingto drum up interest. The right way to post news in a forum is to post thenews once and let the traders decide for themselves on whether or nota trade is viable for the action it receives. Continuous comments orreposting of the news is a key to either get in early or stay away from itand not chase the stock as it is climbing. If you are even 10 seconds lateto buy, the chances that you are buying when you should be selling aregreater.
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THE NEW MARKETMOMENTUMThe introduction of new market players in the last few years has changedthe face of the stock market forever. The stock market your parentsinvested in has evolved into a brand new dynamic market with all newplayers and a whole different type of momentum. Those who are stillplaying the old style market are playing with old information and arenot fully exploiting the current market. This chapter will explore thosechanges and identify the rudimentary changes and players who havechanged it.
THE NEW PLAYERSMarket dynamics is a function of momentum as it relates to upside anddownside trends. The dynamics of the market are derived from theactions of mass psychology. Mass psychology of the marketplace stemsfrom the two basic emotions of fear and greed. Greed causes traders tobuy stocks in the expectation that the stock will rise in value creatingprofit. Fear causes traders to sell these stocks. They fear that the stockwill cease to climb any longer and reduce any unrealized gains.However, the opposite side of the trade enables greed and fear toforce traders to hold losing positions in equities that are not performingto expectations. This scenario begins to turn small losses into largerlosses. The exciting thing about greed and fear is that they produce someincredible market momentum events that ultimately endanger the portfolios of the newer and unknowing active traders. This occurs becausethey are unaware of the forces behind market momentum and how toCopyright © 2002 by Mtrader.com.Click here for Terms of Use.
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react to changes within it. Those who understand the forces of fear andgreed can profit from them handsomely.Before the explosion of the online trading revolution, traders werenot given the incredible access to the market information and participation that we have today. Investors were at the mercy of brokerage housesand institutional momentum without any insight into how stocks moved,why they moved, and how to participate within it other than throughhigh-priced brokers. Granted these market professionals had access to theimportant information and relayed this information to their clients, butit was selective information that was being provided. Although investorshave done extremely well during this incredible growth phase of the bullmarket, they lack the understanding of why they did so well. This is theimportant aspect of the transition from a passive investor to an activetrader that tends to doom many participants as they begin their tradingcareers.In 1987, when traders were unable to access the markets in a timelymanner to exit positions that they wanted no part of, the SEC decidedthat more accountability by market participants was needed to fill ordersfaster. This led to the implementation of SOES and the online explosionbegan. Visionaries of the time began to expand on this wave of the future.Although direct access to market participants was granted, so was accessto market information that was traditionally reserved for the brokeragefirms.This information includes such documents as earnings reports, SECfilings, analyst reviews, and news releases. Although this informationwas always public domain, it was not as easy to receive it in the speedand efficiency that is available today. This shifts the decision-makingpower potential from the brokerage firms to the individual traders.The empowerment of the individual to make his or her own decisions has had some interesting implications in the financial world. Theelements of greed and fear are now able to permeate the market at a fasterrate of application by active traders. This provides for a whole new market momentum to the trading field. Traders are now able to research, formulate, and then react on a decision faster than they had been able towith traditional brokerage functionality.Historically, traders would receive a research report or phone callfrom their broker. They would discuss the issue with their broker andpossibly decide to buy or sell a set amount of shares based on theirbrokers’ advice and information. Investors would quickly receive newsstories on the television, announcing that the markets were quicklyspiraling to new lows or flying to new highs. Upon seeing this informa-
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tion, traders would have to call their brokers to execute a decision. Thiscould take several minutes to a few hours, depending on how well thebroker was able to handle his or her client load. The broker would stillhave to send the order to the market to be executed at the best availableprice.This process has traditionally been very slow and stocks are at muchdifferent price levels than they were when the investor was first receiving the news. The inefficiency of this method is vastly different fromwhere we are today. Traders can now interact with the market participants in real time without hesitation or barriers to market access. Thisprocess bypasses the traditional broker method and adds incrediblemomentum to the market as a whole. Mass psychology decision-makingis now fueling intra-day market momentum at a faster rate.
INSTITUTIONAL MOMENTUMInstitutional participation in the marketplace will always be the primarysource of market momentum. Institutions inherently possess largeamounts of capital and are able to drive sector rotation at key points ofmarket action. They are able to hold large positions in certain areas ofthe market as well as dump their shares at any given time. They are ableto participate in large buy and sell programs as well as initiate them whenthe market action triggers such a necessity.They have been and always will be the smart money of the marketplace. Many newer traders feel they can figure out what institutionsare up to in any given stock either by the size of blocks that cross the tapeor by a certain research report offered at a given time. I have seen manytraders complain that institutions dump their shares into their own initiated upgrades. I have the seen the following comment many times infree rooms and bulletin boards: “There goes big blocks on ABCD.Institutions must know something.”Whether institutions know something or not, it is useless for us tofigure out what that something is. We will never know as active traderswhat institutions are doing while they are doing it. We never know untilthe momentum is close to reversing its direction. Selective disclosure andother forms of legal knowledge are available to institutional traders thatactive traders may not be aware of. Think back to how many times a stockhas a movement and a spike in volume just prior to big news beingreleased to the general public. Although we may want to complainabout this scenario because we do not have general access to it, it has its
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legality and therefore is utilized to the fullest by those who have theaccess to it.Although we see isolated instances of illegal practices, institutionsas a whole are not about to engage in a practice that is illegal and thatcould cost the firm its integrity and image in the financial industry. Wemay want to blame market action on the unscrupulous wrong doings ofinstitutions, but the reality is that very little of this kind of action occurswhen compared to the whole functionality of the marketplace. Furthermore, trying to determine what institutions are about to do in individual stocks is primarily a waste of your time as you will never be able tofully ascertain any answers to this question.Market dynamics does, however, enable us to derive possible expectations on which sector institutions are participating within. Rememberthat traders and media sources often discuss sector rotation publicly. Thegreatest example of this sector participation was the huge Internet stockclimbs in the late 1990s. We saw stocks like Rambus, Yahoo, Amazon.com,Lycos, and eBay make incredible gains. These issues richly rewardedmany investors. These stocks typically came public with a limited float.The small float size allows for stocks to have incredible moves up anddown on any large orders of buying and selling. Thinking back to 1998,I remember Yahoo making a 70-point climb and a 50-point retracementin one day. That is a 120-point swing in one trading day. That is an incredible move in a highly speculative environment.When CNBC or other financial media sources report on thesemoves, they are said to be due to daytraders and short-term traders.Although some of the momentum is no doubt provided by these groupsof traders, it is ridiculous to say that Yahoo climbs hundreds of points ina few years on daytrading and short-term trading momentum. As wetalked about earlier, institutional traders have large amounts of capital.The Internet is clearly the future of our economy. The Industrial Age isover and the Internet economy is in its infancy. When we add up the variables of large institutional money, low float in the majority of the Internetstocks, and an insatiable appetite for Internets, we can expect hugemomentum moves in these kinds of stocks.Media sources report these moves and associate the blame to daytraders. This is far from the truth. The proof that these media sources offeris the share size of the trades that are crossing the tape. I hear reports suchas the following:“Yes, many are attributing this action in Yahoo to daytraders. Weare seeing a lot of 100 and 200 share trades in these stocks crossingthe tape. This would indicate a lot of short-term and daytraderparticipation in these stocks.”
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This is unreliable proof that daytraders are the sole cause of themoves in these stocks. The underlying truth is provided to us in a simple Level 2 review. When looking at these stocks 3 years ago and eventoday to some extent, market participants are only required to show awillingness to buy or sell 100 shares at a time. This is their size liabilityrequirement. Once the size liability is filled, the market participant hasthe right to fill more orders at that price, or he or she must lift off theinside price after 17 seconds. Therefore, because the market participantis required to buy or sell only 100 shares at a time, many 100 and 200share prints are moving across the tape. The market participant may have100,000 shares to buy or sell, but he or she may not do it all at one time.However, on a low-float stock, if a market participant shows thiswillingness to buy or sell 100,000 shares, it may adversely affect the bestprice at which the market participant can execute this order. When theInternet stocks were trading the way they were, meaning very fast andat wide price levels, market participants would be less willing to accepta large posted liability by which they could be executed against.Therefore, they show only 100 shares and fill orders beyond that level asthey so desire. This is why we see many 100, 200, and 500 share trades.It has less to do with momentum created by active traders than it doeswith the functionality of how market participants execute their client’sorders as well as their own.To say that a stock momentum is created by active traders withonly share size prints going across the tape as proof is not telling thewhole story. Although many stocks do move because of active traders,the Internet sector climbs in the past 3 years were more due to institutional-type trading than active trader participation. Later we will discussthe types of stocks that daytraders create momentum within. Marketfallacies are abundant. This is just one of them that is now hopefullycleared up to some extent.As we stated before, the institutions will be primarily referred to asthe smart money. This phrase is derived from the notion and assumption that the public is usually the last to know or is just plain wrong.Many will describe events such as failed rallies and market support levels that are responsible for a certain market momentum. Smart money isseen as doing the reverse of what the public is usually doing. A failedrally is simply an event by which institutional money has already beenput to work at lower levels of accumulation or consolidation.Public money then comes rushing in after sensing a market shift insentiment from bearish to bullish, and the institutions begin to sell theirshares to the late public buyers. The selling pressure by institutional exiting of their positions tends to halt any meaningful upside momentum
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and the market begins to falter. Institutional selling continues and thenpublic buyers get nervous and end up selling their shares when the paingets too great. As the pain is increasing and the public is selling theirshares at a loss, you guessed it, the institutions are once again snappingup shares at value prices again. This is the basic case of bear market rallies and dead cat bounces.
TECHNICAL ANALYSIS MOMENTUMMuch of the market is also weaned on technical analysis. This caninclude anything from simple chart reading to more complex derivationsof stochastics and moving average lines. Although some believe in themand some don’t, the point to these analyses is that enough people do buyand sell decisions based on them. Therefore, because of mass psychology, it is important to have a basic understanding of the continued underlying reasons for market momentum.Simple moving averages such as 50-day and 200-day moving averages can have profound effects on the marketplace psychology as wellas individual averages. However, just knowing what these lines are willnot help a trader. Anyone can look up the 200-day moving average on astock. The importance of that line is the key to understanding why stocksmove the way they do.Generally, as a stock or index approaches a 200-day moving average, traders will look to that level for support in a downtrending market. Should that average be broken, technicians will see this as a bearishsign and possibly trigger sell programs that lead to more market downside. Again, just knowing what key levels are will not help you to understand the momentum. Understanding what these levels mean to a traderis what is important.
ONLINE TRADER MOMENTUMAlthough institutions have the ability to push and the pull the marketplace, the explosion of the online trading phenomenon has pushed a newmarket dynamic into reality. When looking at the sector leaders such asCisco, Microsoft, and Yahoo, these stocks tend to have an incredibleamount of Market Maker participation with huge sizes to buy and sellat each price level. The effect of online traders in issues with large floats
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and enormous market participation is much less than in stocks withlower floats or less market participation at price levels.Online traders do have the ability to move these kinds of stocks inwider ranges than they would normally trade. Primarily, online tradersare attracted to fresh momentum created by one of many forms of interest. Interest can be provided by a press release by the company, a rumorof a takeover, or simple hype by an investment newsletter or stock pickers club. Whatever the reason, Market Maker participants have beenincreasingly aware of the new dynamic that online traders command.When looking at firms such as E*TRADE, Ameritrade, or Schwab,their membership numbers continue to grow quarter over quarter. Theidea of self-investing and controlling their own money is catching on tomore and more of the world. The offering of low commissions versuswhat brokers were charging them is appealing. Research reports and awide variety of timely information is now at their fingertips, so they figure, why pay more per trade if they are essentially receiving the samedata for free? Informational firms and the distributors of this financialand market information are falling over themselves trying to attract theseinvestors to receive information from their service.These services provide information for free or possibly for a smallfee. They are offering the information over the Internet and thus gaintheir revenue from advertising by affiliated companies. This keeps information providers’ costs to their clients low, while those who advertiseon the site can benefit from a larger viewership. When coupling lowercommissions and access to the pertinent information in real time, onlinetrading has certainly become a viable force in the trading community.With the increasing number of online traders, market participantshave to now deal with the increasing possibility that interference withnormal price action can and will result from timely news releases andsimple hype. This is especially frustrating to market participants if theyare trying to fill an order at a certain price. If that price is suddenly unattainable due to a spike up or a huge sell-off caused by mass online participation, then the market becomes a bit more complex for them to fillorders at desired prices. They have to evolve their trading techniques tostay ahead of the participation momentum of online traders.In times of large market speculation and numerous get-rich-quickstories, online trading really gains attention in this environment. Traderstend to throw the underlying fundamentals of companies out the window. Price-to-earnings ratios do not matter to them. Current valuationsversus historical valuations do not matter to them. Market sentiment
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does not matter to them. The only thing that matters to these traders isthat their stock moves in a direction that banks them a profit as fast asit can.Take a look at the valuations and historical charts on stockslike Qualcomm (QCOM), Amazon.com (AMZN), and Yahoo (YHOO)for a few examples from the last 4 years to get the point (see Figures 4-1, 4-2, and 4-3).This is the new market psychology in times when the economy ishot, inflation is in check, and equity prices are flying. Market participantshave to prepare for the fact that traders are not trading companies anymore; they are trading symbols and chasing after momentum stocks.Yesterday’s investors saw the tremendous gains being made in thesestocks and they wanted a piece of it. They were willing to throw cautionto the wind, dump their mutual funds, and chase after it. In short, itturned many investors into true momentum investors. The following isa typical conversation between traders that I hear often.
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Trader A: “What does ABCD do?”Trader B: “I don’t know, but I just made a nice 2 points on it. Thatmomentum was great.”Trader A: “Why ABCD? They have a market valuation that is wayover where it should be. Their P/E is way out of whack with therest of the sector.”Trader B: “What do I care? I just made 2 points on it. It can go to 0for all I care. I took what I wanted from the trade and that is allthat matters to me.”The new market paradigm is that traders are taking what they canfrom the market as fast as they can. They are not satisfied anymore with6-percent a year. They want double-digit portfolio growth and refuse toaccept anything less. They believe in the stock market and its sustainability for producing wealth. They want a piece of it. They do not wantto be diversified to death by traditional investing methods and they arewilling to do it themselves if their brokers are not giving them theirdesired returns. This type of mentality, while it is reality, provides some
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incredible market shifts as those two basic elements of fear and greedcontinue to worm their way through individual investors who are nowmaking their own decisions.In times of a strong bull market and expansive growth, such aswe saw in 1999, individual investors could almost do no wrong. Theysimply buy a high-growth stock and make a bunch of money. They buya high-growth stock, take a nap, wake up, and sell it for a profit. Makingmoney had never been this easy. Or had it? Each speculative cycle contains a huge market move upward and a severe correction to the downside as many market pundits who missed out on the climb begin to talkdown the market. They cite overvaluations, unsustainability of currentmarket prices, and high levels of speculation that always end in a bubble that is about to pop. Although we have seen many of these hugeclimbs and huge falls in the last 5 years, the underlying point to the storyis that although institutions have a hold of the market, online traders arefiguring out how to ride the wave a bit longer.
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SMART MONEY, INFORMED MONEY,AND DUMB MONEYEach spike of momentum to the upside and crash to the downside provides these online momentum investors with the experience and knowledge of what to look for in times of uncertainty. They begin to understandunderlying reasons for market moves and are more apt to participate inthem. Smart money is slowly beginning to include online traders. Dumbmoney is on its way to becoming informed money. They may not besmart enough yet to get in when smart money is getting in, but they aresurely learning what to look for as the increased supply and dissemination of information is continuing to educate these traders.They are not too far behind the learning curve anymore to expectthat the public is always wrong. They may still be later than smart money,but we are slowly moving to another tier of traders. We have smartmoney entering first, informed money entering second, and dumbmoney entering third. Smart money and informed money will be sellingto dumb money. Smart money makes the most in profits. Informedmoney begins to take a piece of the pie or at least not lose as much asthey had been previously. Dumb money continues to get taken to thecleaners. Smart and dumb money will always exist. It will be interestingto see how this middle tier of traders evolves as the increased availability of market knowledge is provided to them.A perfect example of how smart money profits from dumb moneyand how this informed money is catching on can be seen in two marketcatastrophes seen in a 2-year period. In October of 1998, we had a 20percent decline in the Nasdaq, which caused many online traders a lotof stress as they were not used to this kind of market action (see Figure 4-4). For the previous 3 years, it was simply buy a growth companyor Internet stock and profit from it. A newer investor could almost throwa dart and make money because stocks were just continuing to rise. Thesetraders had very little understanding of the economy and how it worked.They didn’t understand how the international and global economiesinteracted with each other to create a foundation for trade and expansion. They were not aware of market internals, the breadth of the market, volume levels, or historical sentiment. They did not understand whatwas about to happen in October of 1998 and why.Speculation was high in the early part of 1998. Internet stocks weresoaring, growth stocks were growing, and people were getting richer orhad friends who were profiting. They felt invincible that the market
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would provide incredible gains for months to come if they could just getin the market at the right time. Outside the market, however, was a serious economic catalyst to problematic global concerns. Primarily, wewere seeing a banking crisis in the stronger international economies.Asian financial distress was getting bigger and Russia was devaluing itscurrency.Greenspan’s comments of irrational exuberance kept gettingrepeated. Finally, long-term capital was in serious trouble and neededhelp by Congress for a bailout. The International Monetary Fund wasbeing asked for economic bailout to struggling economies; the world washeaded for a global meltdown. Newer traders did not see any of this. Allthey saw was their growth stock heading higher. Fundamentals of themarket or individual stocks were thrown out the window. Everyone justwanted a piece of the action.As the early October sell-off ensued, many of these traders werewiped out. Panic selling was leading to a capitulation of dumb money
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selling to smart money. Prior to the event, institutional money wasdumping shares ahead of October.The public money continued to buy shares as institutions were selling all that these newer traders wanted. Eventually, the top in the market was in place. Stocks started to fall, late-to-the-party buyers beganselling in panic, and we hit a market bottom. This left the newer tradersin disgust as they sold near the bottom; smart money could not counttheir profits fast enough because the strong market rebound was sharpand decisive.The Fed began to lower interest rates, the economy was still doingwell, and international economies began to benefit a bit from loweringcentral bank policy. Stocks continued to rise and those who sold near thelow