<s> TradingPairs
Founded in 1807, John Wiley & Sons is the oldest independent publishingcompany in the United States. With offices in North America, Europe,Australia, and Asia, Wiley is globally committed to developing andmarketing print and electronic products and services for our customers’professional and personal knowledge and understanding.The Wiley Trading series features books by traders who have survived themarket’s ever-changing temperament and have prospered—some byreinventing systems, others by getting back to basics. Whether a novicetrader, professional, or somewhere in between, these books will providethe advice and strategies needed to prosper today and well into the future.For a list of available titles, please visit our Web site atwww.WileyFinance.com.
TradingPairsCapturing Profits andHedging Risk with StatisticalArbitrage Strategies
MARK WHISTLER
John Wiley & Sons, Inc.
Copyright © 2004 by Mark Whistler. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New JerseyPublished simultaneously in CanadaNo part of this publication may be reproduced, stored in a retrieval system, or transmitted in anyform or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise,except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without eitherthe prior written permission of the Publisher, or authorization through payment of the appropriateper-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923. 978750-8400, fax 978-750-4470, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 RiverStreet, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: permcoordinator@wiley.com.Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best effortsin preparing this book, they make no representations or warranties with respect to the accuracy orcompleteness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by salesrepresentatives or written sales materials. The advice and strategies contained herein may not besuitable for your situation. You should consult with a professional where appropriate. Neither thepublisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.For general information on our other products and services, or technical support, please contact ourCustomer Care Department within the United States at 800-762-2974, outside the United States at317-572-3993, or fax 317-572-4002.Wiley also publishes its books in a variety of electronic formats. Some content that appears in printmay not be available in electronic books.For more information about Wiley products, visit our Web site at www.wiley.com.Library of Congress Cataloging-in-Publication Data:Whistler, Mark.Trading pairs : capturing profits and hedging risk with statisticalarbitrage strategies / Mark Whistler.p. cm. — (Wiley trading)Includes bibliographical references and index.ISBN 0-471-58428-2 (cloth/cd-rom)1. Pairs trading. 2. Stocks. I. Title. II. Series.HG4661.W46 2004332.64’5—dc222004002263Printed in the United States of America10 9 8 7 6 5 4 3 2 1
Contents
AcknowledgmentsIntroduction
CHAPTER 1
The Nuts and Bolts
What Are Pairs?
xixiii
11
How Do Pairs Work?
3
Who Uses Pairs?
3
Mindset of Reading This Book
4
CHAPTER 2
Why Fundamental Analysis?
5
Common Sense
5
China.com
6
How Fundamental Analysis Relates to Pairs
8
CHAPTER 3
Market Basics
9
Growth and Growth Ratios
12
Growth, PE, and the PEG Ratio
15
PE RatioPEG Ratio
Tying It All Together
CHAPTER 4
Technical Analysis
Candlestick ChartingHammer Bottoms and Hangman TopsDoji Star
1517
19
21232325
v
vi
CONTENTS
Shooting StarsEngulfing Patterns
2526
Support and Resistance
28
Trend Lines
28
Moving Averages
30
CHAPTER 5
Technical Analysis Indicators
33
Stochastics
33
Chaikin Money Flow Oscillator
35
On-Balance Volume
36
Relative Strength Index
36
CHAPTER 6
Basic Pairs Terminology
41
Understanding the Correlation
41
Spread, Differential, and Ratio
42
SpreadDifferentialRatio
434343
Divergence Trading
44
Convergence Trading
45
CHAPTER 7
Importing Data into Excel
47
CHAPTER 8
Understanding Correlations—Steve Price
51
CHAPTER 9
Correlation Simplified
59
What Is a Correlation?
59
Where to Find Correlations
59
Building a Correlation Using Excel
60
Contents
vii
CHAPTER 10 Understanding Stock Correlations in Relationto Indices
65
Why an Index?
65
What Is Beta?
65
How to Apply Beta
66
Where to Find Beta
67
CHAPTER 11 Basic Statistics
69
Frequency Distribution
69
Mean/Median/Mode
71
Mean Deviation
71
Variance
71
Standard Deviation
72
CHAPTER 12 Excel and Statistics
75
Setting Up the Spreadsheet
75
Average, Median, Mode, and Standard Deviation
77
Understanding the Present Data
80
How Do You Know Which Stock to Buy or Short?
80
Charting the Data
83
CHAPTER 13 Differential versus Ratio
87
Differential
87
Ratio
88
CHAPTER 14 Applying Statistics to Pairs
89
Density Curve
89
Understanding the Data
92
CHAPTER 15 Taking a Step Back for a Moment
95
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CONTENTS
CHAPTER 16 Moving Averages and NormalizedStandard Deviation
97
Differential Moving Average
97
Normalized Standard Deviation
99
CHAPTER 17 Money ManagementWhy Money Management?
101101
Psychology of Money Management
101
Understanding How Pairs Can Be Dangerous
103
CHAPTER 18 Money Management II
105
Fundamental Principles
105
Know Yourself
106
The Plan
106
CHAPTER 19 The Reality of Pairs
109
Do Pairs Really Work?
109
Trader or Investor?
113
Making the Style Work for You
113
Intraday Pairs
115
CHAPTER 20 Trading an Actual PairIntroduction
119119
Trading Diary—The Beginning
120
Historical Time Line of Divergence Events
122
CHAPTER 21 The Current SetupUnderstanding Where the Pair Is NowFundamentalsEarningsTechnical AnalysisStatisticsSummary
133133133134135137137
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Contents
Anadarko Petroleum
138
FundamentalsEarningsTechnical AnalysisStatisticsSummary
138140140141141
CHAPTER 22 Trading Diary
143
CHAPTER 23 Correlating Stocks to Indices
187
General Electric and ExxonMobil
187
General Electric and the DIAMONDS
189
ExxonMobil and the DIAMONDS
189
The Three Wise Men
193
CHAPTER 24 Option Basics—Scott P. Evans
195
CHAPTER 25 Understanding Volatility
201
What Is Volatility?
201
Volatility Position Sizing in Your Spreadsheet
201
Volatility and the Individual Stock
204
Weighted Volatility
205
CHAPTER 26 Understanding Volatility and Options
207
Speed and Option Premium
207
Option Strategies for Pairs
208
Calls/PutsCovered Calls/Puts
CHAPTER 27 Using Technical and Fundamental Analysiswith Pairs
208208
211
Technical Analysis
212
Moving Averages
212
x
CONTENTS
Stochastics and Other IndicatorsVolume
FundamentalsPrice-to-Earnings (PE) RatioPrice-to-Sales Ratio
213215
216217219
KBH Homes and Tol Brothers
220
Moving Averages and Support and Resistance as Stops
225
CHAPTER 28 Assorted Advice to Assist Trading
229
CHAPTER 29 The Monitor Sheet
233
CHAPTER 30 Conclusion
237
The Market Bubble
237
Words of Caution
237
Last Words of Advice
238
Appendix I Economic Indicator Summary
239
Appendix II Web sites, Books, and Software
255
Endnotes
257
Glossary—Jonathan Crowell and with Additions fromAndrew and Aaron Long
261
Index
269
About the CD-ROM
273
Acknowledgments
I would like to dedicate this book to you, Mary; I am so proud of you for allof your accomplishments. Sandy and Ed—your love and support has mademe the man I am today. Words cannot express my love for you. Sue, Neil, andKaren and Mike Eck—thank you for being who you are; I love you and youare the most wonderful people in the world. I would like to thank LeighStevens, Pamela Van Giessen, and Lara Murphy for making this book a reality, without you this would book would have never made it to print. Thankyou so much Scot Darr, Steve Price, Scott P. Evans, Jonathan Crowell,Andrew Long, and Aaron Long for your amazing help and contributions.Francois Safeddine, our trading cemented my knowledge—thank you. KevinCuddie, Eric Perlstein, and all of the guys at ETG Securities in Denver—youtruly are super traders. Also, thank you Noel Smith and Mike Palumbo(Third Millenium Securities—Chicago) for your time—which helped togreatly further my options knowledge. To all of my loving family on the EastCoast, you are amazing and magnificent. Hugh McCulloh, though you maynot know this, your guidance two years ago helped make this book, the Website, and the software possible. I would also like to thank some wonderfulpeople for being who you are, and helping make me who I am: Paul, Lauren,and Alexis Whistler; John Crowley (the man who first opened my eyes topairs); Randy and Maddie Nichols; and Sally Schultz (thanks for helping mepass the fourth grade). Diane Hall, you are the most brilliant godmother anyone could ever ask for, I love you. And last, but certainly not least—SaraJacobson, Raifford Patton, and Mark Kuniholm—thank you so much forbeing there when I needed you most.
xi
Introduction
This book is intended for the average investor who would like to gain a newperspective on the market. Traditionally, when we invest, we either buy orsell a stock, and then hope that it moves in our chosen direction. However,at times this strategy leaves us with a “naked” position that is simply at themercy of the market. Thus, pairs trading offers a unique alternative, andallows the individual investor a way to “hedge” positions. Think about it fora moment. If you have a long and a short position, then you are technicallymarket neutral. And if the broader indices fall 200 points—in theory—yourposition should still be “flat.” The goal is to protect our portfolios from dramatic market swings up or down, while finding stock relationship inequalities, in an effort to make money.As a result, this book attempts to present the information of pairs in aneasy-to-read format that allows the reader a new way of approaching investing. In addition, the book is geared for “at home” investors who do not haveexpensive trading software. In fact, if you have access to the Internet andMicrosoft Excel, you can do everything in this book. A little patience anddrive will help you to reshape your current paradigm of the market.
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TradingPairs
CHAPTER 1
The Nuts andBoltsWhat Are Pairs?How Do Pairs Work?Who Uses Pairs?Mindset of Reading This Book
WHAT ARE PAIRS?Where there is a relationship, there is opportunity, and where there is opportunity, there is money. In the ever-elusive world of the stock market, investorsoften think that the only way to make money is to do it the “old-fashioned”way. By this I mean either investing fundamentally in buy-and-hold companies or seeking more conservative and diversified financial vehicles. However, the computer age has opened a Pandora’s Box of trading styles, wheremany individual investors are now finding new ways to make money previously available only to industry insiders and professionals.If our cycles of light were tradable, what would you do if you could buydarkness at noon and short the remainder of daylight? In essence, what ifyou could trade the rotation of daylight, while hedging risk in case of the random eclipse? Amazingly, if we look closely enough, we begin to observe thatthe stock market is illuminated with the same principles of cyclical relationships. In our markets, there is a rotary motion of money continually occurring in stocks, sectors, indices, options, currencies, and even emotions.Our job as a pairs trader is to try and understand the fundamental, technical, and emotional cycles of these rotational relationships, while attempting to capitalize on discrepancies when disharmony appears. You may betterknow this process as arbitrage. “Rrrrrrrrrr . . . arbitrage.” It sounds sexy,doesn’t it? Be careful not to fall in love with this savvy beast, for it can causeyou to lose your hair with the stress it presents! The actual definition of arbitrage is: “The simultaneous purchase and selling of a security in order toprofit from a differential in the price. This usually takes place on different1
2
TRADING PAIRS
exchanges or marketplaces.” (EN 1.1) For the pairs trader, though, we willutilize another form of arbitrage called “statistical arbitrage,” which means:“A profit situation arising from pricing inefficiencies between securities.Investors identify the arbitrage situation through mathematical modelingtechniques.” (EN 1.2) For the purposes of this book, we will focus mainly onusing statistics to (1) identify relationships, (2) assist in determining thedirection of the relationship, and (3) ascertain how to execute our tradesbased on the data presented.Also, in this text, we will use the term pairs trading interchangeablywith statistical arbitrage, thus eliminating any possible conflict of semantics.So what exactly is pairs trading and/or statistical arbitrage? Pairs trading isa style of investing/trading that attempts to institute at least one long andone short position for every trade, while statistically analyzing the relationship presented. (EN 1.1) What’s more, the pairs trader attempts to capitalizeon market imbalances between two or more stocks (or other financialinstruments) in anticipation of making money when the inequality is corrected. In short, the pairs trader believes two or more stocks have enough ofa correlated relationship that statistical analysis will unveil tradable opportunities when the stocks move away from one another. When the two beginto secede from one another, the pairs trader will try to figure out “why” theyare separating and then institute a trade in an attempt to capitalize on eitheradditional divergence or possible reconvergence.To measure these relationships, the pairs trader uses statistics, fundamentals, technical analysis, and even probabilities. One of the main keys topairs trading is finding strong correlations between financial instruments,thus building a foundation for further analysis. We then hope to dissect theempirical data in an effort to unearth information that allows us an efficientand methodical way of attempting to make money in the stock market. Thekey word here is methodical. I would like to distinguish this word fromsystem, as it is important to recognize that we are trying to approach themarket with an orderly (backed by statistics in the case of pairs) but notautomated trading strategy. What’s more, in the first few chapters of thisbook I hope to relay a few commonsense nuggets of fundamental and technical information that will help assist in making accurate decisions when ourmath fails. The overall goal of this book is to empower the individualinvestor with an entirely distinctive paradigm of trading than the typical buyand-hold strategy. Pairs trading is by no means the “holy grail” of trading andwill have its ups and downs, like any other trading style. However, with theproper base of applicable knowledge and impeccable money managementskills, we may find ourselves with an effective trading strategy with which towork from.
The Nuts and Bolts
3
HOW DO PAIRS WORK?Take a moment and imagine a highway and the service road that parallels it.Generally, the service road will follow the highway very closely, exceptwhere terrain or development prevents such. The resulting situation is adivergence of the service road from the highway, while the obstacle is overcome. In the end, the service road will almost always come back togetherwith the highway, as the two have a very highly correlated relationship. Now,imagine the area in between the service road and highway. This area isknown as the spread. The spread is the measured distance between the twoobjects traveling together. The pairs trader attempts to measure the spreadwith statistics in an effort to find a tradable relationship of inequality opportunities, otherwise known as the previously mentioned arbitrage.The key is the correlation between two (or more) stocks, sectors,indices, or other financial instruments to be studied. Because a highway andservice road parallel one another more closely than a highway and TownBoulevard, the highway and service road will likely have a higher correlationthan the latter two. I don’t want to leave you with the impression that thereisn’t opportunity to make money between the highway/boulevard relationship. However, one must simply understand the risks presented when usinga lower correlation or, in this case, a lesser correlated group of roads.In fact, think of all the wonderful opportunities with a lower-correlatedgroup of roads. If the highway is the benchmark road that passes a town, itis likely that several roads within the town parallel the interstate. As a trading analogy, this simple observation may allow the trader to buy and sellmany smaller streets, avenues, or boulevards using the interstate as a largerguide of general direction. This would be the same as using an index like theDow Jones Industrial Average as a benchmark for trend, while buying andselling (shorting) many components within that particular index.Thus, in a nutshell, pairs trading works by betting that two or more securities will diverge or converge in price. You are betting that a $50 stock and a $55stock will either have a larger or smaller spread ($5 in this case) when the tradeis closed. Divergence traders would like to see the spread increase, while convergence traders would prefer to see the spread decrease.
WHO USES PAIRS?Anyone and everyone! Historically, pairs trading has been more of an “institutional” trading style (coveted by hedge funds) for wealthy investors orthose with trading savvy who invest for a living. (As a brief side note, while
4
TRADING PAIRS
hedge funds seem mysterious, they are simply mutual finds that can goshort. That is not to say that all mutual funds cannot go short, though for themost part, many are able to purchase only long positions.) As computershelp to unlock much of the mystery of the financial markets for the averageinvestor, many individuals use the strategy to either “hedge” portfolios or inan effort to make money by intraday or swing trading. (Swing trading refersto holding a position anywhere from two days to several weeks.)It is generally true that institutional investors require more complicatedanalysis and statistics, though at the heart of the issue, the fundamental concept is the same.In fact, by the end of this book, my goal is to teach you, the individualinvestor (or institutional trader), how to create live spreadsheets and trackpairs like a pro! The bottom line is anyone can use pairs, so don’t fear theconcept. As Franklin D. Roosevelt said in 1933, “The only thing we have tofear is fear itself.”
MINDSET OF READING THIS BOOKFirst, grab a cold beer . . . just kidding—maybe wait until Chapter 3!!! If yousmiled or chuckled just now, great! If not, put this book down and seriouslygo get some air; it’s time to relax. While trading is a very serious business,and should be approached with complete dedication, it is also important toremember to take life in strides. This book was written with a pinch ofhumor, while attempting to uncover the very dry (but incredibly interesting)subject of pairs.My only point here is that you shouldn’t take trading so seriously thatyou forget to kiss your loved ones goodnight or forsake spending time withfriends on weekends to work.This book is written in plain simple English, to make it an easy and funread. Pairs trading can be a complicated enough subject; thus, it is my goalto make this book NOT! That being said, please read this book with an openmind and remember that pairs trading is not only a foreign concept to many,but can also pull the “old switcheroo” on you at times. At some points youmay say, “That doesn’t make sense.” If a concept, number, or strategy eludesyou, please simply read on, and you may find yourself having an epiphanyshortly after.In short, read this book while intoxicated and question nothing. Kidding.
CHAPTER 2
WhyFundamentalAnalysis?Common SenseChina.comHow Fundamental AnalysisRelates to Pairs
COMMON SENSEBefore I begin to get into pairs, it is important that I build a small foundationfor which to lay our new pairs knowledge on. I will first cover fundamentalanalysis and then briefly tackle technical analysis. Fundamentally, it isimportant to understand at least a little bit about why stocks move as theydo. In other words, it is incredibly valuable to try to understand how andwhy a stock is currently priced. It is not my goal to make you a superstaranalyst, nor am I claiming to have a “fundamental” formula that will miraculously decipher stock valuation. Rather, I am merely attempting to try andmake sure that we all have fundamental common sense built on a few easilyidentifiable numbers.Fundamental common sense is a necessity, not only to the pairs trader,but to the directional investor as well. Analysts generally study long andhard to truly understand all of the internal workings of a company. However,as a common investor, you may not have 12 hours a day to commit to suchanalysis. Or perhaps you do not have time to study for the Chartered FinancialAnalyst (CFA) designation or the Certified Financial Planner (CFP) title. Ifnot, it is extremely important to at least know where a company stands—ifonly scratching the surface of fundamental analysis.The information in the next few chapters is designed to assist investorsin attempting to understand where a company is headed during the nearterm. On a commonsense level, if you are directional trading or pairs trading,5
6
TRADING PAIRS
and a stock is moving away from you (you are losing money), please at leasttake a look at the internal health of a company and consider the practical valuation of the situation. While you may be reading this and possibly saying toyourself “Yeah bub, tell me something I don’t know,” I encourage you to takea brief moment to remember recent history. How many investors overlookedthe reality of the late 1990s Internet bubble and the numerous overextendedprice-to-earnings (PE) ratios before the bear market ravaged countless portfolios? If you lost money by denying fundamentals during the bubble, thenperhaps the next chapter is for you.
CHINA.COMNo matter how much we would like to believe otherwise, even when themarket may seem most exuberant, company-specific fundamentals cannotbe denied. Spot on; retail investors are usually too quick to overbuy somestocks that seem too good to be true! We have definitely witnessed thisthrough the trading action of many Internet stocks over the last few years.Amazingly, even though you would think we might have learned our lesson,there are still many crazy bulls out there looking for any opportunity to jumpon the Internet bandwagon. For example, a newsletter that I recently wrotefor (briefly) profiled the Internet stock China.com in July 2003.On Thursday, July 31, 2003, we received a question from one subscriberinquiring whether China.com was “worth its salt at the present time?” Thesubscriber was trying to decide whether he should buy China.com eventhough the stock had run from $5 per share to $12 per share in just undertwo months. China.com had gained almost 140 percent in just 45 days fueledby rebounding bear market exuberance.Our reply to the question was:The daily chart of CHINA appears to be forming a lateral wedge as thestock consolidates after running up almost 500% since October 2002.In essence, exuberant bulls have sobered up and are now trying tomake sense of their new position. Typically, when a stock has a majorrally and then consolidates on lower volume, bulls are trying to setthemselves up for another leg up. Once the weaker hands are shakenout of the stock, bulls will likely make an attempt at breaching descending resistance of the current wedge.HOWEVER, in the case of CHINA (see Figure 2.1), one main problem exists . . . and that dilemma is valuation. Tom Jacobs from The
Why Fundamental Analysis?
7
FIGURE 2.1 China.com
Motley Fool has made this apparent in his recent article “30-Baggers,Anyone?” (EN 2.1)Specifically, CHINA does not have earnings and thus, does nothave a PE ratio. The book value of the stock is $3.63, while CHINA hasnegative EBITDA, profit margins, operating margins, ROA, and ROE.Can you say “bubble”? Moreover, sales for the last 12 months clock inat $58.3 million versus the industry average of $122.90 million, whileincome growth was ⫺$8.9 million versus the industry average of⫺$21.2 million. Sales growth equals ⫺6.10%, with the broader industry expanding roughly ⫹30%.So then, what the heck is bullish about this stock?As an analogy, even if you know your ship has a break in thehull, you can’t refute a deck full of mutineers determined to take itout to sea. Thus, I would look at the chart and keep a close eye onwedge consolidation (explained later in the book) during the CURRENT ASCENDING TREND. If the stock breaks out, we may find ourselves on board. However, unlike the rest of our compatriot sailors,we will remember that there is a split in the hull, and thus, we willsecretly wear our life vest underneath our swashbuckling suits.Stocks like CHINA are a good example of the RISKIEST investments in the market. Overall, a good rule of thumb for China.com’scurrent valuation is “when in doubt, stay out.”
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FIGURE 2.2 China.com thru August 15
We were simply taking the commonsense approach of “how is this company trading at $12.00 per share?” Then, only four days later, the stockdumped $3 to roughly $9 (see Figure 2.2).Common sense kept us from making a HUGE mistake! We made ourselvesaware of fundamental analysis—valuation and investor overexuberance—eventhough technical analysis told us to possibly board the ship. The resulting commonsense conclusion was “when in doubt, stay out!” and we were very happythat we did. This is why we must have at least some tools of fundamental analysis in our trading toolbox.
HOW FUNDAMENTAL ANALYSIS RELATES TO PAIRSAfter all of this, you may be asking yourself how and why fundamental analysis relates to pairs. First, I would like to briefly point out that this book will bemostly covering statistical arbitrage as used with convergence trading. However, it is important to understand that underneath the statistics, there must besome sort of fundamental gravity that pulls the pair back together. If you beginto find yourself looking at the statistics of a pair, while also dissecting bothcompanies on a fundamental basis, you are on the right track. Understanding afew fundamental concepts may possibly save many, many mistakes when thestatistical math fails. Thus, if you can double-check your statistics with fundamental valuation, you simply become a more effective pairs trader.
CHAPTER 3
Market BasicsGrowth and Growth RatiosGrowth, PE, and the PEG RatioTying It All Together
irst, there are a few concepts of elementary analysis that should beexamined in order to understand why companies “fundamentally”diverge. While much of this chapter is most likely review for some—and definitely arguable by a few analysts—it is simply a commonsenseapproach to quickly gaining some idea of stock specific valuation, withinfive minutes or less. This chapter will not make you a professional analyst.Rather, it attempts to uncover a few easily accessible ways that the individual investor can quickly glance at a company’s present and future financialhealth.The following section will cover:
F
• Trading liquidity and shares outstanding• Understanding growth and growth ratios• Cash and the current ratio• Earnings and guidanceFirst, we must evaluate our personal risk preference to individualequity liquidity. Stocks that have less volume tend to be more erratic andvolatile, while stocks that trade more shares each day generally haveslower price movements. The greater a stock’s liquidity, the better chanceyou, the individual, have of getting filled at the price you specify to buy or sell.A good example of this is Microsoft (NASDAQ: MSFT) versus the regionalbank Cass Commercial Corporation (NASDAQ: CASS). While both stocksare equally difficult to predict, Microsoft will likely have less volatile shortterm swings than a regional bank, due to greater liquidity. By this I meanthat because Microsoft has much more demand by investors to buy and sellstock at every penny, it will move up or down slower than a stock with lesstrading activity. When you want to sell your shares of Microsoft, you can be9
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TRADING PAIRS
fairly sure that if you put in a market order, you will receive the current bidprice or just slightly below. Conversely, in a thin regional bank stock, onecan quickly lose 50 cents to $1 when filled, even on small orders. The problem is that thin stocks (regional bank stocks in this example) quickly movein one direction or another as market makers or specialists only display theminimum shares required on either the bid or the ask. Even though marketmakers are required to make fair markets, they are not required to go out ofbusiness buying or selling all the stock you want to sell at one price. As ageneral rule of thumb, many investors will not trade stocks that do not havean average daily volume of at least 200,000 shares. Most market trackingprograms will display the average daily volume,