Christopher Farrell - Day Trade Online (2nd Ed.). - Trading Software

213 Pages·2008·2.29 MB·English

OVER 100,000 SOLD!

N A T I O N A L B E S T S E L L E R

day
trade
online

S E C O N D E D I T I O N

C H R I S T O P H E R A . F A R R E L L

A WALL STREET
TRADING
CLASSIC

BEAT WALL STREET
AT ITS OWN GAME

LEARN TO
PROFITABLY
TRADE THE NYSE

FROM TRADING 101
TO CUTTING-EDGE
TRADING STRATEGIES

make money in any market condition

• Incorporate short-term trading techniques that were
once only known by highly paid Wall Street traders—
such as the practice of exploiting the bid-ask spread—
into your online trading endeavors

• See the market from the perspective of an NYSE
specialist or NASDAQ market maker, and profit from
this newfound view

• Learn why the fair order handling rules and recent
changes to the NYSE can be your ticket to profit

• Discover how to quickly spot trading opportunities
before others, by using the NYSE’s specialist system,
and its so-called “house edge,” to your advantage

• And much more

The independent online trader can compete and thrive
in a marketplace dominated by large Wall Street trading
houses, but only by knowing their secrets and beating them
at their own game. The Second Edition of Day Trade Online
will show you exactly how.

CHRISTOPHER A. FARRELL is a national
bestselling author and former Wall Street
bond trader who currently runs the Farrell
Preferred Stock Arbitrage Fund, LP, a
hedge fund. He has been a guest on
numerous television and radio programs,
including CNBC and BBC World News,
featured in magazines such as BusinessWeek and Worth,
and has been a guest speaker at MIT. His works have
been translated into numerous languages worldwide,
including Korean, German, Russian, and Italian. Farrell
is also the author of The Day Trader’s Survival Guide
(HarperCollins). He has over thirteen years of trading experi-
ence, and has traded over three billion dollars worth of stock
since going out on his own. Farrell is a graduate of Colgate
University and can be reached at www.farrelltrading.com.

T
he First Edition of Day Trade Online became a world-
wide phenomenon—and reached the Wall Street Journal,
New York Times, BusinessWeek, and USA Today business
bestseller lists. Since it was first written, the stock market
has evolved, and so too have the opportunities for profit.
That’s why renowned trading expert Christopher Farrell has
created a fully revised and updated Second Edition of his
popular guide.

Written in a straightforward and accessible style, Day
Trade Online, Second Edition provides a comprehensive
overview of how to consistently capture profits as you trade
stocks over the Internet. It skillfully examines all aspects of
this exciting field—from what it takes to get started to an
in-depth analysis of which trading techniques work, which
don’t, and why. Most importantly, this book will show you
how to beat Wall Street at its own game, by exploiting
the buying and selling of the investing public in the same
manner that the Street’s most powerful brokerage firms and
trading houses do.

Opening with a detailed discussion of how Wall Street
works—and what it takes to make it as either a part-
or full-time online trader—this reliable resource quickly
moves on to reveal the inner workings of the short-term
movements of the market and how stocks actually trade.
From here, Farrell examines the mechanics of the market
maker system, the role of the “specialist” on the New York
Stock Exchange (NYSE), and the importance of the bid-ask
spread; while laying the groundwork for trading NYSE stocks
and National Association of Securities Dealers Automated
Quotation (NASDAQ) stocks.

With this information in hand, you’ll become familiar with
specific strategies that will help you quickly spot trading
opportunities and take advantage of short-term inefficiencies
in today’s market.

Filled with in-depth insights and practical advice, this
step-by-step guide will help you:
• Get started in online trading, avoid common pitfalls, and

– c o n t i n u e d o n b a c k f l a p –

– c o n t i n u e d f r o m f r o n t f l a p –

$29.95 USA/$32.95 CAN

“If you’ve been thinking about joining the estimated five million online trad-
ers, then this book is for you.”

—Amazon.com

“Successful at creating a realistic picture of the life of an online trader.”

—Amey Stone, BusinessWeek

“Compared with many day-trading books, which seem to promise readers an
easy road to riches, hedge fund manager Christopher Farrell injects a healthy
dose of reality into this book.”

—Forbes.com

“Useful descriptions of how the NASDAQ market maker system and the
New York Stock Exchange specialist system work.”

—Worth magazine

“My sincere wish is that when you, the reader, finish this book, you will never
look at the stock market in the same way again. Once you see the market through
the mindset not as an investor, but as a market maker, an NYSE specialist, you
will view buying and selling in a way that you have never done before: from the
perspective of the person taking the other side of your trade.”
—From the Preface

When it was first published, Day Trade Online became a worldwide phenomenon and
reached the Wall Street Journal, BusinessWeek, USA Today, and the New York Times
business bestseller lists. Now fully updated for today’s markets, Day Trade Online,
Second Edition shows you how to short-term trade successfully from trading low-risk,
low-volatility stocks to strategies and tactics for seeking greater reward through more
risky opportunities in volatile stocks. Your comprehensive guide to trading online from
start to finish including negotiating trade commissions to real-time quote systems,
Day Trade Online, Second Edition shows you how to beat Wall Street at its own game.
With an emphasis on simplicity, this book will get you started and keep you profitable.

Photo: Tara Nash

F A R R E L L day trade online SECOND EDITION

Praise from the First Edition

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day trade
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Founded in 1807, John Wiley & Sons is the oldest independent publish-
ing company in the United States. With offices in North America, Europe,
Australia, and Asia, Wiley is globally committed to developing and market-
ing print and electronic products and services for our customers’ profes-
sional and personal knowledge and understanding.
The Wiley Trading series features books by traders who have survived
the market’s ever changing temperament and have prospered—some by
reinventing systems, others by getting back to basics. Whether a novice
trader, professional, or somewhere in-between, these books will provide
the advice and strategies needed to prosper today and well into the future.
For a list of available titles, please visit our Web site at www.Wiley
Finance.com.

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day trade
online

Second Edition

CHRISTOPHER A. FARRELL

John Wiley & Sons, Inc.

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Copyright C⃝ 2009 by Christopher A. Farrell. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or
transmitted in any form 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 either the prior written permission
of the Publisher, or authorization through payment of the appropriate per-copy
fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA
01923, [phone], fax [phone], 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 River Street, Hoboken, NJ 07030, (201)
748-6011, fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have
used their best efforts in preparing this book, they make no representations or
warranties with respect to the accuracy or completeness 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 sales
representatives or written sales materials. The advice and strategies contained
herein may not be suitable for your situation. You should consult with a
professional where appropriate. Neither the publisher 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 for technical
support, please contact our Customer Care Department within the United States
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ISBN-13 978-0-470-39520-2

Printed in the United States of America.

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This revision is dedicated in the
memory of my father, who lost his
battle with cancer in December 2001,
but won in the game of life.

“I have fought the good fight.
I have finished the race.
I have kept the faith.”

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CONTENTS

Preface
xiii

Acknowledgments
xix

Introduction
1

SECTION I
THE WORLD OF THE DAY TRADER
5

Chapter 1.
Exploiting the Excesses of Capitalism
7

The House Edge
9
The Bid-Ask Spread
11

SECTION II
INTRODUCTION TO DAY TRADING
17

Chapter 2.
Trading 101: Buying on Bad News and Selling
on Good News
19

The Mind-set of an Online Day Trader
19
A Buyer When the Market Needs Buyers
20
Hit Singles, Not Home Runs
20
Brokerage Commissions Can Destroy Profits
21
Buy in on Fear, Sell in on Greed
22
The Slow Execution
23
Is the NYSE an Easier Market to Trade?
24

SECTION III
HOW TO BEAT WALL STREET AT ITS OWN GAME
25

Chapter 3.
Exploiting Wall Street’s Conflict of Interest: Market
Orders versus Limit Orders
27

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viii
Contents

Understanding Wall Street’s Conflict of Interest
27
Price Makers versus Price Takers
29
The Bargaining Process
30
Price Negotiation—Market versus Limit Orders
32
Wall Street’s Prey
34
Prelude to the Bid-Ask Spread
35

Chapter 4.
The Day Trader’s Crystal Ball: Understanding the
Bid-Ask Spread
37

A Snapshot of a Moving Picture
37
The Mechanics of Price Movement—Understanding
What Makes a Stock Move Higher
39
Example 1: The Quote—Snapshot of a Moving Picture
41
Example 2: The Market Order to Sell—Hitting the Bid
46
Example 3: The Market Order to Buy—Lifting
the Offer
48
Example 4: The Limit Order to Buy—Bidding
for Stock
50
Day Orders versus Good-until-Canceled (GTC)
Orders
52
Example 5: The Limit Order to Sell—Offering Stock
54
Haggling Over Nickels and Dimes
56
Example 6: Moving the Stock Higher
57

Chapter 5.
The Role of the Specialist on the New York
Stock Exchange
61

Using the Specialist System to Your Advantage
64
What If There Were No NYSE Specialist?
66
Buyer of Last Resort
67
Is the Profit the Specialist Makes Justified?
68
A License to Steal?
68
The Specialist’s Limit Order Book
69
Being on Both Sides of the Market
71
Narrowing the Bid-Ask Spread
72
Wide Spreads Protect the Specialist from Volatility
73
Handling a Large Sell Order
74
The Real Intentions of the Specialists
77
Beware When the Specialist Takes the Other Side of
Your Trade
77
The Day Trader as a Shadow Specialist
78
The NYSE’s Fair Order Handling Rules
80
Never Reveal Your Hand
85

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Contents
ix

How Can You Determine Where the Specialist Lurks
in the Stock?
85
Jockeying for Position
87
How Do You Know Where You Stand in Line?
89
When in Doubt, Ask the NYSE Floor
89
Tipping the Odds in Your Favor
92
Beware of the Specialist
93

SECTION IV
INTRODUCTION TO SCALPING THE NYSE: TAKING FOOD OUT

OF THE SPECIALIST’S MOUTH
95

Chapter 6.
The Day Trader’s Secret Weapon: Exploiting
the Bid-Ask Spread
97

How Can You Make Money Trading Stocks that
Don’t Move?
98
The Role of the Scalper
99
Hit Singles, Not Home Runs
100
Operating under the Radar
100
Avoiding the Glamour Stocks
102
Exploiting the Bid-Ask Spread
103
Finding the Trade’s Sweet Spot
103
Simplifying a Complex Process
104
Other Moving Parts to This Trade
105
A Bet with the House?
109
Too Much Work for Only $100 in Gross Profits?
110
A Few Words on Risk
110

SECTION V
TRADING THE MARKET’S MOMENTUM: HOW TO PROFIT FROM VOLATILITY
113

Chapter 7.
Exploiting Market Volatility and Momentum: Strategies
for Trading Volatile Stocks
115

The Specialist and the Upper Hand
116
Playing the Gap Open—A Strategy for Betting
with the House
117
Buying on Bad News
118
Betting on the Specialist
119
Parameters of the Gap-Opening Trade
122
How to Tell If the Opening Trade Will “Clear”
the Specialist’s Limit Order Book
124

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x
Contents

Selling before the Second Wave
125
Trading Tick for Tick with the Market Indexes
127
Why Limit Orders Don’t Work in a Rally
127
Using the S&P Futures to Gauge the Sustainability
of a Rally
129
Lightning-Fast Market Upsurge: How Offers Vanish
in the Vapor Trail
129
Stock for Sale Becoming Scarce
130
Nasdaq and the Role of the Market Makers
131
A Few Words on Short Selling
135
Two Methods for Day Trading Nasdaq Stocks
136
The Apple Computer Trade
139
Buying Strong Stocks on Pullbacks
140
Opening the Stock Abnormally High
141
The Dangers of Buying a Strong Stock on the
Opening Trade
141
Inflicting Heavy Damage on the Market Makers by
Attacking Their Vulnerability
142

Chapter 8.
The Day Trader’s Ticket to the Poorhouse: How I
Managed to Lose $12,000 in Less than 24 Hours
145

The Pain of Missing a Trade
147
How Could the Stock Go Any Lower?
147
The Terrifying Feeling of Getting Caught
in a Downdraft
148
A Feeling of Irresistible Greed
148
The Need to Break Even
150
Buying the Stock for the Third Time
151
Feeling of Devastation Leads to Useful Insights
152
Learning from the Mistake and Moving On
156
Can the Quoted Market Always Be Trusted?
156
A Fool and His Money Are Soon Parted
159

Appendix A.
The Day Trader’s Arsenal: Online Brokers, Trade
Commissions, Real-Time Quote Systems, and the
Home Office
161

Choosing an Online Broker
161
Negotiate the Best Possible Commission Rate
163
Make Sure that the Broker Can Route Directly
to the NYSE
163
Per-Share versus Per-Trade Commission Rates
164
Setting up at Least Two Accounts
164
System Crashes and the Late Fill
165

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Contents
xi

Customer Service, Back-Office Problems, and Trade
Discrepancies
167
The Remedy—Keep Good Trading Records
167
The Home Office and the Virtual Trading Floor
169

Appendix B.
Considerations for Trading for a Living: The
Allocation of Trading Capital, the Pattern Day
Trader Rule, Using Margin and Trading Part-Time
vs. Full-Time
173

Allocation of Trading Capital
174
The Pattern Day Trader Rule
177
Trading on Margin
177
Margin Calls
178
Part-Time versus Full-Time Trading
179

Index
183

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