KNOW WHAT YOU ARE TRADING

If you are going to trade, you should take the time to learn the essence
of a market or stock. Some things can be learned quickly but others you
will only learn over time and by trading. The longer you have been trading
a particular market, the better you will know how it reacts. Trading is a
learning process and if you are attentive you will always be able to learn
something new.

Start by getting to know the basics. If you are trading a futures contract,
make sure you know its margin, the hours it trades, and when the
contract expires, rolls over, or goes into delivery. I remember once trading
the front month in crude and not realizing it was last day of trading,
and I got stuck with taking delivery of 5,000 barrels of oil. I panicked a bit
because I lived in Manhattan and space in a Manhattan studio apartment
is quite tight. I was concerned about what I was going to do with all that
oil. I figured maybe I could make an end table or two but that still left me
with a lot of barrels of oil and I didn’t even have a car back then. Luckily
my clearinghouse took care of it (at a cost, of course). These things are
not uncommon and I have had a customer do it once as well. It is also not
uncommon to not realize when a market closes. Because futures markets
all have different hours, people who trade a lot of them can get caught taking
positions home they don’t really want, simply because they are careless
and were so caught up trading crude oil that they forgot to get out of their
soybean position at 2:15 when it closed. Yes, they can get out after hours,
but they may not get as good a price and they may get a margin call if they
are undercapitalized. It’s not that difficult to know what opens and closes
at what times, and it is something you ought to know. Another simple thing
you should know (and again, I’ve been guilty of this) is what a tick is worth
in a commodity. The first time I traded coffee I had no idea that a penny
move was worth $37.50, (I actually thought it was worth $3.75), nor did I
take the time to notice that on average it moved about $1,500 a day. I made
a trade based on someone’s recommendation without really studying it.
This was a lot more action than I was used to getting in crude, which at the
time was trading at $18/barrel and had about a $300 swing on a good day.
It was both scary and exciting trading coffee. But I soon realized I wasn’t
capitalized properly for it.

The same holds for stocks, there are some stocks that move with a
one-penny spread and others have a dollar spread. You need to know this
before getting involved. The larger the spread is the more you are risking
if you are wrong. When you trade Microsoft at $28 a share you know that
if you change your mind and get out right away you will only lose maybe a
penny or two, but if you trade Google at $628 a share then you may be out
a dollar a share before it has even begun to move.

This leads to the importance of knowing the volatility and liquidity of
a market. The best indicator for knowing liquidity is to look at volume. A
stock that trades 24 million shares a day will take a convoy of Mack trucks
to make it budge. You can trade it all day long and get the bid and the ask
for it if you are patient instead of paying for it. On the other hand, if you
are trading a goofy stock like AKF (Ambac Financial Group), that has an
average trading volume of less than 80,000 shares a day, and you try to
buy 5,000 shares you could actually make the stock move a little, at least
temporarily until you are filled. Then it will most likely go back where it
was before you bought it. It’s harder to trade thin markets as you have to
pick your spots much better just to get a fair price. Look at Figure 6.3 and
you’ll see that it’s hard to find any support from a thinly traded stock. I have
never looked at this stock and just found it randomly searching for a thin
stock. Commodities can be quite dangerous when trading thin markets.
Unless you are on the floor yourself, you can get taken for a ride in a thin
market. Your stops may get filled even if the market is not in the area.
Mysteriously at lunchtime when there are three guys in the pit the market
could make a quick move to hit the stops and come right back. I’ve seen it
happen and I’ve been a part of it when I traded on the floor, so yes, it does

FIGURE 6.3 1-Minute AKF

Source: © TradeStation Technologies 1999. All rights reserved.

happen. Just remember the thinner the market, the better you have to pick

your stop locations or the more likely they are to get filled.