Wednesday, January 26, 2011

Level II Quotes


OK, so following yesterday's post on why stock prices move, I promised to post more info on the market structure.

Below is an example of simple quotes which are often associated with stock quotations. The bid is what someone is willing to buy the stock at and the ask is what someone is offering to sell their stock at... the difference between them is called a bid-ask spread. The Last column indicates the last price agreement, where stocks were traded, and volume is how many shares have been traded so far.


There are also the bid size and ask size which shows the number of shares (in 100s) at the price shown.... so here the highest price someone is willing to pay for GOOG at the moment is
$617.01 and they have 100 shares to sell. Similarly, someone else (or a collection of people) are willing to buy at $618, there are 200 shares willing to be traded at that price.

The quotes are similar to the car example from yesterday's post, however, here you only see the best prices, but not really what others are willing to pay or offer..... so you don't know who else is buying or selling cars - how many or how much. Below is a Level II quote monitor:


The left column is the bid, the right is the ask. These are all a list of people waiting to buy or sell their stocks at specific prices. You can click on the image to enlarge and see the text better.

So you can see in the bid column, there is someone waiting to buy 100 shares at $617, BUT the next one after that is at $616.58, and someone or collection of people waiting to buy 1100 shares at $616.50. Similarly in the ask side.

This information is very helpful and in a way gives you an in-depth look at what's driving the market... basically a look at supply and demand info!! You can see that all it takes is for someone to be willing to sell 400 shares of GOOG at market for the price to reach $616.55 from the current $617.50 last traded price!! Ever heard of anyone saying that big players can move the market with their orders? That's what it means - if someone all of a sudden dumped a large number of shares, it could drive the price of the stock down, same is true for driving the price up with market buy orders.

BTW, Level II quotes are not free and brokerages usually charge a monthly fee for allowing access to this data.

Why do stocks go up?

Seems like a pretty simple question doesn't it?

It's one of those questions that you hear and figure you know the answer to, but take a moment and try to answer it.... why did Google just go from $640.31 to $641.25 in 3 seconds? Has the value of the company and its products changed somehow in that time period? ..... What's making it move higher?

To the question "why do stock prices rise?" most people answer, "because there are more buyers than sellers so the price goes up!" Well this isn't quite right, there are no more buyers than there are sellers, you need one buyer and one seller to make a transaction, so someone just bought Google at $640.75 and someone else sold it exactly that same price.

To completely understand this, you have to grasp the idea that the stock market is an auction system of buyers (bidding) and sellers (asking) for prices.... hence the bid and ask.

To get a better idea, I will use an analogy I recently read in a book. Let's say you put your BMW up for sale at $50,000, someone comes in and offers you $45,000 for it. You now have a market, a buyer and a seller, but no transaction is taking place because nobody has agreed on a price. You bring down the price to $48,000 and the buyer agrees... now a trade has taken place and the "Last" known price on that BMW is $48,000.... this is how "Last" or "Latest Trade" prices are posted on stocks.

Now, let's expand this. You put the BMW for sale at $50,000, and someone else has put a similar one for sale at $51,000 and someone else at $52,200. The same buyer wants to buy at $45,000. BUT now a hedgefund guy wants to buy his top two sales guys BMWs (which are similar... you know, to avoid jealousy)... he looks into the market and sees three are for sale. He doesn't have time to haggle over a silly couple of thousand dollars, he wants the cars NOW! So, he buys the lower priced $50,000 one, but he still needs another, and there are no more for sale at $50k!! Since he wants the same cars and he wants them now he goes to the other seller and buys the other BMW for $51k. Now the "last" price or "latest traded" price on that specific BMW is $51,000. Market prices went up!

Stocks are the same, there are sellers at certain prices, and they only have a certain number of shares to sell. So more buyers don't necessarily bring up prices, but buyers who want the stock NOW do! They buy the lowest priced stock, when there are no more sellers willing to sell at that price there will be sellers willing to sell at higher prices... if the buyers are willing to pay a little more they buy the shares from the higher sellers too and the price of the stock rises!!

The next post will show more of this with Level II quotes....

Monday, January 17, 2011

Talking kills....... your portfolio!

Even though I'm starting to post to the blog again.... this time around some things are gonna be different!! The main thing is that I will no longer post my trades on the blog... and I will tell you my reasoning for this.

Since the last post and the loss of the BIDU trade, I' ve done much self reflection and analysis of the trade. Since then I've read many books on behavioral finance which although seems to be a buzz-word these days, is a very interesting topic on which I will post more details later.

The focus of behavioral investing/finance is that we're all human and as humans our brains work a certain way.... a sort of "snakes = danger" kind of behavioral pre-programming, if you will. The point is that some of these pre-programmed behaviors is actually counter intuitive and work against you in the world of today and especially in the world of investments and trading.

One main topic of behavioral finance is the confirmation bias. This is when you have bought a stock based on whatever reason you had... good or bad! Once you have a position in it you are inclined to talk about it. The more you talk about it, the more you convince yourself of your reasons, and the more emotionally attached you get to it.

For example, a typical convo could go like this:

I ask,"so what are you holding these days?"
You: "I just went long RIMM!"
Me: "I don't know, the market keeps beating it down."
You: "I've done my research, it's undervalued, it has great products, everyone has a Blackberry and the PlayBook is gonna blow iPad outta the water!"

This seems like a pretty harmless convo right? WRONG!!!
You may not think about it, but your mind has just attached a bit of emotional value to this particular investment/trade!! More that justifying it to your friend, you have justified it to yourself... and this is the most dangerous thing to do.

Through more conversations you will attach more emotional value to it and it becomes that much harder to sell if you're wrong about the decision and its time to cut your losses and move on... because you now deeply believe your decision was right, why else would you explain it to everyone?!... selling at a loss becomes a hit to your self-esteem and we as humans will do anything to avoid that.... including holding a trade way past the place where you KNOW you shouldn't be holding.

So this is now one of my trading rules.... "Never discuss open positions"...
This way when it comes down to selling, my mind is clear and unattached from the position. My advice to every trader out there is to avoid telling friends, family, or anyone for that matter about open positions and reasons for your trade.

More on this interesting topic later...



Saturday, January 15, 2011

I'm back, a little scarred and a little wiser

I recently read a stat that there are currently 20 million inactive blogs on the internet, which someone has started and somewhere along the line didn't bother to continue to post to. Now I don't know where that number comes from, but the idea of starting a blog and giving up on it somehow gave me the feeling of admitting defeat and that is certainly NOT my intention.

If anything I have learned much from this huge drawdown and as a result want to put the lessons learned out there so that others can avoid it......... although as a word of warning, I must say that I've read many books, blogs, and trader strategies and they all warn to cut losses immediately and before they become big, so reading may not do any good.... the best way to learn is to experience it and let it leave a scar - that way you never forget.

For all who followed by blog until June of 2010, know that I used to post all my trades as well as the occasional educational piece on trading. I made a trade in June and shorted many contracts of BIDU Call options and this spelled disaster for my account. I did not cut my losses and it grew.... and fast!!! It took me a while to sort it all out and for all to see I will post my trading account equity line for 2010, measured monthly.

The losses from the BIDU trade put a huge damper on my account, and at its peak caused a 32% drawdown.... which was unacceptable because it was caused by a single trade.

After I closed the trade at an enormous loss and with much psychological pains I stopped trading for 3 months until I sorted through the emotions. Afterwards I came back to the table with a clear mind and started to build my account up again.... and by October of 2010 the account was profitable again and it ended the year with a 7% annual gain.

In my next posts I will talk more about the process and the lessons learned.... There will be some changes to the style of the blog, BUT I am back and will be posting again so stay tuned.