Retail vs. Institutional Traders
Individual traders, like you and I, are called retail traders. We can be part-time traders, or full-time traders, but we're not working for a firm and we’re not managing other people's money. We retail traders are a small percentage of the volume in the market. On the other hand, there are Wall Street investment banks, mutual funds and hedge funds, the so-called institutional traders, and most of their trading is based on sophisticated computer algorithms and high frequency trading. Rarely is any human involved in the day trading operations of these large accounts. Through whatever means, institutional traders have considerable money behind them and they can be very aggressive.
You may correctly ask, “How can an individual trader, like you and me, coming later to the game, compete against institutional traders and win?”
The Achilles’ heel of most institutional traders is that they must trade, while individual traders are free to trade or to stay out of the market as they deem best. Banks must be active in the market and trade large volumes of shares at almost any price. An individual trader is free to wait for the best opportunities to arise.
Unfortunately, however, the majority of retail traders fritter away this fantastic advantage by over-trading. An individual who wants to succeed against the giants must develop patience and eliminate greed. The ultimate problem of losers is not their account size but their lack of self-discipline, over-trading, and their bad money management.
I always use the analogy of retail day trading and guerrilla warfare. Guerrilla warfare is an irregular approach to warfare in which a small group of combatants, such as paramilitary personnel or armed civilians, use hit-and-run military tactics, such as ambushes, sabotage, raids and petty warfare, to maneuver around a larger and less-mobile traditional military force. The United States military is considered to be one of the most formidable fighting forces in the world. However, they suffered significantly as a result of jungle warfare tactics used against them in North Vietnam. Earlier examples include the European resistance movements which fought against Nazi Germany during World War Two.
In guerrilla trading, as the term suggests, you are in hiding, waiting for an opportunity to move in and out of the financial jungle in a short period of time to generate quick profits while keeping your risk to a minimum. You don’t want to defeat or outsmart investment banks. You are simply waiting for an opportunity to reach your daily profit target.
As a retail day trader, you profit from volatility in the market. If the markets are flat, you are not going to make any money; only high frequency traders make money under these circumstances. Therefore, you need to find stocks that will make quick moves to the upside or to the downside in a relatively predictable manner. Institutional traders, on the other hand, are trading with very high frequency and will profit from very small movements of price, or as it is sometimes called, from a “choppy price action”.
It is extremely important to stay away from stocks that are being heavily traded by institutional traders. As an individual retail day trader, you must stick to retail trading territory. You will not trade stocks that other retail traders are not trading or not seeing. The strength of retail day trading strategies is that other retail traders are also using them. The more traders using these strategies, the better they will work. As more people recognize the line in the sand, more people will be buying at that point. This, of course, means the stock will move up faster. The more buyers, the quicker it will move. This is why many traders are happy to share their day trading strategies. It not only helps other traders to become more profitable, but it also increases the number of traders who are using these strategies. There is no benefit in hiding these methods or keeping them secret.
As part of the algorithmic trading by computer systems, the majority of the stocks will trend with the overall market unless they have a reason not to. So, if the market is moving up, the majority of stocks will be moving up. If the overall market is going down, the prices of the majority of stocks will also go down. But, remember, there will be a handful of stocks that will buck the trend of the market because they have a catalyst. I call these stocks Alpha Predators. I will explain them in Chapter 4 and describe how to find them. This is what retail traders are looking for - that small handful of stocks that are going to be running when the markets are tanking, or tanking when the markets are running.
If the market is running, and these stocks are running too, that's fine. You just want to make sure you are trading stocks that are moving because they have a fundamental reason to move and are not just moving with the overall market conditions.
You may ask, what is the fundamental catalyst for stocks that make them suitable for day trading? Here are some examples:
- Earnings reports
- Earnings warnings/pre-announcements
- Earnings surprises
- FDA approval/disapproval
- Mergers/acquisitions
- Alliances/partnerships/major product releases
- Major contract wins/losses
- Restructuring/layoffs/management changes
- Stock splits/buybacks/debt offerings
When I do reversal trades (Chapter 7), my favorite reversal trades are on stocks that are selling off because there has been some bad news regarding that company. If there is a quick sell off because of bad news, many people will notice and start monitoring the stock for what is called a bottom reversal. If stocks are trending down with the overall market, such as oil was some time ago, you cannot do a good reversal trade. Their value pops up by 10 cents, and you think it’s a reversal, but then they are sold off for another 50 cents. They’re selling off because they’re trending with both the overall market and their sector. Oil was a weak sector for a while and the majority of the oil and energy stocks were selling off. When a sector is weak, that is not a good time for making a reversal trade. That’s where have to differentiate.
So here’s the fourth rule of day trading:
Rule 4: Always ask, “Is this stock moving because the overall market is moving, or is it moving because it has a unique catalyst?”
That’s when you have to do a little bit of research. As you become more experienced as a trader, you will be able to differentiate between catalyst-based price action and general market trending.
As discussed, as a retail trader, you must be careful that you are not on the wrong side of the trade against institutional traders. But how do you stay out of their way? Instead of trying to find institutional traders, you find out where the retail traders are hanging out on that day and then you trade with them. Think about a schoolyard for a moment. You don’t want to be off in the sandbox doing your own thing, trading a stock that no one is paying attention to. You’re in the wrong place. Focus where everyone else is focused: focus on the stock that is moving every single day and receiving literally a ton of action. That is what day traders will be looking at. Can you day trade stock like Apple or Priceline or Coca-Cola or IBM? Of course you can, but these are slow moving stocks that are dominated by institutional traders and algorithmic traders, and in general terms they are going to be very hard to day trade. Think of it as the equivalent of hanging out in that isolated sandbox instead of hanging out with your peers in the playground where the cool cats are.
How do you determine what retail traders are focused on and your place in that playground?
There are a couple of ways to find your best place. One is by watching day trading stock scanners. I explain later in Chapters 4 and 7 about how I set up my scanner. The stocks that are gapping significantly up or down are going to be the stocks that retail traders are watching. Secondly, it's good to be in touch with social media and a community of traders. StockTwits and Twitter are usually good places to learn what is trending. If you follow a handful of traders, then you'll be able to see for yourself what everyone is talking about. There is a huge advantage to being in a community of traders, such as a chat room, and there are many chatrooms on the Internet.
As the reader of this book, you are welcome to join our private Vancouver Traders chatroom (www.Vancouver-Traders.com). We have hundreds of traders and we are talking about what is hot today. If you’re trading completely on your own, you're off in the corner of that proverbial playground. You're not in touch with what other traders are doing, and inevitably you will make it really hard on yourself because you will not know where the activity is. I have tried blocking out social media and trading in a bubble, basically doing my own thing, and it did not work. Draw on the laws of high school survival to guide you!
A little more about what I do: As a day trader, I don’t trade based on the company’s fundamentals such as product, earnings, earnings-per-share growth and financial statements. I’m not a value investor and I’m not a long term investor. I don’t trade Futures either, but I do use Futures to gain an understanding of the overall market direction in the near-term future. I am also a swing trader. In swing trading, I personally do care very much about the fundamentals of the companies I choose to trade: their earnings, dividends, earnings-per-share, and many other criteria. But swing trading is not the focus of this book, so I won’t pursue that topic for now.
I’m also a FOREX (foreign exchange market) trader and sometimes I trade commodities and currencies. But in the mornings, I am mostly an equities day trader and I focus on the real stocks. The majority of day traders don’t trade penny stocks or on the over-the-counter (OTC) market. Penny stocks are extremely manipulated and they do not follow any of the rules of the standard strategies. We at www.Vancouver-Traders.com trade real stocks. Sometimes we may be trading Facebook (ticker: FB) and sometimes we may be trading Apple (AAPL), but we will always be trading the stocks that are having a big day. You may be surprised, but on almost every single day in the market, there's a stock having a big day because the company has released earnings, had a newsbreak, or had something bad or good happen to it. These are the fundamental catalysts that you must look for.
What does my day look like as a day trader? You will read about it in detail in Chapter 8, but a day in my life typically starts at around 6 a.m. (9 a.m. New York time) with pre-market scanning. I’m scanning to see where there is volume in the market. As early as 5:30 a.m., you’ll know what stocks are gapping up or gapping down. Then I start scouring through the news for catalysts that explain the gap. I start to put together a watch list. I rule some out and then I pick and choose which ones I do and don’t like. By 9:15 a.m. (New York time) I am in my chat room, going over my watch list with all of our traders. By 9:30 a.m., when the bell rings, my plans are ready.
From when the market opens at 9:30 a.m. until around 11:30 a.m. New York time, is when the market will have the most trading volume and also the most volatility. This is the best time to trade and to especially focus on momentum trading (which will be explained later). The advantage of having all of that volume is that it provides liquidity. This means there are plenty of buyers and plenty of sellers, which in turn means that you can easily get in and out of trades.
Around mid-day, you can have good trading patterns but you won't have the volume. This means a lack of liquidity, which makes it harder to get in and out of stocks. This is especially important to consider if you want to take large shares. My focus has always been on trading at the market’s opening, which is 9:30 a.m. in New York (Eastern time). I personally trade only within the first one or two hours of the market’s opening. If you join the private chatroom that I mentioned above, you will see that I rarely make any trades after 10:30 a.m.
On a good day I have reached my goal by 7:30 a.m. Vancouver time (10:30 a.m. New York time) and I’m easing up. Often by lunchtime I've already hit my goal and I'm going to be sitting on my hands unless there is that perfect setup. From 4 p.m. until 6 p.m. I am in trading courses and we're reviewing our trades from the day.
Why is the market at low volume during the mid-day and afternoon? Imagine you made $1,000 by 10 a.m. What are you going to do? Are you going to walk away with that profit or will you keep trading until you lose that money? Hopefully you will walk away. Many people are finished for the day at some point in the morning, and then they are going to go golfing or spend the rest of the day at their leisure. But, if they have lost $1,000 by 10 a.m., those traders are going to keep fighting it out to stay in the market. They're going to keep trading, trying to make back what they lost. That means that mid-day trading is dominated by traders who have lost in the morning and are aggressively trying to regain their losses. That causes a lot of volatility, and not in a good way. That causes stocks to shoot up and down because people are going in and out with market orders. It’s this time of day that I consider to be dominated by more amateur traders and trading. Extrapolating from this, I go really easy at mid-day.
I avoid pre-market trading because there’s a very low liquidity as there are very few traders trading. That means stocks can pop up a dollar, then drop a dollar, and you can’t get in and out with large shares. You have to go really small, and you have to use such small positions that, for me at least, it's just not worth it. If you don't mind trading in only a couple of hundred shares, then you can certainly trade pre-market.
I live in Vancouver, Canada, so in my time zone the market opens at 6:30 a.m. (Pacific time). This means that my days start really early. The great advantage for me is that I can be finished trading before most of the people in my city are even out of bed. I can then spend the rest of my day skiing, climbing, with family and friends, or focusing on other work and the other businesses that I have. I try to hit my daily goal by 7:30 a.m. my time (which is 10:30 a.m. Eastern time) and then ease up. You know how easy it is to lose money. Once you have some money in your pocket, you should hold on to it.
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