Doc Maher examines market orders when trading NASDAQ stocks.
Added market volatility can be exciting at times, but also nerve wracking. Although you may not have much confidence in your trading strategy these days, there is a simple way you can help your bottom line and lower your blood pressure at the same time. Limit orders can accomplish both. I will also discuss the importance of volume and how the marketplace can impact your trade. Today’s installment will cover volume.
THE PLAY – Long Stock
TRADE FORMATION
On August 15 the trader entered the following positions (quantity was not disclosed):
Bought to open JOSB at $27.00 at 11:19 AM
Bought to open JOSB at $27.68 at 1:16 PM
Sold JOSB at 27.18 at 1:38 PM
The trade note stated:
Wow! I just gave back my profit! I doubled my bet at $27.67. I entered a market sell when the real time price was $27.30. It filled at $27.18. It looks like selling 2000 shares at once really hurt me and got me a bad fill.
ALL-STAR COMMENTARY
I am sure that even though we are looking at a trade made by Running_with_Scissors, many of you have found yourselves in a similar situation. This is a nightmare scenario. The gains you worked so hard to capture are destroyed by the execution price. The price was one amount when the order was submitted, but the fill comes back quite different – and usually not in your favor.
VOLUME
Let’s start with the trade note. The trader sites the volume of shares in the order as the cause of the poor execution. That certainly could be a likely cause if the stock is lightly traded (illiquid). This means that 2000 shares represents a disproportionately large share of the average daily volume. If the daily volume is low enough, that size trade could be significant, which could make it difficult to get out. The symbol JOSB is Joseph A. Banks Clothiers. Yahoo Finance provides the average stock volume over the last three months as 1,395,670. Trading 2000 shares doesn’t seem like it would have a big impact compared to that because the order size represents less than one-percent of the volume. However if the average daily volume was only 20,000 shares, that would be a different story. Here the order size represents ten-percent!
Click the image for a larger chart.
Looking at the daily chart (left) you can see that the volume of JOSB was recently 1.4 million shares. However it fluctuates from day to day with some days trading less than half of that amount. On August 15th, the volume was strong with 1.9 million. There is another item to keep in mind regarding volume, but that will be covered in the next section.
MARKETPLACE
Let’s move on to the next factor - where, or in this case, how the shares trade. JOSB trades on the NASDAQ, along with other four and five letter symbols. NASDAQ is actually an acronym which stands for National Association of Securities Dealers Automated Quotations. The NASDAQ is an electronic market where market makers (actually market maker firms) virtually come together to do business. These firms get together to trade shares with each other via an electronic network. There is no physical centralized meeting place like the NYSE. Everything is done through computers and phones.
Market maker firms buy and sell shares of a specific company and act in one of three ways for every trade. They may buy or sell to fill a customer’s order (acting as a dealer), they might pair buying customers with selling customers, or they may buy or sell shares for the benefit of the firm itself. Collectively, these different roles are known as making a market in a security. A NASDAQ market maker may trade one stock or many stocks. One stock may also have many different market maker firms trading the same stock.
Let’s go back to volume for a moment – specifically dealer volume. Market makers acting in a dealer capacity usually account for most of the volume traded. On the NASDAQ system, when an investor sells 100 shares of JOSB to a dealer (market maker firm), the dealer reports a 100-share transaction. When another investor buys the 100 shares of firm X from the dealer, he reports another 100-share transaction. Only 100 shares of firm X have changed hands between the two investors, but trading volume of 200 shares has been reported. Because true volume is described as investor-to-investor trading, some consider this reporting method as over inflating volume. This is known as double-counting.
In the last few years, there have been some rule changes to make the NASDAQ reporting more accurate, but the feeling in the trading community is that it has not helped that much. What does this mean for you? I have heard some people say that they do not trade stocks unless they have average daily volume greater than 500,000 shares. In the case of NASDAQ stocks, you may wish to double your personal requirement or discount the reported volume by 40-50%. In Running_with_Scissors’ trade, this point is moot as JOSB volume is still ample enough to absorb a 2000 share order.
Tomorrow we’ll continue our discussion on the NASDAQ Marketplace and how Level II plays a role in this process.
"Income Trader"
Doc's previous posts: Three new tools: EPS, P/E, and PEG and Why is Fundamental Analysis Important
Click here for a list of previous TradeKing All-Star blogs.
Nicole Wachs contributed to this post.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Jonathan F. Maher, PhD has a professional business relationship with TradeKing.