Definitive guide to starting day trading
Diupdate
Introduction:
Day trading is a controversial modality that involves short-term operations on the stock market. Many people are interested in this way of investing, but they do not know that it requires a very rigorous behavior and discipline. In addition, there are several myths and truths about day trading that need to be clarified. One of them is that large corporations do not make intra-day trades. Does that mean that day trading does not work?
To answer this question, it is necessary to understand a little about how the financial market works. There are different types of markets, such as the derivatives market and the spot market.
Spot market: It is the most popular among stock market investors, working in a relatively simpler way than other markets. The spot market represents the operations of buying and selling shares at the prices determined by the supply and demand of the moment.
Derivatives market: Derivatives are financial instruments whose prices are linked to another instrument that serves as their reference. For example, the oil futures market is a type of derivative whose price depends on the transactions carried out in the spot oil market, its reference instrument.
Within the derivatives market, we have:
Futures market: It is the environment where futures contracts are traded, a type of derivative. In a few words, futures contracts represent the commitment to buy or sell a certain amount of a certain good on a future date and at a pre-defined price.
Forward market: Is a negotiation in which two parties - buyer and seller - assume a long-term commitment. Thus, it is determined that today a number X of shares (for example) will be bought, and that the payment will take place on a future date.
Options market: Are investments that guarantee the investor the right, for a determined period, to buy or sell an asset - usually shares - for a pre-determined value on a specific date in the future. It is a type of derivative, because the price of the options varies according to the price of the assets to which they are linked.
The futures market is one where contracts are traded that establish the price and the date of delivery of a certain asset in the future. For example, a coffee producer can sell a coffee futures contract to guarantee their profit and protect themselves from price fluctuations in the spot market. The spot market is one where assets are traded now, such as the shares of a company. The futures market is one of the best markets for day trading, as it offers higher liquidity, leverage and volatility.
Large corporations, however, do not usually do day trading in the futures market, as they have other goals and strategies. They use the futures market to hedge, that is, to protect themselves from the risks of the spot market. They also have a very large volume of operations, making it difficult to enter and exit the market quickly. In addition, they need to follow rules and regulations that limit their investment possibilities.
This does not mean that day trading does not work for large corporations. They can do day trading in other ways, such as using the high-frequency market. This market is based on algorithms and automated systems that perform thousands of operations in fractions of seconds. This way, they can take advantage of the opportunities and fluctuations of the market with greater efficiency and speed.
Therefore, day trading is a modality that works for different profiles of investors, as long as they know how to use the appropriate tools and methods. Day trading is not an investment, but rather a form of speculating in the financial market. It involves risks, but it can also bring good results for those who have knowledge, discipline and emotional control. In a centralized market, all offers to buy and sell securities are directed to the same trading channel. In this system, the observable prices of different assets are the only prices available to the public. A notable example is the New York Stock Exchange (NYSE), where all buy orders are matched with sell orders in a central exchange. This provides greater security to market participants, as transactions are carried out in an organized and regulated environment.
Let’s first understand how the centralized market works:
The centralized market is a way of organizing financial transactions in a single trading channel, where the prices of the assets are public and regulated. This type of market offers greater security to investors, by having various defense mechanisms that prevent fraud, defaults and extreme fluctuations. In this text, I explain how the centralized market works and what are some examples of defense mechanisms in the main stock exchanges in the world.
What is the centralized market and how does it differ from other types of market?
In a centralized market, all offers to buy and sell securities are directed to the same trading channel. In it, the offers related to the same asset are exposed to acceptance and competition by all parties authorized to trade in the system. In other words, in the centralized market of the stock exchange, the observable prices of different assets are the only prices available to the public. A well-known example is the New York Stock Exchange (NYSE), where all bids (buy orders) are matched with sales (sell orders) in a central exchange. This provides greater security to market participants, as transactions are carried out in an organized and regulated environment.
A centralized market differs from other types of market, such as the decentralized market or the over-the-counter market. In a decentralized market, there is no single trading channel, but rather several locations where offers can be made. For example, the foreign exchange market (forex) is a decentralized market, where participants can trade currencies among themselves on different platforms, banks or brokers. In an over-the-counter market, transactions are made directly between the parties, without the intervention of an exchange or an intermediary. For example, the derivatives market is an over-the-counter market, where participants can trade customized contracts that are not standardized or regulated. These types of market can offer greater flexibility and privacy, but also involve higher risks and costs.
What are some examples of defense mechanisms in stock exchanges?
Stock exchanges are institutions that manage the centralized market and that establish the rules and procedures for trading. They are also responsible for ensuring the security and efficiency of transactions, using various defense mechanisms that protect investors from possible losses. Some of these mechanisms are:
Central Clearing: Or clearing House is an intermediary entity that acts between buyers and sellers in the financial market. Its role is to facilitate trading and ensure the integrity of transactions. It records, clears, manages risk and settlement of operations, requiring participants to deposit margins (guarantees) to cover possible losses. This reduces systemic risk. An example of an exchange that uses central clearing is the CME Futures (Chicago Mercantile Exchange), which trades futures and options contracts on commodities, indices, currencies and other assets.
Price Limits: Are maximum and minimum ranges that asset prices can vary in a given period. They prevent extreme fluctuations that harm investors or the functioning of the market. If the price of an asset reaches the upper or lower limit, trading is suspended or limited until the price returns to an acceptable level. An example of an exchange that uses price limits is the CME Futures, which sets daily limits for the prices of futures contracts.
Circuit Breakers: Are mechanisms that temporarily interrupt trading in case of excessive volatility. They aim to avoid situations of panic, manipulation or imbalance in the market, giving time for investors to reassess their positions and make more rational decisions. Circuit breakers can be triggered by different criteria, such as the fall or rise of an index, an asset or a sector. An example of an exchange that uses circuit breakers is the NYSE, which suspends trading if the S&P 500 index falls or rises more than a certain percentage in a day.
Opening and Closing Auctions: Are moments when operations start and end on the stock exchange. They help to stabilize the prices of the assets, by concentrating the demand and supply in a short time interval. During the auctions, buy and sell orders are recorded, but not executed, until a balance price is found that satisfies the largest number of participants. An example of an exchange that uses opening and closing auctions is the NYSE, which holds the auctions at 9:30 am and 4 pm (New York time).
Market Makers: Market makers (or market makers) are agents who commit to buy and sell certain assets at any time, providing liquidity and continuity to the market. They make money from the difference between the buy and sell prices (spread) and from the commissions they receive. They also help to reduce volatility and improve price formation. An example of an exchange that uses market makers is the NASDAQ, which is fully electronic and has more than 500 market makers who trade more than 3,000 stocks.
Electronic System: The electronic system is a way of carrying out financial transactions through digital platforms, without the need for a physical location or a human intermediary. This allows greater speed and efficiency in operations, as well as reducing costs and errors. The electronic system also facilitates access and participation of different types of investors, from institutional to individual. An example of an exchange that uses the electronic system is the NASDAQ, which was the first stock exchange to operate fully online, since 1971.
Margins: are values deposited by participants to cover possible losses in futures contracts. They help to reduce the risk of default and ensure the integrity of the market. The CME futures contracts have specific guarantees, which vary according to the traded asset, I will explain more later.
The price limits are maximum and minimum ranges that the prices of the assets can vary in a given period. They prevent extreme fluctuations that harm investors or the functioning of the market. If the price of an asset reaches the upper or lower limit, trading is suspended or limited until the price returns to an acceptable level. The CME establishes two types of price limits: Daily Price Fluctuation Limit: Prevents offers with prices that vary too much in relation to the previous day’s settlement price. Each contract has an upper (high) and a lower (low) limit. Fluctuation Limit: At the opening, there are fluctuation limits for each expiration month. If exceeded, trading is temporarily suspended. These mechanisms protect price formation and prevent extreme movements.
The New York Stock Exchange does not use margins like the CME futures contracts. On the spot market, assets are not subject to price limits. Instead, it uses a "circuit breaker", which temporarily suspends trading when prices fall. The circuit breaker is based on the S&P 500 spot index.
It also uses opening and closing auctions, times when trading begins and ends on the exchange. These help stabilize security prices by concentrating demand and supply in a short period of time. During the auctions, buy and sell orders are registered, but not executed, until an equilibrium price is found that satisfies the largest number of participants. Auctions take place at 9.30am and 4pm (New York time).
The technology exchange mainly brings together shares in technology companies. It has no daily price limits, but uses other mechanisms to safeguard the individual behavior of securities, such as auction tunnels and rejection.
It is completely electronic and has more than 500 market makers trading more than 3,000 shares. Market makers are agents who commit to buying and selling certain securities at any time, providing liquidity and continuity to the market. They make money from the difference between the buying and selling prices (spread) and from the commissions they receive. They also help to reduce volatility and improve price formation.
Explaining the stock exchange auctions
The stock auction is a protection mechanism of the Stock Exchange that occurs when there is a sudden change in the price of an asset. It aims to prevent large fluctuations in prices, protecting investors. In this text, I will explain how the stock auction works and what are its benefits and challenges.
What is the stock auction and how does it work?
The stock auction is a process that happens when the price of an asset undergoes a significant change in relation to its previous value. This change can be caused by various factors, such as news, events, rumors or speculations. During the auction, the shares leave the traditional trading floor and continue to be traded in a closed system of buy and sell offers. In this system, the orders are recorded, but not executed, until a balance price is found that satisfies the largest number of participants. The auction lasts a few minutes, but can be extended if there is a lot of demand or supply. The auction ends when the balance price is found or when the time limit is reached.
The stock auction is also important because it allows investors to have time to evaluate their decisions and trade their assets with more confidence. It also prevents the prices from being manipulated or distorted by malicious agents, or by irrational movements of the market. In addition, it ensures that transactions are carried out in a transparent and secure manner, following the rules and norms of the Stock Exchange.
What are the main types of auctions on the Stock Exchange?
There are three main types of auctions on the Stock Exchange, which occur at different times of the trading session. They are:
Extraordinary Auction: Activated in case of appreciation or depreciation from 10% in relation to the closing price of the previous day, or to the opening price of the day. This type of auction is used to protect investors from sudden changes in the prices of the assets, which can be caused by external or internal factors. For example, if a company announces a financial result much above or below the expected, the price of its share can rise or fall very quickly, generating an extraordinary auction.
Pre-Opening Auction: It happens 15 minutes before the opening of the trading session. This type of auction is used to test the prices and the formation of the assets at the beginning of the trading session, considering the information and expectations of the market. For example, if there is relevant news about the economy or politics, the price of the assets can change before the opening of the trading session, generating a pre-opening auction.
Closing Auction: In the last five minutes of the trading session. This type of auction is used to determine the closing price of the assets, used as a reference for the next day. Only the shares that are part of some index of the Stock Exchange can participate in this auction. For example, if a share is part of the S&P 500, it participates in the closing auction, which defines its final price of the day.
You already know how the centralized market works, where all buy and sell offers are directed to the same trading channel. This prevents the large participants from manipulating the prices of the assets as they please. This is because the market dynamics ensure that the game is fair to everyone.
But how to understand this market dynamics? How to know what other participants are doing and how it affects the prices of the assets? For this, you need to know the market microstructure, which is the study of the interactions between buyers and sellers, influencing the price formation of the assets. For traders, especially scalpers, understanding the microstructure is essential.
Here are the main points about the market microstructure:
Efficient Market: The efficient market theory suggests that all available information about assets is already reflected in the prices. This hypothesis does not consider human complexity and subjective interpretation of information. In practice, some participants have privileged access to information and use specific techniques. This creates momentary imbalances in supply/demand, generating price movements.
Market Reality: To understand the market reality, you need to observe three essential tools: the order book, the aggressive volume and the times and sales. We explain what they are and how they relate to the market microstructure.
Why are they so important?
To understand the dynamics of the financial market, you need to know three essential tools: the order book, the DOM (Depth of Market) and the volume of the trade history. We explain what these tools are, how they work and how they can help you in your operations.
Order Book: Is a record of all buy and sell orders of a financial asset at a given time. It allows you to track the liquidity of the market, that is, the ease of buying or selling a share. The order book shows information such as the name of the asset, the best buy and sell price, and the traded volume. Each asset has its own book, updated as new orders arrive. The order book helps to identify the supply and demand of the asset, as well as the support and resistance levels. For example, if there are many buy orders at a certain price, this means there is a strong demand for the asset, which can make the price rise. The opposite also applies to sell orders. The order book is essential for Tape Reading, which is a technique that analyzes the flow of aggression and liquidity in the market.
DOM (Depth of Market): Is an advanced version of the order book. It shows the depth of the orders at each price level, that is, how many orders there are in each price range. It allows you to visualize the available liquidity and the aggressors, the participants who execute the orders in the market. The DOM helps to identify the trend and the strength of the market. For example, if there are more aggressive buyers than sellers, this means there is a positive flow of money, which can make the price rise. The opposite also applies to aggressive sellers.
Volume of Trade History: Is the record of all transactions carried out on the stock exchange for a given asset. It shows the price, quantity, time and direction of each transaction. The volume of trade history helps to understand the dynamics of the market, as it reveals the intensity and speed of trading. It can also reveal important patterns and trends, such as breakouts, reversals and consolidations.
These tools are crucial for traders and investors who want to have a broader and deeper view of the financial market. They allow you to track the liquidity, supply, demand, trend and intensity of the market, as well as identify opportunities and risks in your operations. With them, you can make more informed and assertive decisions, increasing your chances of success.
bid/ask is the difference between the offer price and the sale price of the asset.
The ESZ22 is a derivative of the S&P 500 index that expires in December 2022. The order book of the ESZ22 is a record of all buy and sell orders for this future operation at a given time. Each value level in the book represents a buy or sell offer for a certain number of derivatives.
but before we understand how the futures contract works: the expiration letters
ES= asset code, Z expiration month letter and 22= 2022
Example of the expiration months of the contracts:
January (F)
February (G)
March (H)
April (J)
May (K)
June (M)
July (N)
August (Q)
September(U)
October (V)
November (X)
December (Z).
The S&P futures contract uses only 4 months, having a duration of 3 months each contract, using the letters H, M, U and Z
and between one expiration and another there is something called liquidity rollover:
Why does this happen?
This happens because large corporations are always building positions in futures contracts, since the main objective of a futures contract is hedging, so consequently there are large positions being made in these futures markets.
Imagine that you have a portfolio of stocks or cryptocurrencies, but unlike the futures market, these assets do not expire, they stay there until you get rid of them, now imagine that you paid a price for these assets, then your position will be where your participation in that paper was made. Unlike you, large corporations, investment banks, insiders in large companies have large buy or sell positions in papers, and also in futures contracts, but these futures contracts expire every 3 months in the American market. Every expiration happens always on Friday of the third week of the month of the letter that is in force, but the dismantling of positions takes a week due to the number of participants or the number of lots that are positioned.
In the example of the S&P the ESZ2 (for rithimic data) or EPZ22 (for CQG Continuum data) are this week migrating the positions, opportunities during the rollover are bad due to the toxic flow that enters these 2 contracts, since the 2 are in operations, what happens is that for sure you will lose money, energy or time.
The liquidity rollover in the American assets affects the world so much that European assets such as Dax and euro stoxx 50 futures contracts roll over the liquidity at the same time, which can harm operations even in markets that are not to expire like ibovespa futures or dollar futures.(excerpt from my article on liquidity rollover that is written in Portuguese), usually the recommended is to stay away from this week:
Margin and construction of the current order book
Each tick is the smallest possible variation in the value of the derivative. In the case of the ESZ2, each tick is equal to 0.25 points, equivalent to 12.50 dollars per derivative.
The volume consumption occurs when an order is executed in the market. When a buy order is executed, it consumes the volume of the sell offers in the book.
example of a scenario where the market was with spread 4571.75/4571.50 and walked to 4570.50 displacing consuming all price levels that follow. the lot consumed becomes volume and goes to the trade history. That is, it becomes volume in the market.
The Time and Sales is a record of all the transactions performed on a given financial asset at a given time. It is used in technical analysis to understand the market behavior. It can be accessed through a trading platform displayed in a separate window. The window shows a list of all the transactions performed for a given asset in a tabular format. Each main component of the Time and Sales is organized into columns, such as date/time, value/change and volume. The data lines are often color-coded to indicate whether the transaction occurred on the bid or ask.
Margin and construction of the current order book
The bid-ask spread of a financial asset is the difference between the offer price and the sale price. The first is the maximum value that a buyer pays for an asset, while the second is the minimum value that a seller accepts to sell the same asset. This information is very important in the price table, as it indicates how close or far the prices are. The smaller the bid-ask spread, the more trades occur and the orders are executed faster.
The way the market is made and developed is the reason why large players do not do day trading, because, in fact, they do not need to do that, because their priority is others.
We will understand what priority would be:
Priority is a term that refers to something that has more importance or relevance than another. In the area of medicine, priority is a situation that requires preferential or anticipatory attention. For example, heart attack, stroke and trauma are considered priority situations. On the other hand, emergency is when there is a critical situation, with the occurrence of great danger and can become an urgency if not properly attended. Dislocations, sprains, severe fractures and dengue are considered emergencies.
The order book is a record of all buy and sell orders for a given financial asset at a given time. Each value level in the book represents a buy or sell offer for a certain number of derivatives. Each tick is the smallest possible variation in the value of the derivative. In the case of the ESZ2, each tick is equal to 0.25 points, equivalent to 12.50 dollars per derivative. The volume consumption occurs when an order is executed in the market.
When a buy order is executed, it consumes the liquidity of the sell offers in the book. Likewise, when a sell order is executed, it consumes the liquidity of the buy offers in the book. The Time and Sales is a record of all transactions performed on a given financial asset at a given time.
It allows investors to track the liquidity of the market and the need for a large company to lock their positions on the stock exchange is usually based on factors such as volatility, movement and investment strategy. When an event or catastrophe occurs, the need can increase significantly, depending on the nature of the event and the impact it can have on the stock exchange.
For example, a natural disaster can affect the production of a company, which can lead to a drop in the value of the shares. In this case, a large company may need to act quickly to protect their positions on the stock exchange.
And within this need, it has to adapt to the limitations of the exchange's security mechanisms.
Knowing your place in the stock market:
My size and the size of a large corporation in the stock market are totally different, because I can at any time open my terminal and execute a transaction in the current bid/ask spread, but a large player cannot do that and if he, for example, needs to act with 5000 S&P 500 contracts he would need to move the value until he completes all his necessary transactions. The comparison of a price maker and a common investor is like comparing an Antonov plane with a person.
Price makers and market makers may face limitations when entering the bid/ask due to their size. When a large investor enters the exchange, he can have a significant impact on the value of the financial asset. The Commodity Futures Trading Commission (CFTC) of the United States has strict regulations to prevent manipulation of the exchange. The CFTC closely monitors the activities of the exchange and can take legal action against anyone who violates its rules. Imagine the difficulty of a giant aircraft carrier passing through a canal, everyone will notice that he is there, so if he wanted to hide it would be difficult to go unnoticed. That’s how a giant in the market is.
Price makers and market makers use various strategies to enter the stock market without facing legal issues of price manipulation. One of the most common strategies is trade distribution, which involves splitting a large trade into several smaller trades and distributing these trades at different price levels in the order book. This helps to avoid the price of the financial asset being significantly affected by a single trade.
Another common strategy is algorithmic trading, which involves using algorithms to execute trades automatically based on specific conditions of the stock market. These algorithms can be programmed to execute trades at specific times or in response to certain events of the stock market.
Moreover, big players can also use other strategies, such as high-frequency trading and statistical arbitrage, to enter the stock market without attracting much attention.
Trade distribution is a strategy used by price makers and market makers to avoid significant impacts on the price of the financial asset. It involves splitting a large trade into several smaller trades and distributing these trades at different price levels in the order book. This helps to avoid the price of the financial asset being significantly affected by a single order.
Another common strategy is the use of iceberg trades, which are large trades split into several smaller and hidden trades, usually by using an automated program, aiming to conceal the actual amount of the trade. The term “iceberg” comes from the fact that the visible parts are only the “tip of the iceberg” given the larger amount of limit trades ready to be placed. They are also sometimes referred to as reserve trades.
Big player is can also use other strategies, such as algorithmic trading, high-frequency trading and statistical arbitrage, to enter the financial activity without attracting much attention.
Price makers and market makers can do day trading, but they usually focus on long-term investment strategies. This is because day trading involves buying and selling financial assets in a short period, usually within the same day. As big players usually trade large volumes of capital, they may have difficulty entering and exiting the activity quickly without significantly affecting the valuation of the financial asset.
Why long term?
Precisely due to the limitations that exist in the activity. The stock activity is already more attractive for long-term positioning, as it has many lots per valuation levels, but the protection auctions in the NYSE stock market are a mechanism that aims to prevent the valuations of the stocks from suffering excessive variations in a short period. They are triggered when the stocks reach a fluctuation limit, being a maximum or minimum variation in relation to the closing valuation of the previous day. When this happens, the negotiations are suspended for a few minutes and the transactions are grouped into an auction, which determines the new equilibrium valuation of the stocks. This process aims to protect investors from sudden movements of the activity and ensure the liquidity and transparency of the operations.
The maximum fluctuation of a paper per day depends on the type and liquidity of the stock. The NYSE establishes different levels of fluctuation limits for each stock, which can vary from 5% to 20%. These limits are adjusted periodically according to the conditions of the activity. You can consult the values of the fluctuation limits on the NYSE website or in the file “Daily Trading Fluctuation”.
So the fluctuation ceases to be a concern for the big players where they focus on the long term, thus ceasing to worry about the microstructure of activity to worry about more complex issues such as macroeconomics, and macro-founded information.
In addition, day trading has become competitive every day that passes, as big players in addition to the long term also manage to benefit from day trading using high-frequency algorithms entering and exiting the operation quickly.
Why is the complexity of Day trading so high?
We understand that today it involves several variables that we need to understand before we can start working with it. The first of these variables is a number of participants, of the market, these participants are divided into some profiles.
They are classified between:
Individual investors are ordinary people who allocate their own money in the market. They can buy papers, bonds and other financial products through intermediaries of values.
Legal entity investors are companies that allocate their money in the market. They can buy papers, bonds and other financial products through intermediaries of values.
Investment funds are groups of investors who pool their money to buy papers, bonds and other financial products. They are managed by professionals from the financial market and charge a fee for the services provided.
Investment clubs are groups formed by individuals who join together to invest jointly in the market. They are managed by their own club members with a maximum limit of 150 participants.
Investment robots are software that use algorithms to make investment decisions in the market. They are created by companies specialized in financial technology and can be used by individuals or legal entities.
In other words, there is not just one type of profile that is behind the market.
Now imagine
NYSE: according to B3, the Brazilian trading, in 2022 there were about 5 million individual investors in Brazil, representing 1.4% of the total investors in the NYSE. Assuming that the proportion of individual investors in the NYSE was similar to that of Brazil, it estimated that the total number of investors in the NYSE was about 357 million. Of this total, about 74% were institutional (funds, clubs, companies, etc.) and 26% were individual (individuals and legal entities). Therefore, it estimated that the number of institutional investors in the NYSE was about 264 million and the number of individual investors was about 93 million.
Nasdaq: in 2022 there were about 4,000 companies listed on the trading, with a total market value of more than 17 trillion dollars. It did not find specific data on the number of investors by type in the Nasdaq, but according to an [article] from CNN Brasil, in 2020 about 55% of adults in the United States invested in the stock market. Considering that the adult population of the United States was about 209 million in 2020, it estimated that the number of individual investors in the Nasdaq was about 115 million. It did not find data on the participation of institutional investors in the Nasdaq, but assumed that it was similar to that of the NYSE, and estimated that the number of institutional investors in the Nasdaq was about 230 million.
CME Group: In 2022 there were more than 10,000 products traded on the trading, with an average daily volume of more than 19 million contracts. It did not find specific data on the number of investors by type in the CME Group, but according to a [report] from the own trading, in 2020 about 35% of the traded volume came from North America, 28% from Europe, Middle East and Africa, 25% from Asia-Pacific and 12% from Latin America. Estimating that the total number of investors in the CME Group was about 54 million, being about 19 million in North America, 15 million in Europe, Middle East and Africa, 13 million in Asia-Pacific and 6 million in Latin America.
That is, there are several participants with different types of decision making.
Fundamental analysis: is a way of evaluating the financial health and growth potential of a company, using indicators such as profit, revenue, debt, equity, etc. This study will identify the intrinsic value of a stock and compare it with its market price, to find buying or selling opportunities1. P/E, ROE, revenue: are some of the indicators used in fundamental analysis.
P/E/ROE: P/E is the acronym for price/earnings, which represents the ratio between the price of the stock and the earnings per share. ROE is the acronym for return on equity, which represents the profitability of the investment in a company. Revenue is the total value of the sales of a company in a given period. Correlation: is a statistical measure that indicates the degree of relationship between two variables. In the financial market, correlation can be used to analyze the dependence between two assets, such as stocks, currencies, commodities, etc. Correlation ranges from -1 to 1, where -1 indicates a perfect inverse relationship, 0 indicates a null relationship and 1 indicates a perfect direct relationship.
Hedge: is a strategy that consists of performing a financial operation that aims to protect an asset or a liability against the variations of quotation, interest rate, exchange rate, etc. The hedge works as an insurance, that reduces the risk of losses in case of adverse fluctuations of the market.
Arbitrage: is a strategy that consists of taking advantage of the differences in quotation of the same asset or of equivalent assets in different markets, or moments. Arbitrage aims to obtain profits without risk, buying the cheaper asset and selling the more expensive one simultaneously. Lock: is a strategy that consists of setting up a combination of operations with options, aiming to limit the risk and the return of the operation. A lock can be bullish or bearish, depending on the expectation of the investor about the variation of the quotation of the underlying asset.
Based on greeks options: is a strategy that consists of using the greeks of the options to evaluate the risks and the opportunities of the operations with options. The greeks are measures derived from the pricing model of the options, that indicate the sensitivity of the options to the variables of the market, such as quotation of the underlying asset, time until expiration, volatility, interest rate, etc. The main greeks are delta, gamma, theta, vega and rho.
Technical analysis (trend follower Elliot): is a method of studying the behavior of the quotations of the stocks, using graphical and statistical tools. This method aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the techniques of this method is the Elliot wave theory, which proposes that the movements of the quotations follow a fractal pattern composed of impulsive and corrective waves.
Technical analysis (with indicators): is a way of analyzing the behavior of the stock prices, using graphical and statistical tools. This way aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the features of this way are the technical indicators, being mathematical formulas applied to the prices or the volumes of the stocks. Some examples of technical indicators are moving averages, Bollinger bands, MACD, RSI, stochastic, etc.
Technical analysis (mean reversion): is a way of studying the behavior of the stock prices, using graphical and statistical tools. This way aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the strategies of this way is the mean reversion, which consists of using the moving averages as a reference to identify entry and exit points of the operations. The idea is that the prices tend to return to the mean after moving away from it.
Technical analysis (price action): is a way of studying the behavior of the prices of the stocks, using graphical and statistical tools. This approach will identify patterns, trends, supports, resistences and other signals that indicate the future movements of the market. One of the techniques of this analysis is the price action, which consists of using only the prices as a source of information, without resorting to technical or fundamental indicators. The price action is based on the reading of the candles, being graphical representations of the opening, closing, high and low prices of each period. For example, a bullish candle indicates that the price closed above the opening price, showing the strength of the buyers.
Technical analysis (patterns of nature) is the use of numerical or geometrical sequences inspired by nature, such as the Fibonacci sequence, being a series of numbers that follows the rule that each term is the sum of the previous two. The Fibonacci sequence can be used to draw retracement and extension levels of the prices, which can work as reversal or continuation points of the trends. For example, if the price of a stock falls from R$ 100 to R$ 80, and then rises to R$ 89, it is making a retracement of 50% of the previous movement, which is one of the Fibonacci levels.
Besides the techniques based on charts, there are other ways of analyzing the financial market, such as the patterns and the seasonal behavior. These phenomena affect the fluctuation of the values of the stocks, related to the periodicity or the seasonality of some economic, social or natural factors.
They are repetitive and predictable movements of these assets, with variable durations, from daily to annual. The seasonal variation is the fluctuation of them according to seasonal factors, such as weather, holidays, events, etc. For example, some may perform better in the summer than in the winter, or in certain months of the year. A famous case is the January effect, being the tendency of the stocks to rise more in that month than in the others.
Cycles and seasonality: is the agricultural market, which trades agricultural commodities, such as grains, coffee, sugar, cotton, etc. The agricultural market is influenced by several factors, such as supply and demand, weather, pests, public policies, exchange rate, etc. Investors can operate in the agricultural market through futures contracts or options of these commodities. For example, if the investor believes that the price of coffee will rise in the next month, he can buy a coffee futures contract and profit from the difference between the purchase price and the sale price.
Quantitative analysis: is a way of evaluating the performance and risk of the financial assets, using mathematical and statistical models. Quantitative analysis aims to identify patterns and anomalies in the historical or current data of the assets, to create investment strategies based on algorithms. Quantitative analysis can involve the use of artificial intelligence, machine learning or big data. For example, a quantitative analyst can use a linear regression model to estimate the relationship between the price of a stock and its earnings per share, and use this information to decide whether it is worth buying or selling that stock.
Tape reading: is a way of following the flow of orders of the financial market in real time, using tools such as the order book and the times and trades. The tape reading aims to identify the intentions of the big players of the market, such as banks, funds and financial institutions, to follow the same direction or anticipate the changes of trend. For example, if the tape reading shows a large volume of buy orders of a stock at a certain price, this may indicate that there is a strong demand for that stock, and that its price tends to rise.
Macroeconomic analysis: is a way of analyzing the national and international economic scenarios, using indicators such as GDP, inflation, interest rate, exchange rate, trade balance, etc. Macroeconomic analysis aims to understand the impacts of economic policies and geopolitical events on the financial market and the sectors of the economy. For example, if the interest rate rises, this can negatively affect consumption, investment and economic growth, and consequently, the performance of the stocks of companies linked to these sectors.
Conclusion:
The financial market is not for amateurs, nor for aspirants. There is no point in taking away the merit of those who operate and do day trading, because that does not make you better than them. Those who are consistent in the stock market are because they understand the participants, the microstructure and the variables of the market. Because all this is only 10% of the trader’s formation in the financial market, because he still needs to combine all this with an intelligent decision making where he divides it into
Traders are athletes of the mind, who need to have discipline and psychological strength to operate and work with this every day. That’s why nature selects only the best, and they don’t have time to waste. Do you want to be one of them? Study, seek knowledge, learn the environment in which you operate, practice. A market professional takes years to evolve, that’s why day trading will never have pity on you. If the great minds of the world are in the market with the best technology available, why would you, who are a beginner, overcome them all?
With time, the trader will have gone through psychological evolutions over time, so keep firm and always seek knowledge.
For this, you need to know your size, know that you don’t move the price, know your place in the market. Also know that the market changes, and you should always swim towards the market and never against it.
Day trading is a controversial modality that involves short-term operations on the stock market. Many people are interested in this way of investing, but they do not know that it requires a very rigorous behavior and discipline. In addition, there are several myths and truths about day trading that need to be clarified. One of them is that large corporations do not make intra-day trades. Does that mean that day trading does not work?
To answer this question, it is necessary to understand a little about how the financial market works. There are different types of markets, such as the derivatives market and the spot market.
Spot market: It is the most popular among stock market investors, working in a relatively simpler way than other markets. The spot market represents the operations of buying and selling shares at the prices determined by the supply and demand of the moment.
Derivatives market: Derivatives are financial instruments whose prices are linked to another instrument that serves as their reference. For example, the oil futures market is a type of derivative whose price depends on the transactions carried out in the spot oil market, its reference instrument.
Within the derivatives market, we have:
Futures market: It is the environment where futures contracts are traded, a type of derivative. In a few words, futures contracts represent the commitment to buy or sell a certain amount of a certain good on a future date and at a pre-defined price.
Forward market: Is a negotiation in which two parties - buyer and seller - assume a long-term commitment. Thus, it is determined that today a number X of shares (for example) will be bought, and that the payment will take place on a future date.
Options market: Are investments that guarantee the investor the right, for a determined period, to buy or sell an asset - usually shares - for a pre-determined value on a specific date in the future. It is a type of derivative, because the price of the options varies according to the price of the assets to which they are linked.
The futures market is one where contracts are traded that establish the price and the date of delivery of a certain asset in the future. For example, a coffee producer can sell a coffee futures contract to guarantee their profit and protect themselves from price fluctuations in the spot market. The spot market is one where assets are traded now, such as the shares of a company. The futures market is one of the best markets for day trading, as it offers higher liquidity, leverage and volatility.
Large corporations, however, do not usually do day trading in the futures market, as they have other goals and strategies. They use the futures market to hedge, that is, to protect themselves from the risks of the spot market. They also have a very large volume of operations, making it difficult to enter and exit the market quickly. In addition, they need to follow rules and regulations that limit their investment possibilities.
This does not mean that day trading does not work for large corporations. They can do day trading in other ways, such as using the high-frequency market. This market is based on algorithms and automated systems that perform thousands of operations in fractions of seconds. This way, they can take advantage of the opportunities and fluctuations of the market with greater efficiency and speed.
Therefore, day trading is a modality that works for different profiles of investors, as long as they know how to use the appropriate tools and methods. Day trading is not an investment, but rather a form of speculating in the financial market. It involves risks, but it can also bring good results for those who have knowledge, discipline and emotional control. In a centralized market, all offers to buy and sell securities are directed to the same trading channel. In this system, the observable prices of different assets are the only prices available to the public. A notable example is the New York Stock Exchange (NYSE), where all buy orders are matched with sell orders in a central exchange. This provides greater security to market participants, as transactions are carried out in an organized and regulated environment.
Let’s first understand how the centralized market works:
The centralized market is a way of organizing financial transactions in a single trading channel, where the prices of the assets are public and regulated. This type of market offers greater security to investors, by having various defense mechanisms that prevent fraud, defaults and extreme fluctuations. In this text, I explain how the centralized market works and what are some examples of defense mechanisms in the main stock exchanges in the world.
What is the centralized market and how does it differ from other types of market?
In a centralized market, all offers to buy and sell securities are directed to the same trading channel. In it, the offers related to the same asset are exposed to acceptance and competition by all parties authorized to trade in the system. In other words, in the centralized market of the stock exchange, the observable prices of different assets are the only prices available to the public. A well-known example is the New York Stock Exchange (NYSE), where all bids (buy orders) are matched with sales (sell orders) in a central exchange. This provides greater security to market participants, as transactions are carried out in an organized and regulated environment.
A centralized market differs from other types of market, such as the decentralized market or the over-the-counter market. In a decentralized market, there is no single trading channel, but rather several locations where offers can be made. For example, the foreign exchange market (forex) is a decentralized market, where participants can trade currencies among themselves on different platforms, banks or brokers. In an over-the-counter market, transactions are made directly between the parties, without the intervention of an exchange or an intermediary. For example, the derivatives market is an over-the-counter market, where participants can trade customized contracts that are not standardized or regulated. These types of market can offer greater flexibility and privacy, but also involve higher risks and costs.
What are some examples of defense mechanisms in stock exchanges?
Stock exchanges are institutions that manage the centralized market and that establish the rules and procedures for trading. They are also responsible for ensuring the security and efficiency of transactions, using various defense mechanisms that protect investors from possible losses. Some of these mechanisms are:
Central Clearing: Or clearing House is an intermediary entity that acts between buyers and sellers in the financial market. Its role is to facilitate trading and ensure the integrity of transactions. It records, clears, manages risk and settlement of operations, requiring participants to deposit margins (guarantees) to cover possible losses. This reduces systemic risk. An example of an exchange that uses central clearing is the CME Futures (Chicago Mercantile Exchange), which trades futures and options contracts on commodities, indices, currencies and other assets.
Price Limits: Are maximum and minimum ranges that asset prices can vary in a given period. They prevent extreme fluctuations that harm investors or the functioning of the market. If the price of an asset reaches the upper or lower limit, trading is suspended or limited until the price returns to an acceptable level. An example of an exchange that uses price limits is the CME Futures, which sets daily limits for the prices of futures contracts.
Circuit Breakers: Are mechanisms that temporarily interrupt trading in case of excessive volatility. They aim to avoid situations of panic, manipulation or imbalance in the market, giving time for investors to reassess their positions and make more rational decisions. Circuit breakers can be triggered by different criteria, such as the fall or rise of an index, an asset or a sector. An example of an exchange that uses circuit breakers is the NYSE, which suspends trading if the S&P 500 index falls or rises more than a certain percentage in a day.
Opening and Closing Auctions: Are moments when operations start and end on the stock exchange. They help to stabilize the prices of the assets, by concentrating the demand and supply in a short time interval. During the auctions, buy and sell orders are recorded, but not executed, until a balance price is found that satisfies the largest number of participants. An example of an exchange that uses opening and closing auctions is the NYSE, which holds the auctions at 9:30 am and 4 pm (New York time).
Market Makers: Market makers (or market makers) are agents who commit to buy and sell certain assets at any time, providing liquidity and continuity to the market. They make money from the difference between the buy and sell prices (spread) and from the commissions they receive. They also help to reduce volatility and improve price formation. An example of an exchange that uses market makers is the NASDAQ, which is fully electronic and has more than 500 market makers who trade more than 3,000 stocks.
Electronic System: The electronic system is a way of carrying out financial transactions through digital platforms, without the need for a physical location or a human intermediary. This allows greater speed and efficiency in operations, as well as reducing costs and errors. The electronic system also facilitates access and participation of different types of investors, from institutional to individual. An example of an exchange that uses the electronic system is the NASDAQ, which was the first stock exchange to operate fully online, since 1971.
Margins: are values deposited by participants to cover possible losses in futures contracts. They help to reduce the risk of default and ensure the integrity of the market. The CME futures contracts have specific guarantees, which vary according to the traded asset, I will explain more later.
The price limits are maximum and minimum ranges that the prices of the assets can vary in a given period. They prevent extreme fluctuations that harm investors or the functioning of the market. If the price of an asset reaches the upper or lower limit, trading is suspended or limited until the price returns to an acceptable level. The CME establishes two types of price limits: Daily Price Fluctuation Limit: Prevents offers with prices that vary too much in relation to the previous day’s settlement price. Each contract has an upper (high) and a lower (low) limit. Fluctuation Limit: At the opening, there are fluctuation limits for each expiration month. If exceeded, trading is temporarily suspended. These mechanisms protect price formation and prevent extreme movements.
The New York Stock Exchange does not use margins like the CME futures contracts. On the spot market, assets are not subject to price limits. Instead, it uses a "circuit breaker", which temporarily suspends trading when prices fall. The circuit breaker is based on the S&P 500 spot index.
It also uses opening and closing auctions, times when trading begins and ends on the exchange. These help stabilize security prices by concentrating demand and supply in a short period of time. During the auctions, buy and sell orders are registered, but not executed, until an equilibrium price is found that satisfies the largest number of participants. Auctions take place at 9.30am and 4pm (New York time).
The technology exchange mainly brings together shares in technology companies. It has no daily price limits, but uses other mechanisms to safeguard the individual behavior of securities, such as auction tunnels and rejection.
It is completely electronic and has more than 500 market makers trading more than 3,000 shares. Market makers are agents who commit to buying and selling certain securities at any time, providing liquidity and continuity to the market. They make money from the difference between the buying and selling prices (spread) and from the commissions they receive. They also help to reduce volatility and improve price formation.
Explaining the stock exchange auctions
The stock auction is a protection mechanism of the Stock Exchange that occurs when there is a sudden change in the price of an asset. It aims to prevent large fluctuations in prices, protecting investors. In this text, I will explain how the stock auction works and what are its benefits and challenges.
What is the stock auction and how does it work?
The stock auction is a process that happens when the price of an asset undergoes a significant change in relation to its previous value. This change can be caused by various factors, such as news, events, rumors or speculations. During the auction, the shares leave the traditional trading floor and continue to be traded in a closed system of buy and sell offers. In this system, the orders are recorded, but not executed, until a balance price is found that satisfies the largest number of participants. The auction lasts a few minutes, but can be extended if there is a lot of demand or supply. The auction ends when the balance price is found or when the time limit is reached.
The stock auction is also important because it allows investors to have time to evaluate their decisions and trade their assets with more confidence. It also prevents the prices from being manipulated or distorted by malicious agents, or by irrational movements of the market. In addition, it ensures that transactions are carried out in a transparent and secure manner, following the rules and norms of the Stock Exchange.
What are the main types of auctions on the Stock Exchange?
There are three main types of auctions on the Stock Exchange, which occur at different times of the trading session. They are:
Extraordinary Auction: Activated in case of appreciation or depreciation from 10% in relation to the closing price of the previous day, or to the opening price of the day. This type of auction is used to protect investors from sudden changes in the prices of the assets, which can be caused by external or internal factors. For example, if a company announces a financial result much above or below the expected, the price of its share can rise or fall very quickly, generating an extraordinary auction.
Pre-Opening Auction: It happens 15 minutes before the opening of the trading session. This type of auction is used to test the prices and the formation of the assets at the beginning of the trading session, considering the information and expectations of the market. For example, if there is relevant news about the economy or politics, the price of the assets can change before the opening of the trading session, generating a pre-opening auction.
Closing Auction: In the last five minutes of the trading session. This type of auction is used to determine the closing price of the assets, used as a reference for the next day. Only the shares that are part of some index of the Stock Exchange can participate in this auction. For example, if a share is part of the S&P 500, it participates in the closing auction, which defines its final price of the day.
You already know how the centralized market works, where all buy and sell offers are directed to the same trading channel. This prevents the large participants from manipulating the prices of the assets as they please. This is because the market dynamics ensure that the game is fair to everyone.
But how to understand this market dynamics? How to know what other participants are doing and how it affects the prices of the assets? For this, you need to know the market microstructure, which is the study of the interactions between buyers and sellers, influencing the price formation of the assets. For traders, especially scalpers, understanding the microstructure is essential.
Here are the main points about the market microstructure:
Efficient Market: The efficient market theory suggests that all available information about assets is already reflected in the prices. This hypothesis does not consider human complexity and subjective interpretation of information. In practice, some participants have privileged access to information and use specific techniques. This creates momentary imbalances in supply/demand, generating price movements.
Market Reality: To understand the market reality, you need to observe three essential tools: the order book, the aggressive volume and the times and sales. We explain what they are and how they relate to the market microstructure.
Why are they so important?
To understand the dynamics of the financial market, you need to know three essential tools: the order book, the DOM (Depth of Market) and the volume of the trade history. We explain what these tools are, how they work and how they can help you in your operations.
Order Book: Is a record of all buy and sell orders of a financial asset at a given time. It allows you to track the liquidity of the market, that is, the ease of buying or selling a share. The order book shows information such as the name of the asset, the best buy and sell price, and the traded volume. Each asset has its own book, updated as new orders arrive. The order book helps to identify the supply and demand of the asset, as well as the support and resistance levels. For example, if there are many buy orders at a certain price, this means there is a strong demand for the asset, which can make the price rise. The opposite also applies to sell orders. The order book is essential for Tape Reading, which is a technique that analyzes the flow of aggression and liquidity in the market.
DOM (Depth of Market): Is an advanced version of the order book. It shows the depth of the orders at each price level, that is, how many orders there are in each price range. It allows you to visualize the available liquidity and the aggressors, the participants who execute the orders in the market. The DOM helps to identify the trend and the strength of the market. For example, if there are more aggressive buyers than sellers, this means there is a positive flow of money, which can make the price rise. The opposite also applies to aggressive sellers.
Volume of Trade History: Is the record of all transactions carried out on the stock exchange for a given asset. It shows the price, quantity, time and direction of each transaction. The volume of trade history helps to understand the dynamics of the market, as it reveals the intensity and speed of trading. It can also reveal important patterns and trends, such as breakouts, reversals and consolidations.
These tools are crucial for traders and investors who want to have a broader and deeper view of the financial market. They allow you to track the liquidity, supply, demand, trend and intensity of the market, as well as identify opportunities and risks in your operations. With them, you can make more informed and assertive decisions, increasing your chances of success.
bid/ask is the difference between the offer price and the sale price of the asset.
The ESZ22 is a derivative of the S&P 500 index that expires in December 2022. The order book of the ESZ22 is a record of all buy and sell orders for this future operation at a given time. Each value level in the book represents a buy or sell offer for a certain number of derivatives.
but before we understand how the futures contract works: the expiration letters
ES= asset code, Z expiration month letter and 22= 2022
Example of the expiration months of the contracts:
January (F)
February (G)
March (H)
April (J)
May (K)
June (M)
July (N)
August (Q)
September(U)
October (V)
November (X)
December (Z).
The S&P futures contract uses only 4 months, having a duration of 3 months each contract, using the letters H, M, U and Z
and between one expiration and another there is something called liquidity rollover:
Why does this happen?
This happens because large corporations are always building positions in futures contracts, since the main objective of a futures contract is hedging, so consequently there are large positions being made in these futures markets.
Imagine that you have a portfolio of stocks or cryptocurrencies, but unlike the futures market, these assets do not expire, they stay there until you get rid of them, now imagine that you paid a price for these assets, then your position will be where your participation in that paper was made. Unlike you, large corporations, investment banks, insiders in large companies have large buy or sell positions in papers, and also in futures contracts, but these futures contracts expire every 3 months in the American market. Every expiration happens always on Friday of the third week of the month of the letter that is in force, but the dismantling of positions takes a week due to the number of participants or the number of lots that are positioned.
In the example of the S&P the ESZ2 (for rithimic data) or EPZ22 (for CQG Continuum data) are this week migrating the positions, opportunities during the rollover are bad due to the toxic flow that enters these 2 contracts, since the 2 are in operations, what happens is that for sure you will lose money, energy or time.
The liquidity rollover in the American assets affects the world so much that European assets such as Dax and euro stoxx 50 futures contracts roll over the liquidity at the same time, which can harm operations even in markets that are not to expire like ibovespa futures or dollar futures.(excerpt from my article on liquidity rollover that is written in Portuguese), usually the recommended is to stay away from this week:
Margin and construction of the current order book
Each tick is the smallest possible variation in the value of the derivative. In the case of the ESZ2, each tick is equal to 0.25 points, equivalent to 12.50 dollars per derivative.
The volume consumption occurs when an order is executed in the market. When a buy order is executed, it consumes the volume of the sell offers in the book.
example of a scenario where the market was with spread 4571.75/4571.50 and walked to 4570.50 displacing consuming all price levels that follow. the lot consumed becomes volume and goes to the trade history. That is, it becomes volume in the market.
The Time and Sales is a record of all the transactions performed on a given financial asset at a given time. It is used in technical analysis to understand the market behavior. It can be accessed through a trading platform displayed in a separate window. The window shows a list of all the transactions performed for a given asset in a tabular format. Each main component of the Time and Sales is organized into columns, such as date/time, value/change and volume. The data lines are often color-coded to indicate whether the transaction occurred on the bid or ask.
Margin and construction of the current order book
The bid-ask spread of a financial asset is the difference between the offer price and the sale price. The first is the maximum value that a buyer pays for an asset, while the second is the minimum value that a seller accepts to sell the same asset. This information is very important in the price table, as it indicates how close or far the prices are. The smaller the bid-ask spread, the more trades occur and the orders are executed faster.
The way the market is made and developed is the reason why large players do not do day trading, because, in fact, they do not need to do that, because their priority is others.
We will understand what priority would be:
Priority is a term that refers to something that has more importance or relevance than another. In the area of medicine, priority is a situation that requires preferential or anticipatory attention. For example, heart attack, stroke and trauma are considered priority situations. On the other hand, emergency is when there is a critical situation, with the occurrence of great danger and can become an urgency if not properly attended. Dislocations, sprains, severe fractures and dengue are considered emergencies.
The order book is a record of all buy and sell orders for a given financial asset at a given time. Each value level in the book represents a buy or sell offer for a certain number of derivatives. Each tick is the smallest possible variation in the value of the derivative. In the case of the ESZ2, each tick is equal to 0.25 points, equivalent to 12.50 dollars per derivative. The volume consumption occurs when an order is executed in the market.
When a buy order is executed, it consumes the liquidity of the sell offers in the book. Likewise, when a sell order is executed, it consumes the liquidity of the buy offers in the book. The Time and Sales is a record of all transactions performed on a given financial asset at a given time.
It allows investors to track the liquidity of the market and the need for a large company to lock their positions on the stock exchange is usually based on factors such as volatility, movement and investment strategy. When an event or catastrophe occurs, the need can increase significantly, depending on the nature of the event and the impact it can have on the stock exchange.
For example, a natural disaster can affect the production of a company, which can lead to a drop in the value of the shares. In this case, a large company may need to act quickly to protect their positions on the stock exchange.
And within this need, it has to adapt to the limitations of the exchange's security mechanisms.
Knowing your place in the stock market:
My size and the size of a large corporation in the stock market are totally different, because I can at any time open my terminal and execute a transaction in the current bid/ask spread, but a large player cannot do that and if he, for example, needs to act with 5000 S&P 500 contracts he would need to move the value until he completes all his necessary transactions. The comparison of a price maker and a common investor is like comparing an Antonov plane with a person.
Price makers and market makers may face limitations when entering the bid/ask due to their size. When a large investor enters the exchange, he can have a significant impact on the value of the financial asset. The Commodity Futures Trading Commission (CFTC) of the United States has strict regulations to prevent manipulation of the exchange. The CFTC closely monitors the activities of the exchange and can take legal action against anyone who violates its rules. Imagine the difficulty of a giant aircraft carrier passing through a canal, everyone will notice that he is there, so if he wanted to hide it would be difficult to go unnoticed. That’s how a giant in the market is.
Price makers and market makers use various strategies to enter the stock market without facing legal issues of price manipulation. One of the most common strategies is trade distribution, which involves splitting a large trade into several smaller trades and distributing these trades at different price levels in the order book. This helps to avoid the price of the financial asset being significantly affected by a single trade.
Another common strategy is algorithmic trading, which involves using algorithms to execute trades automatically based on specific conditions of the stock market. These algorithms can be programmed to execute trades at specific times or in response to certain events of the stock market.
Moreover, big players can also use other strategies, such as high-frequency trading and statistical arbitrage, to enter the stock market without attracting much attention.
Trade distribution is a strategy used by price makers and market makers to avoid significant impacts on the price of the financial asset. It involves splitting a large trade into several smaller trades and distributing these trades at different price levels in the order book. This helps to avoid the price of the financial asset being significantly affected by a single order.
Another common strategy is the use of iceberg trades, which are large trades split into several smaller and hidden trades, usually by using an automated program, aiming to conceal the actual amount of the trade. The term “iceberg” comes from the fact that the visible parts are only the “tip of the iceberg” given the larger amount of limit trades ready to be placed. They are also sometimes referred to as reserve trades.
Big player is can also use other strategies, such as algorithmic trading, high-frequency trading and statistical arbitrage, to enter the financial activity without attracting much attention.
Price makers and market makers can do day trading, but they usually focus on long-term investment strategies. This is because day trading involves buying and selling financial assets in a short period, usually within the same day. As big players usually trade large volumes of capital, they may have difficulty entering and exiting the activity quickly without significantly affecting the valuation of the financial asset.
Why long term?
Precisely due to the limitations that exist in the activity. The stock activity is already more attractive for long-term positioning, as it has many lots per valuation levels, but the protection auctions in the NYSE stock market are a mechanism that aims to prevent the valuations of the stocks from suffering excessive variations in a short period. They are triggered when the stocks reach a fluctuation limit, being a maximum or minimum variation in relation to the closing valuation of the previous day. When this happens, the negotiations are suspended for a few minutes and the transactions are grouped into an auction, which determines the new equilibrium valuation of the stocks. This process aims to protect investors from sudden movements of the activity and ensure the liquidity and transparency of the operations.
The maximum fluctuation of a paper per day depends on the type and liquidity of the stock. The NYSE establishes different levels of fluctuation limits for each stock, which can vary from 5% to 20%. These limits are adjusted periodically according to the conditions of the activity. You can consult the values of the fluctuation limits on the NYSE website or in the file “Daily Trading Fluctuation”.
So the fluctuation ceases to be a concern for the big players where they focus on the long term, thus ceasing to worry about the microstructure of activity to worry about more complex issues such as macroeconomics, and macro-founded information.
In addition, day trading has become competitive every day that passes, as big players in addition to the long term also manage to benefit from day trading using high-frequency algorithms entering and exiting the operation quickly.
Why is the complexity of Day trading so high?
We understand that today it involves several variables that we need to understand before we can start working with it. The first of these variables is a number of participants, of the market, these participants are divided into some profiles.
They are classified between:
Individual investors are ordinary people who allocate their own money in the market. They can buy papers, bonds and other financial products through intermediaries of values.
Legal entity investors are companies that allocate their money in the market. They can buy papers, bonds and other financial products through intermediaries of values.
Investment funds are groups of investors who pool their money to buy papers, bonds and other financial products. They are managed by professionals from the financial market and charge a fee for the services provided.
Investment clubs are groups formed by individuals who join together to invest jointly in the market. They are managed by their own club members with a maximum limit of 150 participants.
Investment robots are software that use algorithms to make investment decisions in the market. They are created by companies specialized in financial technology and can be used by individuals or legal entities.
In other words, there is not just one type of profile that is behind the market.
Now imagine
NYSE: according to B3, the Brazilian trading, in 2022 there were about 5 million individual investors in Brazil, representing 1.4% of the total investors in the NYSE. Assuming that the proportion of individual investors in the NYSE was similar to that of Brazil, it estimated that the total number of investors in the NYSE was about 357 million. Of this total, about 74% were institutional (funds, clubs, companies, etc.) and 26% were individual (individuals and legal entities). Therefore, it estimated that the number of institutional investors in the NYSE was about 264 million and the number of individual investors was about 93 million.
Nasdaq: in 2022 there were about 4,000 companies listed on the trading, with a total market value of more than 17 trillion dollars. It did not find specific data on the number of investors by type in the Nasdaq, but according to an [article] from CNN Brasil, in 2020 about 55% of adults in the United States invested in the stock market. Considering that the adult population of the United States was about 209 million in 2020, it estimated that the number of individual investors in the Nasdaq was about 115 million. It did not find data on the participation of institutional investors in the Nasdaq, but assumed that it was similar to that of the NYSE, and estimated that the number of institutional investors in the Nasdaq was about 230 million.
CME Group: In 2022 there were more than 10,000 products traded on the trading, with an average daily volume of more than 19 million contracts. It did not find specific data on the number of investors by type in the CME Group, but according to a [report] from the own trading, in 2020 about 35% of the traded volume came from North America, 28% from Europe, Middle East and Africa, 25% from Asia-Pacific and 12% from Latin America. Estimating that the total number of investors in the CME Group was about 54 million, being about 19 million in North America, 15 million in Europe, Middle East and Africa, 13 million in Asia-Pacific and 6 million in Latin America.
That is, there are several participants with different types of decision making.
Fundamental analysis: is a way of evaluating the financial health and growth potential of a company, using indicators such as profit, revenue, debt, equity, etc. This study will identify the intrinsic value of a stock and compare it with its market price, to find buying or selling opportunities1. P/E, ROE, revenue: are some of the indicators used in fundamental analysis.
P/E/ROE: P/E is the acronym for price/earnings, which represents the ratio between the price of the stock and the earnings per share. ROE is the acronym for return on equity, which represents the profitability of the investment in a company. Revenue is the total value of the sales of a company in a given period. Correlation: is a statistical measure that indicates the degree of relationship between two variables. In the financial market, correlation can be used to analyze the dependence between two assets, such as stocks, currencies, commodities, etc. Correlation ranges from -1 to 1, where -1 indicates a perfect inverse relationship, 0 indicates a null relationship and 1 indicates a perfect direct relationship.
Hedge: is a strategy that consists of performing a financial operation that aims to protect an asset or a liability against the variations of quotation, interest rate, exchange rate, etc. The hedge works as an insurance, that reduces the risk of losses in case of adverse fluctuations of the market.
Arbitrage: is a strategy that consists of taking advantage of the differences in quotation of the same asset or of equivalent assets in different markets, or moments. Arbitrage aims to obtain profits without risk, buying the cheaper asset and selling the more expensive one simultaneously. Lock: is a strategy that consists of setting up a combination of operations with options, aiming to limit the risk and the return of the operation. A lock can be bullish or bearish, depending on the expectation of the investor about the variation of the quotation of the underlying asset.
Based on greeks options: is a strategy that consists of using the greeks of the options to evaluate the risks and the opportunities of the operations with options. The greeks are measures derived from the pricing model of the options, that indicate the sensitivity of the options to the variables of the market, such as quotation of the underlying asset, time until expiration, volatility, interest rate, etc. The main greeks are delta, gamma, theta, vega and rho.
Technical analysis (trend follower Elliot): is a method of studying the behavior of the quotations of the stocks, using graphical and statistical tools. This method aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the techniques of this method is the Elliot wave theory, which proposes that the movements of the quotations follow a fractal pattern composed of impulsive and corrective waves.
Technical analysis (with indicators): is a way of analyzing the behavior of the stock prices, using graphical and statistical tools. This way aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the features of this way are the technical indicators, being mathematical formulas applied to the prices or the volumes of the stocks. Some examples of technical indicators are moving averages, Bollinger bands, MACD, RSI, stochastic, etc.
Technical analysis (mean reversion): is a way of studying the behavior of the stock prices, using graphical and statistical tools. This way aims to identify patterns, trends, supports, resistances and other signals that indicate the future movements of the market. One of the strategies of this way is the mean reversion, which consists of using the moving averages as a reference to identify entry and exit points of the operations. The idea is that the prices tend to return to the mean after moving away from it.
Technical analysis (price action): is a way of studying the behavior of the prices of the stocks, using graphical and statistical tools. This approach will identify patterns, trends, supports, resistences and other signals that indicate the future movements of the market. One of the techniques of this analysis is the price action, which consists of using only the prices as a source of information, without resorting to technical or fundamental indicators. The price action is based on the reading of the candles, being graphical representations of the opening, closing, high and low prices of each period. For example, a bullish candle indicates that the price closed above the opening price, showing the strength of the buyers.
Technical analysis (patterns of nature) is the use of numerical or geometrical sequences inspired by nature, such as the Fibonacci sequence, being a series of numbers that follows the rule that each term is the sum of the previous two. The Fibonacci sequence can be used to draw retracement and extension levels of the prices, which can work as reversal or continuation points of the trends. For example, if the price of a stock falls from R$ 100 to R$ 80, and then rises to R$ 89, it is making a retracement of 50% of the previous movement, which is one of the Fibonacci levels.
Besides the techniques based on charts, there are other ways of analyzing the financial market, such as the patterns and the seasonal behavior. These phenomena affect the fluctuation of the values of the stocks, related to the periodicity or the seasonality of some economic, social or natural factors.
They are repetitive and predictable movements of these assets, with variable durations, from daily to annual. The seasonal variation is the fluctuation of them according to seasonal factors, such as weather, holidays, events, etc. For example, some may perform better in the summer than in the winter, or in certain months of the year. A famous case is the January effect, being the tendency of the stocks to rise more in that month than in the others.
Cycles and seasonality: is the agricultural market, which trades agricultural commodities, such as grains, coffee, sugar, cotton, etc. The agricultural market is influenced by several factors, such as supply and demand, weather, pests, public policies, exchange rate, etc. Investors can operate in the agricultural market through futures contracts or options of these commodities. For example, if the investor believes that the price of coffee will rise in the next month, he can buy a coffee futures contract and profit from the difference between the purchase price and the sale price.
Quantitative analysis: is a way of evaluating the performance and risk of the financial assets, using mathematical and statistical models. Quantitative analysis aims to identify patterns and anomalies in the historical or current data of the assets, to create investment strategies based on algorithms. Quantitative analysis can involve the use of artificial intelligence, machine learning or big data. For example, a quantitative analyst can use a linear regression model to estimate the relationship between the price of a stock and its earnings per share, and use this information to decide whether it is worth buying or selling that stock.
Tape reading: is a way of following the flow of orders of the financial market in real time, using tools such as the order book and the times and trades. The tape reading aims to identify the intentions of the big players of the market, such as banks, funds and financial institutions, to follow the same direction or anticipate the changes of trend. For example, if the tape reading shows a large volume of buy orders of a stock at a certain price, this may indicate that there is a strong demand for that stock, and that its price tends to rise.
Macroeconomic analysis: is a way of analyzing the national and international economic scenarios, using indicators such as GDP, inflation, interest rate, exchange rate, trade balance, etc. Macroeconomic analysis aims to understand the impacts of economic policies and geopolitical events on the financial market and the sectors of the economy. For example, if the interest rate rises, this can negatively affect consumption, investment and economic growth, and consequently, the performance of the stocks of companies linked to these sectors.
Conclusion:
The financial market is not for amateurs, nor for aspirants. There is no point in taking away the merit of those who operate and do day trading, because that does not make you better than them. Those who are consistent in the stock market are because they understand the participants, the microstructure and the variables of the market. Because all this is only 10% of the trader’s formation in the financial market, because he still needs to combine all this with an intelligent decision making where he divides it into
Traders are athletes of the mind, who need to have discipline and psychological strength to operate and work with this every day. That’s why nature selects only the best, and they don’t have time to waste. Do you want to be one of them? Study, seek knowledge, learn the environment in which you operate, practice. A market professional takes years to evolve, that’s why day trading will never have pity on you. If the great minds of the world are in the market with the best technology available, why would you, who are a beginner, overcome them all?
With time, the trader will have gone through psychological evolutions over time, so keep firm and always seek knowledge.
For this, you need to know your size, know that you don’t move the price, know your place in the market. Also know that the market changes, and you should always swim towards the market and never against it.
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Artigo secreto: Minha experiência sobre a MFF. Ela é uma das piores (Exclusivo) br.tradingview.com/chart/WIN1!/FsCn2eHv/
Artigo secreto: Minha experiência sobre a MFF. Ela é uma das piores (Exclusivo) br.tradingview.com/chart/WIN1!/FsCn2eHv/
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