Trading Discipline: Size Does Matter
Tuesday, June 19, 2007
By Don Rodgers
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Stealth is the rule of the day when trading low-volume stocks.
Last week we traded (NASDAQ: RCCC, BullBoards). The reminder is important to point out just how difficult it can be to execute sell orders on a low volume stock. In short, you should be aware of the SIZE OF ORDER. This point will be clarified below. On June 12 we executed the order at $37.60 (the entry was $35.74) and the target was $38.18 (the high reached that day was $38.20). However, as we wanted to close out the position, the spread kept widening to the downside making it difficult to exit. The total volume on that day was just under 500,000 shares, but the share lots being executed were small-increments of 100-300 at a time. When our posted sell order for 2500 shares hit the inside ask, the bids pulled right away from it. A quick scan of the Level II showed market makers gathering at $38.50, but there was no way we were going to hit that upper level that day. To our relief, the only downside level showing any build was at $35.30, so again, there was no danger at the time of the stock really moving down hard. It became a game of bluff, which is one of the dangers of trading a low volume stock. The spreads can be an absolute killer. There is usually no problem getting filled on the order and we were filled, although it did take a few minutes. However, when traders see an order going through at approximately nine times the normal size on the buy, what happens is a game of financial chicken. Traders will see how much you really want to keep the stock and will pull the bids down well under your price trying to figure out if you have a stop placed on it. And this is where it all gets tricky. When the spread begins to widen it happens in a number of ways.
A: The ask remains the same but the inside bid drops significantly, increasing the spread and on paper creating a rather anxious time as you can see the paper loss build with each downtick. So, what do you do? First off, you remove the streaming profit/loss figure so it is not like a klaxon going off as you are trying to think. Without the constant reminder of a red paper loss streaming in your face you can relax and concentrate solely on the technical aspects of the play.
B: The inside ask increases, the bid stays low and you start trying to fill the order to the topside hoping there is an invisible order (iceberg) in there somewhere from a buyer who wants to buy the stock as much as you would like to sell it. However, in the case we're discussing, there were no hits, and orders placed prior to ours receive priority so we're forced to pull the order for a second time.
C: The inside bid increases and you begin to notice a consensus building higher than the inside ask and a slow measured sell off of the ask, but still not enough volume for you to place your order.
After a period of time we were back in the green on the trade but still to exit we would have worked the price down against our own position. In other words, we had more to sell than buyers wanted at that moment. A market order would have taken out the first half of the position in profit and the second half would have taken it low enough to show a small loss on the trade. We wanted to execute the entire order in one shot to minimize having our order pieced off in small increments and leaving us with odd lots which are difficult to get rid of unless you sell into a rapid move with volume via a market order.
Near the close, the price became more static, and the bids dropped significantly so that at the close there was almost a 60-cent spread with the bid below our entry. A quick look at the daily showed us slightly above a previous long target and coming up to a new long swing entry so we made the decision to hold the position overnight and see what the next day's trading would bring. However, this is not something we like doing because small trades could significantly sink the share price. We were also well enough above the last target that if a pullback was going to occur it would have done so already and with that in mind we felt more confident we would come out okay. The next day the stock opened a penny higher than the target from the previous day of $38.18 and then fell quickly down to just above our entry of $37.60 and then began a slow steady climb. The $38.50 level had increased from the previous day so we decided to peg that as our exit point. As the trading day progressed we saw the entry getting near, the bid/ask really tightened up and as we hit the $38.51 level we saw the opening we wanted and placed our sell a few minutes into the candle and the stock then gapped up on the next candle and we got lucky and were able to exit. As we sent the order to market the stock quickly increased in price and we were filled on the sell from $38.65 all the way up to $38.80. The stock hit a high of $38.82 on the second candle we exited on and added another six cents to hit a high of $38.88 for the day on the next trade before falling off into the close.
The stock saw another few days of nice gains but we decided that low volume stocks are not the place to be since we normally trade fairly large positions,. We had a new swing entry of $39.48 on the stock with a move to $42.68 (stop loss from the entry was $1.61) and the trailing stop was $1.20 from the high (in this case it was $42.41 missing our target by 27 cents). Currently the price is $39.11. The low Monday was $39.03, and the volume was 278,556, or a drop of 88 cents for every 100,000 shares which is significant.
The chart at the end of the column is from Monday's trading and clearly illustrates how difficult it can be to exit a position, especially when the trade is working against you. There are significant differences between the open and close of each of the candles and then the volume of them. Compared to other stocks, the price moves down in this case are pretty severe considering the associated volume attached to them.
In summary, if you place an order on the buy or short at volumes significantly larger than the average trade size, especially if you plan on day trading, you are sending a signal to the sharks out there that you are potentially their next meal. If you are an investor, size is less of an issue although if you had invested in RCCC last week, you would see a sizeable erosion of your profit in trying to exit your position. You could have ended up (depending on position size) driving the price down against yourself as you moved out, and may have had to place multiple orders, which would further erode your margins as commissions added to the slippage. So if you are planning on trying to trade low volume stocks (not penny stocks) you have to be aware of this simple rule: when entering your position don't be noticed. If you have to average up your price on a long position (and vice versa entering a short) by taking smaller bites then do so but always keep in mind that one day you will want to sell and it will be difficult to exit without hurting your margin. In our case we were able to take advantage of correctly reading the bullish nature of the chart and the Level II at the time and we did get lucky on the exit; had we held we would have made significantly greater profit but given the move down on Monday, taking profit when you can is always a good idea. The pullback after coming near the target is important because it did so at the target area, bringing the resistance into play, unlike our entry where it already had moved well beyond the previous target of $35.81.
Click the image to get the full size chart.
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Don Rodgers has been actively trading the markets since 1999, and has been a frequent guest on a number of internet-based trading shows. He has also taught his unique technical analysis to both professional and non-professionals and has done consulting work for a number of Canadian and American brokerages. Since 2006 he has been concentrating his technical analysis in the area of oil and gas. He will concentrate on providing advice as to the intricacies of the market as well as answering stock specific inquiries. Please send your questions to questions@entryandexitinvesting.com or visit www.entryandexitinvesting.com for illustrations of how his technical analysis functions.
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