Finding Liquidity
Any successful momentum trader will tell you that one key to success is the ability to get your orders filled. Virtually anyone can be a successful momentum paper trader. Why? Paper trading is easy. Very easy. Anyone should be able to successfully paper trade after several months of effort. The difficulty is in converting paper success into real success, with real dollars. The sole obstacle to this transition is getting your orders filled.
What is the best way to get your orders filled to buy a momentum stock on the move? I wish I knew. I am aware of a number of options, and will try to discuss my opinions of the strengths/weaknesses of each.
Some people find excellent success by using discount brokers (i.e. those that receive payment for order flow from a market maker). Often times, these brokers can get your order filled instantly, at the inside bid or ask. Sometimes, even receiving price improvement on their orders. This is possible, since market makers deal with thousands and thousands of orders per day from the discount brokers. These orders are, on balance, very profitable to the market maker. Therefore, the market maker is willing to lose money on those occasional orders placed by ‘smart' traders in order to profit from the ongoing order flow from the ‘dummies'. In addition to excellent fills, discount brokers can also offer cheap commissions. => What a combination!
Unfortunately, discount brokers also have some weaknesses. In a very active stock, the market maker can turn off their auto-execution system and have all of their orders executed manually. In this case, your order could be filled very slowly, while you are left hanging for a fill report. Also, the discount broker may not offer access to Level II data, and may not have an order entry setup that is conducive to quick order placement. However, all things considered, using a discount broker for daytrading can be very intriguing.
ECN's are the solution many traders employ to execute their trades. Screw the market makers! Who needs them! Well, actually, it can be very difficult for a momentum trader to use ECN's for their order execution. Island orders are filled from the book on a first come first serve basis. The challenge is to identify the trade opportunity extremely quickly, and be the first trader to get your order to the ISLD for the fill. Otherwise, you will have to attempt a fill several levels above the ask to get filled once the stock turns up. Conversely, you might sell your long position several levels below the bid price, once the stock turns. Repeatedly giving up one or more levels on entry and exit is a short path to suicide, in my opinion. Therefore, the key is to be fast, very fast. You must hit the ISLD ask at the moment the stock is turning, and before ISLD leaves the inside ask. This can be very difficult, but is possible.
Other traders use ‘smart' order routing systems to fill orders in momentum stocks. Most Real Tick III firms have access to ARCA order routing, and Cyber Trader uses a similar technology. I have never used either of these systems, but I am skeptical that they could be used indiscriminately to enter momentum stocks. Both order routing systems, I believe, rely on SelectNet order routing to send the order to the ‘best' market makers that are ‘most likely' to fill your order. The problem is that all of the market makers are sworn to screw you, and you will only get a fill from them when it is to their advantage (slight sarcasm acknowledged).
I guess the final options for the momentum trader is to attempt order executions using SOES, SelectNet or by posting an ISLD order. Unfortunately, these methods are all very hazardous to the momentum trader. Although using the SOES or SelectNet systems used to be a quick road to success, rule changes have made using these systems equivalent to simply asking for market maker pity to fill your order. It won't happen, unless the stock is about to reverse. Of course, you can always post an ISLD order to buy at the bid. However, when a momentum stock moves up, how often do you see trades occur at the bid? Virtually never, until the stock reverses, then you're stuck in a losing position.
Once, I thought I had the perfect solution to getting all of my orders filled quickly at the inside bid or ask. Unfortunately, I woke up and the dream was shattered.
I don't know the ‘best' way to fill an order. There are strengths and weaknesses to each method. A successful trader needs to know which methods work best for them. I have probably missed several other methods for filling orders in momentum stocks. For completeness, feel free to add other methods to get orders filled, along with their strengths/weaknesses.
Good luck to all!
-Eric
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