Your Real Risk (the offers behind the big offer, the bids underneath the big bid)
Always determine your real risk before you make a trade. Below is One Good Trade offered by Charles. It is an excellent example of how you should always determine what your real risk is before your make a trade. Sometimes your risk on the downside may appear to be 3 cents, yet it is really 25 cents. We ask that you find as many risk versus reward opportunities where your reward is 5 and your risk is 1 (5 cents to 1 cent, 10 cents to 2 cents, 50 cents to 10 cents, etc.). Trading is a game of math. If you make enough trades with a favorable risk versus reward your numbers will be outstanding.
Please review the chart and Charles' comments below, and then I will make some comments. Please pay special attention to the comments in bold.
1- Proper Preparation: Filled out the am sheet (I know there is a conference call at 11:00)
2- Hard Work: Watched almost every tick in the am
3- Patience: I noticed a hold on the offer at 56.50. When the offers got tested at 56.50, the specialist would show 1000 shares on the inside market and not in the open-book. The first time the specialist kept the 1000 share offer, but printed much more. The next few times he would decrement the 1000 share offer, print some bigger quantities, and then refresh the offer. The last time it holds the offer the specialist shows 50,000 shares at 56.50. The big offer steps down to 56.45 and then 56.40. It finally breaks through 56.50 about ten minutes before the conference call.
4- A Detailed Trading Plan: I wanted to get short in front of the held offer at 56.49. When the stock was about to test the level, there were no offers until a 100 share offer at 56.54. There were 100 share offers at 56.57, 56.58, and 56.60. I didn’t know my risk/reward. If the 56.50 offer lifted, I probably wouldn’t get out for ten cents.
5- Discipline: I didn’t know where my exit point would be if it went against me. I did not make the trade.
6- Contribution To Our Desk: Zak was trading the stock in the morning and I mentioned the hold to him.
7- Replay Your Important Trades: I reviewed the trading scenario with Steve and Mike. I made an entry in my trading journal.
Charles noticed a big seller in CIT at 56.50. He was considering shorting in front of this level. He immediately asked himself what his risk versus his reward was. He searched for the offers behind the offer to help him answer this question. At first, there wasn't a big offer at 56.50, just 10 NYSE 56.50, and he could not spot many offers behind this offer. If 56.50 lifted he was not sure what his risk was. So it was hard for him to quantify whether he had a favorable risk versus reward scenario.
However, the time the Specialist showed 50k (50 NYSE 56.50) shares after it had held the 56.50 previously, he should have gotten short. You should still look behind the offer at 56.50 to try and calculate your risk versus your reward. But now with the huge offer you can watch to see if that offer decrements. And if it does you can cover at 56.50. That big offer at 56.50 now most likely adds further protection for you. It is possible that the 56.50 offer for 50k is fake and will get pulled. It is possible that there would have been a huge print at 56.50, clearing the offers, and no way to cover until 56.60. But after you have seen the offer hold once and there is a big offer, it is more probable that the stock will trade lower next. If you are wrong, you are wrong and just cover.
When you are considering getting short, look behind the offer and ask where you can cover. This will help you determine your real risk with this trade. The same applies for getting long. Look at the bids underneath the bid or the level you recognize is holding. Understand your real risk.
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