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Given the avalanche of books on trading and investment, how strange that it should be impossible to find one devoting a single chapter to trade execution! Certainly, this area is most important for frequent traders, because good or bad execution can make all the difference in transaction outcomes! Below, you'll find some helpful tips on Execution Skills.
Demand/Supply at a Glance:
Bid/Ask Sizes
As previously mentioned, bid/ask prices are always posted with corresponding bid and ask sizes, which serve as measures of the strength and depth of the bid/ask prices. They tell us about the supply/demand pressures on a stock at a given moment. We can summarize important Bid/Ask size concerns as follows:
- A large bid size indicates a strong demand for the stock.
- A large ask size shows that there’s a large supply of the stock.
- If the bid size is significantly larger than the ask size, then the demand for the stock is larger than the supply of the stock; therefore, the stock price is likely to go up.
- If the ask size is significantly larger than the bid size, then the supply of the stock is larger than the demand for the stock; therefore, the stock price is likely to drop.
Because bid/ask prices and sizes change quickly in real-time, supply and demand also change quickly in real-time. Experienced traders always pay very close attention to the bid/ask sizes of a stock to monitor the supply-demand dynamic. Short-term traders usually buy a stock only when the demand is higher and sell a stock if demand suddenly becomes lower relative to supply.
One effective and widely used short-term trading strategy based on supply and demand is the following:
- Place a limit order to buy a stock at the middle ((bid+ask)/2) when you see that the ask size is small and the bid size is much larger (this strategy does not work if the stock price is quickly declining).
- Place a limit order to
short
sell a stock at the middle ((bid+ask)/2) when you see the bid size is small and the ask size is much larger (this strategy does not work if the stock price is quickly advancing).
Example:
In a relatively quiet trading period, suppose that you suddenly notice the following:
| Ticker |
Bid
Price |
Ask
Price |
Size
(Bid x Ask) |
| YHOO |
124
1/2 |
125 |
1400
x 200 |
You can place a limit order to buy 200 shares of YHOO at 124 3/4.
Now suppose you see
| Ticker |
Bid
Price |
Ask
Price |
Size
(Bid x Ask) |
| YHOO |
124
1/2 |
125 |
300
x 2800 |
You could place a limit order to
short
sell 200 shares of YHOO at 124 3/4. Most likely you’ll get into the trade and the momentum will soon help you make a small profit. Then you can set a stop loss order at your entry price level to protect yourself from losing the trade.
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