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Advanced Day Trading Concepts

Day Trading is like any othe rbusiness. If you are going to make money at it, you need to understand it inside out. You need to be familiar with more advanced day trading concepts such as level II, ECN, what Market Makers are, Moving Averages, reversals and other technical indicators.

Level II

Level II includes the best bid and ask for a particular day trading stock at any particular time. Level II goes beyond this by showing you all the bids and asks available for a particular stock in a long list. As you can imagine, the value of this information can't be overstated, day trading relies on having sufficient information to make a trading decision, and Level II gives you ALL the information - where EVERYBODY has their prices, however big or important they are.. Level II also helps you guage the momentum (the rate of change in price) of a stock - i.e. is it accelerating upwards, or is the strength of a move 'slackening off'?. Level II gives you not only the bid and ask for each participant, but also the number of shares they want to trade, and how they want to route the order.

Level II screen are usually pretty simple, with 2 columns (one for bids, one for asks). Each column is split into 3 sub columns, the NAME of the participant, the SIZE of the order, and the PRICE they are willing to trade at.

VOD (Vodafone Grp)
Name Size Bid   Name Size Ask
GSCO 400 24.50   ISLD 100 24.39
MLCO 200 24.45   JPMS 200 24.42
ISLD 100 24.40   NITE 400 24.58

On the left you can see open buy limit orders (Bids) starting with the highest (best) price. On the right you can see the ASK prices, which are open sell limit order arranged starting with the lowest. "Name" is the standard 4 letter symbol of the participant who placed the order (eg: Goldman Sachs has an open order to buy 400 shares of VOD at 24.5 or lower). Sometimes the participant is an electronic system (eg: ISLD has an open sell order for 100 shares of VOD at 24.39. In the above example, the best bid is 24.5 and the best ask is 24.39 - the difference between these is effectively the 'spread'. Traders using ordinary online brokers such as Ameritrade usually only get to see the best bid and ask, adn therefore can have no real feel for how 'strong' or 'deep' the market is beneath the best price.

ECNs (Electronic Communication Networks)

You know that Level II shows the market participants that have open orders for a stock or security. An ECN matches orders for any buyers and sellers for a stock. Since ECNs are computer systems, an ECN execution usually takes less than a second to find a matching bargain and do the trade. A direct-access broker gives day traders access to ECNs through their trading software. The best-known ECN is Instinet (symbol INCA on Level II) although they seem to have been having some problems of recent times, losing business to faster, cheaper, hungrier ECNs like ISLAND. According to the National Association of Securities Dealers (NASD), Island traded more Nasdaq securities than any other ECN (about 10% of the total trade volume). If you insist on using an online broker or even worse, phoning your full-service broker, day trading will be very difficult for you.

Market Makers

The other participants you will see on Level II are generally "market makers." These are the huge corporations like Goldmans, Morgans, and Merrill Lynch. Market makers provide liquidity in th emarket becausein return for certain exchange privileges, they guarantee to 'make a market' (i.e. quote a price) no matter WHAT is happening, even if the price is in free fall (of course, you might not LIKE the price they quote!). Market makers trade on their own account (nibbling the difference between the bid and ask) and they execute orders for their clients (ranginging from small individual investors to giant large institutional investors such as mutuals). Most online brokers send most of their orders to only one market maker with whom they have a relationship (i.e get a kickback for it). If you use direct access trading, you avoid this problem.

Order Routing

Order routing is the process of choosing how to send your order to the market (via an ECN or market maker). If you day trade through an online broker (eg Datek) or a full-service broker (shivers!), your order will be routed how the broker wants to route it, NOT for your best benefit.. If you use direct access trading, however, YOU decide which ECN or market maker to trade thru. It may seem confusing at first compared to the simplicity of standard online broking, but once you get used to routing your own orders, you will startv to understand the overwhelming benefits.

Technical Analysis

Technical Analysis (and particularly support and resistance) are THE most important weapon in your day trading arsenal. Even with the best order routing and day trading information, if you can't decide whether to trade or not, you are dead in the water. Technical Analysis uses past price movements to predict future price movements, and takes many forms. Major banks employ 'quants' - day trading maths jocks who create incredibly complicated mathematical day trading models of the markets. Frankly, this is a waste of time, and you should KISS - Keep it simple. If you know where the day's support and resistance are, you can be on the right side of the market most of the time, and that is how you make money. But how do you calculate support and resistance? There are many 'home spun' methods, such as pivots, but the best way by FAR is to use the from and resistance levels are never absolute - they are always 'zones' within which you need to be alert, and if you understand what is likely to happen should certain trading events occur, you can place your stock trade with confidence, sure that the weight of the entire market is behind you.

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