How does one make profit given the following situation?
Assume no commision.. and the prices are in dollars.
It is just a hypothetical situation.. If say I think that the fair value of the stock is 46 and the bid/ask is 48/52 then ..then I should short sell the stock for 48 $ right?
Also I can't figure out what would be the situations in the other cases say if the stock price is 50 etc..
Also I can't figure out what would be the situations in the other cases say if the stock price is 50 etc..
arabianights
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You do nothing or you join the bid and offer...
This guy is right..Markets are in fact efficient and "fair value" will always be the last traded price..!
Jaydee
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Depends if you believe in the EMH or not. The stock may be in the process of trying to find value.
Anyhow, for 1-3 I would offer the next tick below 52 and for 4 & 5 I would bid the next tick above 48. Where I'm looking to get out on these trades, assuming my estimates of fair value are correct, should be pretty obvious.
mb325
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I bet a few trillion has been lost over the years when people took this view on a stock.
I suppose it all depends on your definition of 'fair', and whether the market cares about fair or unfair.
So say the next tick below 52 is 51 so one has to sell it for 51 netting a profit of 51-46 or 51-48 or 51-50 and buy it for say 49 netting a profit of 52-49 and 54-49...
That sounds about right. Wanted to know what exactly one has gotta do in such situations.
mb325: I used the fair value as just an example and not to trade etc...this one was an example I thought of to see what the likely strategy has to be to gain profit if indeed something like this happens.
oildaytrader
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Buy only if it is trending/breaking out with momentum.Pay a higher price as long as it is trending.
Otherwise keep out of the markets.
Nothing is too expensive , if it gives a profit.Cheap stocks aren't cheap if they give no profit.
A few words of wisdom , even legendary brownies need to learn
http://www.chartpattern.com/10_golden_rules.html
http://www.dacharts.com/articles/_22rulestrading.htm
The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is "low." Nor can we know what price is "high." Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed "cheap" many times along the way.
Now say there is only one market maker(he/she is the only one we can trade with) for this particular stock and he/she is buying at 48 and selling at 52, how would one make a profit in the 5 situations described in the problem? Is it possible to make a profit in all the situations or is it possible to profit in only one or two situations?
Jaydee
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Not sure I agree with this, ODT. There are a lot of short-term, scalpy, equity traders who perform market making trades like this and favour sideways action. Can't say I'm one of them but, in the old days of VOD trading with a tick = 0.25p, the traders I knew loved to take a single tick multiple times when it wasn't trending. When it started trending, they usually got clobbered if they didn't pull their orders in time as they would have them stacked at every near touch bid and offer in the book.
oildaytrader
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Agree or disagree , but disagree with "the trend is your friend"
All these sideways boys are gambling with a 50/50% chance, the true edge is in trending markets.
Every backtest I have done has confirmed it.
So Goldman's is shorting, trader thinks its cheap, Goldman pay's bigger bonus
Jaydee
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I wouldn't bother in these situations. At best you are risking 5 ticks (say the spread + 1) to make 2. MMs are right rip off artists (and rightly so, I'd do the same if I were them), you only have to look at the illiquid AIM stocks to see what a bad deal you are getting. Some stocks require you to make 50% before you break even due to the mind blowing spreads the MMs charge.
Jaydee
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I don't disagree with the statement above for my style of trading. However, for the style I described, it is harmful to these traders.
It's not 50/50 - they are a) good order book readers and b) can often scratch the trade quickly before it goes bid or offer over
I find this meaningless in this context as you can't back test the form of trading I'm taking about unless you have an algorithm which can filter through an historic orderbook as well as T&S data. This is very hard to code.
Your back tests are focused on longer term trading which is fine but not giving you the full picture. The best scalpers are few and far between but they are exceptionally talented at the type of trading they do.
foredog
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Ok take 54 as fair value.
The single MM is quoting 48 -52.
You could go and bid 50.5 for stock, then they may counter at 51 so you still get them cheaper. (if they have a seller at 48 or 49 or even 50 they may be happy to trade for the smaller turn to get biz done)
BUT if there is enough stock around that the MM can sell it well below the offer then do you really want to be long of that stock anyway???
Mr. Charts
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Spot on.
The value of a stock (or most things) is the price someone is prepared to trade it for at that time. There is no right or wrong, fair or unfair. It's worth what someone pays for it.
As such it varies with supply and demand.
Whether your opinion is that it will be worth more or less at any other point in the future is merely an opinion.
It is what it is, not what you wish it to be.
Richard
