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Pre-market Traps
The premarket game starts around 8:30am (EST) and lasts until 9:29am (EST) (on Nasdaq). Early in the session, MMs (marker makers) will start to gap their inside bid prices subjective to news or sector strength. We have constantly seen the premarket gap and traps take in many amateur traders. The rule of thumb here is to remember that the ECNs, usually INCA and ISLD (sometimes TNTO), are the only real indicators. Market makers know they can not get hit pre-market and therefore can display any post or price they want with virtually no risk. Market makers can get preferenced on selectnet pre-market, but that is at their option to fill or ignore. Therefore, you will often times see unscrupulous market makers jacking up their bids and offering them out on INCA giving the illusion of a discount.
A prime example was GERN on 11/6/98. GERN had released some findings on stem cells and hyped it big time in their conference call after-hours bringing in huge media attention. Earlier in the trading day, GERN was trading in a range of 7-7/8 to 10-1/16. JPMS (JP Morgan) is the ax in this security. MONT (Montgomery Securities) was also heavily accumulating (stepping inside bid on the wiggles and holding support). We also noticed JPMS start to support the bid and accumulate shares at a heavy rate around 3pm and into the close. JPMS has historically been a seller, so the fact that he was accumulating led us to believe something was up. The 3 min and 13 min moving average charts showed a wide divergence to the upside, which confirmed a solid up trend and the accumulation drove the stock to close within ¼ of its intra day high.
The conference call confirmed what apparently JPMS and MONT’s actions implied. GERN was going to be big the next morning. We happen to have been lucky enough to snake (LAST AND ONLY) 800 shares at 10-3/4 on ISLD after-hours. Obviously a limit order left by a wide-eyed trader who didn’t put in the extra effort to listen to the conference call… sloppy.
The following morning, GERN’s news made big headlines in the New York Times, USA Today, Wall Street Journal etc. Once again, GERN had done a great job of pumping this news. Pre-market on level 2 started the bidding at $15 and quickly ran to a high of $31. The inside bid at the high of $31 was a 200 size by JPMS around 9:10am. However, INCA was offering out at $26 on the ask. Many traders took the bait and purchased the shares through INCA up to $26 thinking that GERN was going higher on the open since they saw that $31 bid by JPMS. Closer to the open, Inca came in and tried to exit shares on the ask fast and hard driving the price lower. JPMS finally stepped of the inside and the respective MM’s all jumped off their bids as GERN opened at $22 and promptly sold off to the 17’s. Unfortunately, many traders got sucked into buying pre-market thinking that it would run higher on the open and fell right into the hands of the market makers. Needless to say, JPMS and MONT had a field day unloading their shares into the oncoming buyers.
Always know that INCA and ISLD are your real indicators pre-market because they are your only forms of entry and exit and they are all that counts. Be wary of stocks that show INCA undercutting the inside bid price closer to the market open. This is a classic gap and trap pattern.
Pre-market ECN Arbitrage:
Every so often, there are easy money opportunities that arise because of the difference in ISLD and INCA pricing. The window of opportunity in these plays is very thin and you must be fast to take advantage. The setup is simple, you will see an INCA or ISLD bid price HIGHER than an ISLD or INCA ask price. Usually, this is the result of a sloppy trader taking their eyes off the pre-market spreads. Their loss, you gain. Case like these, you simply buy on the ask (INCA) and sell on the bid (ISLD) or vice versa. Keep in mind of course, that you are playing arbitrage from two different ECNs as the nature of a limit book will only display the best prices.
Eg: Pre-market GMGC showing 1k at 5-3/4 inside bid on ISLD versus 1k at 5-1/2 inside ask on INCA. Buy at 5-1/2 on INCA through preference selectnet or call it in and sell immediately to ISLD at 5-3/4 for a quick ¼ scalp.
Blocks trades
Many traders tend to misunderstand the significance of block trades on the time of sales. Usually, when there is a block (10k shares or more) on the inside bid price printed on the time of sales report, this is a block sell and vice versa when the blocks are on the Ask. However, a block sell on the bid is often times indicative of a block covering and results in a short term reversal depending on the size of the block(s) and the market maker on the inside ask especially on “dumper” stocks. The reason is that the market makers are actually covering their shorts from the client, be it an institution or mutual fund.
Here are the mechanics. For example, if a hedge fund wants to dump 50,000 shares of ASND stock, they would go to a market maker say GSCO (Goldman Sachs) and tell them to ‘work’ the order. GSCO would then start shorting 50,000 shares worth of ASND in their own account, thus driving the price of the stock lower in the process. When GSCO reaches its 50k short, it will then cover the shares by buying them directly from the hedge fund and printing it on the time of sales. When that 50,000 share block appears, it means that the selling pressure is diminishing and many skilled trades will take advantage of this opportunity to take some cheap shares, thus driving the price up and thus a reversal.
This is a simplified example, but you get the point. The opposite applies for blocks on the inside ask or above, these are block buys and often times indicative of the buying pressure slowing down. In all honesty, the calibers of the market maker’s skills apply greatly as to the ease of deciphering their intentions. A PWJC is easier to read than a GSCO. The clearest buy signals are when the ax market maker covers blocks switches to the inside bid position with a wide spread on dumper stocks. Yummy!
This artice was written by the Underground Trading Pit,
http://www.undergroundtrader.com/
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