Well, there are probably more, but I wanted to chime in and make this distinction. I've seen traders using both styles successfully and both call it "enveloping." In one case, a trader will put out some bids and offers away from one or many more volatile stocks. The intention is to catch a trade through driven by one of several events. Something like the late morning "clean up" of a large order is ideal because it will really spread that bid or offer, you get filled, then the stock reverts back to it's original level because the buying or selling pressure is gone. Clearly, the above method is safer during a rangebound or choppy market. There's certainly risk.... any new trader ought to approach this very carefully. Another way you can catch a trade through is right before some news breaks on a stock or worse, it gets halted. Guess what? You'll be on the wrong side of that move. That's one of the dangers of trading a very large basket in your envelope program: you can't really follow the individual stocks very carefully. As far as canceling orders that are resting in the market, I'd be cautious there as well. Here's a personal story that I hope will help make the point. Several days of the week, I sit in a trading office in which several of the traders run live news feeds, others have briefing.com, and we have squawk going. (I purposely leave out Bloomberg TV or CNBC because we all know that for breaking news...well...enough said.) I trade Citi during the day. On this day, I was enveloping Citi. It had been weak relative to the market for the last hour or so, and the market was rangebound. Citi was trading around xx.79, and I had a short offer in the book at xx.87. I became aware that something was up almost a full two minutes before the SPoos exploded in chaos and any of the news services picked up the story. How? Well, I went to *lower* my offer to .84 because Citi just wasn't trading up, and I was getting a bit more aggressive on entering short. That order just locked up. No cancel, no response, just locked. Then everyone else in the office starting screaming about their orders, and the SPoos began rockin'! There was a rumor that Osama bin Laden had been captured. I was filled short at my xx.87, just as I had been planning, but now two or three prints later, Citi was offered almost 70 cents higher. Ouch! (Citi has only medium volatility, so you can imagine what some of the other stocks did....) For the record, that trade hurt, but I have no problem with it whatsoever. These things happen and will continue to happen. It's part of our profession. I didn't make my 70 cents back in Citi that day, but I did over the next week. So, whether you are "sized up" on just one or two stocks or trading 400 or 600 shares across a large basket be aware and be prepared for these sorts of events. Yes, you'll take a hit. Yes, it'll be expensive. You'll deal with it and keep trading. That's the key, make sure that you can keep trading...don't be oversized for catastrophe with this method. It won't be the system's fault, the exchange's fault, or the firm's fault. Be aware of the risk, and you will take the responsibility. If you are prepared for all of that, then definitely look at enveloping. There is clearly an upside to this method, just keep the whole picture in view.
I thought my last post might get truncated.... so here's the rest continued.... The second method of enveloping that I alluded to above is a bit more static approach. Again, it is used when the market is rangebound or choppy. As some have suggested, if a stock is demonstrating a upwards or downwards bias, perhaps trading only one side would yield higher probability entries. In this case, your enveloping orders aren't looking to catch a price spike, like a tradethrough, but rather are set to capture the high and low points of a range... (<grin> like "channeling stocks dot com...yuk! sorry, couldn't resist...) Another example, this one from my trading today. For most of the afternoon, as the SPoos chopped back and forth just above their pivot, Citi traded in the range of 44.30 to 44.40. Because it was somewhat weak, I preferred the sell side. I did buy the stock a few times (44.28 and 44.32) but I was biased to selling it around 44.40. So, I "enveloped" Citi with a buy order in the mid to upper .20's (less aggressive) and sell short orders at .38, .40, and .45 (I was expecting the SPoos to rally to their previous day's high, and wanted to sell Citi all the way up.) This is what I refer to as a more "static" enveloping. I wasn't cancelling and moving my orders to catch a tradethrough, but rather trading the range that I had observed Citi print throughout the afternoon. I was still enveloping because I had orders on both sides of Citi, but I did so with a different intent. One last point: the whole time I was carefully watching the SPoos. If they had rallied through the previous day's high with energy, and the other markets (NQ and YM) followed, enveloping was off. Instead of being short at .40, I wanted to be long at .40, as I would have expected Citi to make a push for it's close of the previous day, some ten cents higher.
if there are no large buyers or sellers midday, do these price spikes happen that often? Is it "safer" to envelope midday? And for any practitioners, what kind of size spread out over how many stocks is necessary to make this worthwhile? Are you guys catching .10 prints? How often?
"I would say the chance of getting hit in the WRONG direction when a serious event occurs is over 90%." So, you're saying that a catastrophic move will happen 9 of 10 days? Or, are you saying that in a lifetime of trading that something serious may happen once? I got stuck when the plane crashed at JFK (right after 9/11, since I was visiting another office, and chatting with the traders (not watching the news). I got filled on 16 buy orders, and traded for 3 hours to turn a serious negative to a positive......so, I'm not saying that things "can't happen" it's just that I don't focus on losing (heck, I don't even use stop orders!), I focus and intend to make money on each trade (knowing full well that we only need a 70+% success rate as a goal). So, we can agree that "stuff happens" - I just look at the things a little differently, and hope that whatever strategy you're using is working wel for you.!! Time for the opening.......keep all those planes flying!! Don
Maybe we should keep this thread about enveloping orders. There are a lot of other strategies with this problem: going naked options and holding overnight w/ no hedges come to mind. Maybe it would be more productive to talk about specifics?
I agree with Don. Not enveloping only because of the "catastophe scenerio", doesn't make sense. By that logic, none of us should trade because our stock could always get halted and we could get crushed. We accept the small possibility of that kind of problem. Although the "catastophe" problem should be recognized and prepared for, for instance by reducing your size or having a hedge prepared with futures or other derivitives, I think be wise for any trader if feasible.
I agree that prop traders with limited capital at risk can have a good risk/reward ratio with envelopes. I did them and made good money. BUT I do not feel the risk/reward is worth it for a firm promoting it to all of their traders. The firm is more at risk with this strategy than any other that I can think of. That was my point and I would enjoy hearing arguments against that.
I think he meant that when a serious event occurs you will get the wrong side of the envelope 90% of the time. Not that the event will occur 90% of the time. From what I have seen, to envelope you have to be a skilled trader. The few big losers thrown in there can really wipe out a lot of smaller gains. I don't think its appropriate for a beginner, at least not on a large basket. Doing it on a few large stocks like Don does is probably the best way to learn.
If the firm is doing envelopes as a primary strategy, I would guess that there is more risk. Don, what do you guys do? Do you just hope that the shorts balance out the longs? Dustin, I think this strategy is best at prop firms. Or at any firm that says, "your capital deposit is your only liability." Even if a prop firm doesn't back you, that is a huge plus! Don, what's your firm's policy? If a trader takes on 10X leverage and loses 9X more than his capital in a catastrophe, what happens? Does he end up wiping monitors in a bright office for eternity?