Size and Depth Matter

I added some new context to an old issue Wednesday. Lately I have been dabbling in some thinly traded stocks. I did not do much of this when trading on the big box desk but I know there are added considerations in these names. You have to trade smaller size and be mindful of wider bid ask spreads, and sometimes wider swings in price. But I added some perspective about trading these stocks by learning it the hard way. I like using real world moments to illustrate these points so here goes.

On Monday I bought Spartech (ticker:$SEH). After the fill I did what I always do, put in a bracket order for my exit: A limit sell at my target and a stop loss at my pain threshhold. This is not a set it and forget it strategy, but I call it my food poisoning strategy. If I were to get food poisoning and had to spend an extended period of time away from my terminal I have some downside protection and upside profit taking built in for flash crashes, earthquakes, sovereign defaults and breakouts. I will adjust these as trades move my way, perhaps turning the stop loss into a trailing stop or raising it. My target for this trade was 8.5 and my stop was 7.20. As SEH was sinking Wednesday going into the 1:00pm hour my stop was getting close to being hit. Then I received a fill at 7.21. The stock never traded below 7.21. I was the low fill for the day. Congratulations to me. This really ticks me off when it happens (being the low fill) so I dug into it, probably just grinding salt into my wounds. This is what I found.

For less than 1 second a bid at 7.23 was pulled uncovering a bid at 7.20 which immediately brought in a bid at 7.21. That fraction of a second triggered my stop loss and consequently filled me at 7.21 a few seconds later. It was a small position for a small loss I was willing to take upon entering, so not a big deal. That was not the moment. The perspective came almost immediately after this investigation though, and it added to my risk management tool box.

In this case the bid uncovered when the 7.23 was removed was only 3 cents lower. And when it was exceeded to 7.21 I actually saved a penny. But what if it had been a throwaway bid 30 cents lower that sat there for 20 seconds. I am fully aware that stocks can gap down or be halted or make a major move outside of trading hours and that stops do not protect against that. That is not the ‘ah ha’ moment I am discussing. My ‘ah ha’ moment was that I need to pay closer attention to the market depth in thinly traded stocks, as a potential gap can happen any moment. I had picked my stop for a reason, but realize that I need to choose either a bit more buffer or prepare for a fill much below my stop with a thinly traded stock. Or maybe no thinly traded stocks after a night out for Lebanese.

As always you can see details of individual charts and more on my StockTwits feed and on chartly.)

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