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March 1, 2003

Batten Down The Hatches

By John A. Byrne Editor

It takes plenty of luck and a strong stomach to play the trading game these days. The game

sometimes takes a pro who uses various offsetting strategies to reduce his risk, a pro who has an intimate knowledge of his stocks. In this market, he cannot take his eye off the ball. Not since the Great Depression have stocks swung up and down so much in a rapid-fire succession of days. Nasdaq now has price swings of about two percent, on two out of five days. It contrasts sharply with Nasdaq in the early 70s. That's when those swings happened on one out of 10 days. Traders obviously look for price swings. But these new swings are sometimes more difficult to manage than the swings of the recent glory years. Back in the 1990s, stocks were on an upward trajectory, dotcoms were pricing at $150 a share, and the minimum increment was not a penny.

What's a trader to do, other than drown his sorrows? As anyone who has attended a conference, or listened to some of the sharpest minds in the business, the best approach for some takes benchmarking and strategies such as VWAP. It will be a familiar theme with this issue of Traders Magazine. It is also a theme in a wonderful essay by Gregory Bresiger on our Website, Traders Online (www.tradersmagazine.com). Bresiger, who likes to tell it straight, challenges the very notion of what constitutes best execution.

As a topic of discussion and debate, the science of trading is becoming more popular. At one Street firm, two respected analysts recently examined in a report, what a buyside trader must do. Jeff Bacidore and George Sofianos, of Goldman Sachs' equity derivatives and trading research department, do not recommend one approach over another. For instance, seeking to cross stock, they note, may be an effective way of reducing liquidity impact. However, sometimes, "better informed traders will offer to trade only when the terms are favorable to them based on their better information." A buyside desk may mininize information leakage, these trading scholars suggest, by not "shopping" the order or breaking it up into predictable pieces. The desk could take another approach and solicit a principal bid from a dealer. But, they say, dealers generally require some form of price concession as compensation for taking the additional risk. That can lead to a larger "liquidity impact."

Then there is the reliable, but not always helpful VWAP, or volume weighted average price. "The primary value-added of an automated VWAP algorithm is its ability to reduce liquidity impact by spreading the order out over time as a means of reducing liquidity impact," according to the Goldman analysts. But if all of this sounds as though the sky is falling, then maybe it's time to look at some Nasdaq stocks that might remind you of the good old days: These are stocks that are actually rising today. These are financial stocks. For more, read the Cover Story by Peter Chapman. In the meantime, batten down the hatches.

John A. Byrne

Editor