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Conquering Fear in Trading

In this exclusive to Traders Magazine, therapist Storm Copestand examines how traders can manage expectations and conquer their fear during the entire execution process.

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August 14, 2007

Getting an Edge

By John Hintze & Michael Scotti

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And if volatility should return to the marketplace, traders are likely to become even more important for small- and mid-cap stocks. To be sure, the CBOE Volatility Index, a measure of market expectations of near-term volatility, has been unusually low since 2003, despite some shifts here and there.

But brokers and their institutional customers alike foresee the inevitable return of volatility, and some have taken steps to ready themselves.

Small- and mid-cap companies are generally defined as having market capitalizations between $300 million and $2 billion, and between $2 billion and $10 billion, respectively. Trades in some of these names have always been the hardest ones for which to find liquidity. Increased volatility would make that job that much harder.

Jefferies & Co., which does 75 percent of its business in the small- and mid-cap arena, has gone on a hiring spree in the last year, pulling over high-cost talent from competitors to ramp up its services in the realm of less-liquid stocks. A key criterion of those hires was whether the executives brought experience in committing capital-a significant change for Jefferies, which had been primarily an agency shop. "The new captains now running the sectors all have broad and deep capital-committing experience," says Ross Stevens, co-head of equities at Jefferies. Stevens joined the firm in November 2005 from Banc of America Securities, where he was chief operating officer for equities and the head of electronic trading services.

Buyside Specialists

Putnam Investments, meanwhile, split its domestic trading desk into two groups about 18 months ago, charging one set of traders with focusing specifically on stocks with market caps under $4 billion. "We wanted our traders to develop greater expertise in those areas and work more specifically with portfolio managers and analysts involved in those types of funds," says Richard Block, director of global equity trading at Putnam.

Block says the move succeeded in prompting traders to work more closely with portfolio managers to understand their investment objectives. It's also enabled his crew to huddle and pool information about sellside firms-and to analyze which ones are most effective in specific areas. "We're getting a more granular understanding of sellside expertise in different capitalization areas, down from the sales trader to the position trader, and which firms' product offerings are strongest in different areas," he says.

All the major brokerage firms are investing heavily in their electronic trading products. Stevens of Jefferies says his firm, in addition to hiring traders, has been analyzing trading patterns of illiquid stocks and developing algorithms to exploit them. He notes that unusual trading volume in a small-cap stock tends to persist, and that a "lead-lag" effect often takes place when a large-cap stock moves significantly. "Say a large cap jumps 2 percent. A small-cap stock in the same industry may also jump, but five, 10 or 20 minutes later," Stevens says. He adds: "Algorithms can exploit that."

In fact, Stevens says, Jefferies is building its strengths in the small- and mid-cap arena in large part for when volatility returns and buyside traders need that extra helping hand. Events earlier this year suggest that's a good strategy. The 400-point drop in the Dow Jones Industrial Average on Feb. 27 resulted in the NYSE Hybrid market seeing its share in listed-stock volume jump to 70 percent, a fleeting reminder of how traders turn to the familiar in times of peril.

Being Prepared