How to Beat the Market Makers at Their Own Game: Uncovering the Mysteries of Day Trading

By Fausto Pugliese

The basic skills for becoming a successful trader from a master of the game

Written by Fausto Pugliese (founder and CEO of Cyber Trading University) this must-have resource offers a hands-on guide to learning the ins and outs of active trading. How to Beat the Market Makers at Their Own Game gives professionals, as well as those relatively new to investing, a behind-the-scenes look at the inner workings of the marketplace and a comprehensive overview of basic trading techniques. The book explains how to apply the trading strategies of acclaimed trader Fausto Pugliese. Step by step the author covers the most common market maker setups, shows how to identify market maker traps, and most importantly, reveals how to follow the direction of the lead market maker in an individual stock.

Throughout the book, Pugliese puts the spotlight on Level II quotes to help investors understand how market makers drive prices and manipulate the market. This handy resource is filled with the tools needed to interpret market maker activity so traders can truly understand the market and trade accordingly.

• Offers an accessible guide for developing the investing skills to trade with confidence
• Filled with the real-world trading experiences and techniques of Fausto Pugliese
• Covers simple technical patterns that are important in day trading
• Includes a website with exercises to help master the book's techniques

How to Beat the Market Makers at their Own Game will become your well-thumbed resource for learning what it takes to succeed in short-term stock trading.

• Language: English
• Publisher: Wiley
• Release date: Jul 28, 2014
• ISBN: 9781118745656

Book preview

Introduction

Contrary to popular media reports, day trading is alive and well in America. This isn't a comeback for day traders either; many of us never left. I continued day trading throughout the shakeup of the early 2000s, and during that time, I consistently made money. For years, day trading has represented a significant portion of my income and it continues to do so even now, despite today's economic climate. I'm not alone; my company, Cyber Trading University, has trained thousands of people to do the same thing, and many of these people have gone on to duplicate, or in some cases exceed, my success. In the following chapters, I will share the system I have relied upon and perfected with you.

Of course, this is not to say that there hasn't been a shakeup in the industry. Many traders lost their shirts in 2000 and in times since. The truth of the matter is that most of these people weren't day trading in the first place; they were the unfortunate victims of an out-of-control fad that called itself day trading. In actuality, this fad was anything but day trading—it was outright speculation.

You must remember that during the late 1990s, making money in the stock market was incredibly easy. In fact, it was almost impossible to lose money in the market. The Standard and Poor (S&P) 500 Index averaged a 20 percent or greater return every year from 1995 to 1999. Remarkably, the S&P 500 had poor performance compared to the Nasdaq Composite. In the years 1995 and 1998, the Nasdaq rose by 40 percent, and in 1999, the year before the bubble burst, it was up 86 percent. With the market going up 86 percent in a single year, how could you possibly lose money?

People signed up with online brokers and began trading stocks with little or no training. Most of them lacked a predefined strategy or even the knowledge that they needed one in order to succeed. These traders would simply search for the latest hot stock, buy it, watch it rise in price, sell it, and collect their profit. It could not have been any easier.

As we all know, there is no free lunch in life—what goes up must come down. That is exactly what the market did, starting in 2000.

To be sure, not all stocks went down. With most stocks falling and with many day traders having no discernible strategy to pick the few winners out there, it's easy to understand what happened. Utter financial devastation fell on many day traders.

A few of us did survive. In fact, with the decreased competition, we thrived. And as we started sharing our secrets of success, our ranks began to grow.

Before I explain the system and how it works, I want to make a few things clear. First and foremost, this is not a get-rich-quick system. I am not promising that you will go from homeless to living in a mansion in six months by day trading. That simply isn't a realistic expectation. One of the primary tenets of my day trading system is to set (and attain) realistic goals.

Another important tenet of this system is humility. Very often, people approach the topic of trading with the mindset, I'm smarter than most people, so I'll make money. Well, if that is how you're thinking, get that idea out of your head immediately! Yes, you might have been voted the smartest kid in your high school class, or you might have graduated magna cum laude. In the stock market, however, you don't know squat. Don't worry, neither did I (and I mean it)!

Quite honestly, I have no idea which stocks are safe investments and which are bad ones. And guess what? I don't care. I'm not in the business of picking good stocks. I'm in the business of making money in the stock market, and as you will soon discover, the two are not necessarily the same.

So how do I pick my stocks then? I leave my ego at the door and play follow the leader. I learn what the market makers are doing and mimic their movements. If they're buying XYZ Company and expect a $2 bounce, then I buy XYZ Company with them and sell when they do. In this book, I'll show you how to find this information and more importantly, how to act on it. However, I can't stress enough that you must let go of your ego and not second guess the real experts.

The final, and arguably most crucial, piece of the puzzle is discipline. Like anything else in life, discipline also requires some work and effort. Sadly, this is something that many people don't understand, and they quickly jump to the conclusion that the system doesn't work.

For instance, most people are familiar with the power of compound interest. We know that if you invest a small amount of money at regular intervals over a long period of time, you can accumulate an astonishing amount of money. To illustrate, if you put aside $5 from your first weekly paycheck starting at 18 years of age and continue doing the same thing every week, that money will grow to almost $1.8 million (assuming a modest return of 10 percent per annum) by retirement. That's a pretty simple thing that anyone could do to retire as a millionaire. Sadly, the number of people who bring this plan to fruition is not enough.

The same thing is true about this day trading system. It works. But it will only work for you if you put in the time, effort, and discipline required. To work at it, you must be regimented. Without these critical tools, you will not be able to make money—at least not consistently. I am not trying to scare you away from day trading, I just want you, the reader, to understand that success will only come to those who make the commitment.

I was born and raised in New York, the financial capital of the world, and I've been trading stocks for decades. As one of the first independent traders to take advantage of the Direct Access Trading technology boom that started in 1987, I acquired a wealth of knowledge from years of hands-on experience, as well as working side by side with some of the most practiced and successful traders in the industry.

Following my initial cultivation of knowledge and expertise, others noticed my success, and I was suddenly swamped with requests from other traders who sought trading advice. I took pride in sharing my insights with associates, as well as strangers. As the questions, e-mails, letters, and phone calls continued pouring in, I found myself overwhelmed with this unexpected responsibility. As a result, I decided to establish Cyber Trading University, where my knowledge can be shared with others in a more appropriate environment.

Due to the success of Cyber Trading University since its inception, I have decided to generate a comprehensive version of active trading that is intended for both expert and novice individuals alike, who simply want to learn how the system operates. I'm going to take a systematic approach to explaining the system to you. First, I'll explain how the market works, and by that, I mean how it really works. Second, I'll explain the basic strategy of how to execute my system, given the tools available to you. Finally, I'll share with you some secrets of the trade so that you can avoid making the mistakes that I've seen countless traders make over the course of my career.

Of course, there are no guarantees in this book, or in life for that matter. I'm confident that after reading How to Beat the Market Makers at Their Own Game, you will begin to understand the fundamentals that every trader should know. However, without further education in all the subject matter contained in the book, you will not become a consistent and profitable day trader.

Happy Trading!

CHAPTER 1

The Direct Connection

Before delving into the specifics of locating stocks and placing buy and sell orders, let's take some time to get a clear understanding of how trading works in the stock market. It is possible for you to become one of the very few people who understand just how the market process works. Believe it or not, most people—even traders who have been investing and dabbling in the stock market for years—have no clue how their trades get executed.

To start off, let's consider a typical investor with an online brokerage account. He or she has no idea how his or her trades are executed. And guess what? They don't need to know. All the trader needs to know is how to access the account, place an order, withdraw funds, and so forth. The process of pressing the button to sell a stock and how that translates into cash in the trader's account isn't important at all.

After all, I have no idea how my car works, and I don't need to know how my car works to be able to drive it to the office or the supermarket or even across the country. All I need to know is how to operate the car: how to start it, how to put it in gear, how to use the brake and gas pedals. For my limited purposes, it doesn't matter what is happening under the hood, so long as it happens when I need it to happen.

However, this limited knowledge would never cut it if I wanted to be a professional race car driver. To get the maximum performance out of my car, I would need to know exactly what happens when I push the gas pedal or the brake. This extra knowledge would help me achieve maximum acceleration out of turns and minimize pit stops. As you know, in a 500-mile auto race, the difference between winning and often losing comes down to a few feet.

The same thing holds true for you as an active trader. The difference between the winning trades that put food on your table and losing trades that might force you into getting a night job is minuscule. It often comes down to cutting a few cents off the buy and sell prices of your trades. Therefore, we're going to start with a very quick overview of just what happens when you execute an order through an online broker.

Trading Through an Online Broker

Below, you will find a diagram (Figure 1.1) illustrating what happens when you execute a buy order through your online broker.

FIGURE 1.1 Order Flow—The Steps Between Placing Your Order and When It Is Executed with an Online Brokerage Firm

In most cases, your online brokerage firm is going to do one of two things:

First, if your broker makes a market in the stock (i.e., it holds shares in its own account or for other clients of the firm) then the broker will sell you some of its shares. Obviously, this is the fastest and least expensive way to get you the shares you have requested.

Second, if your broker doesn't make a market in the stock, it may sell your order to another firm. This practice is called payment for order flow. It would not surprise me if you have never heard of this, but payment for order flow is incredibly common. In fact, this is the way online brokers generate most of their income.

If you're like most people, you probably think that your online broker makes money by charging you a commission to make trades on your behalf. After all, this seems logical—you pay them a fee, and they provide a service for that fee. It is the American way. Well, it was the American way, but not anymore.

The sad truth is that a brokerage commissions make up a tiny percentage of the revenue for a typical online broker. Contrary to popular belief, they aren't in the business of selling stock to you or buying stock from you. Your online broker is in the business of selling your trades to another firm, which is willing to pay a lot of money for the honor of placing a trade for you. Therefore, in essence, your online broker is getting paid twice: once by you and once by the person who places your trade.

Now, you may be asking, Why would someone pay my online broker to provide a service? Shouldn't they be charging the online broker instead? When you dig down deep enough and learn what really happens when you place a trade with your online broker, you'll realize that the answer is No. This is particularly true when you place a market order.

As the name implies, a market order is an order to buy or sell at whatever the market price happens to be at the time. Obviously, this gives the online broker a lot of flexibility in placing your order. While it would be wonderful if your shares were sold to the highest bidder, or bought from the lowest seller, this isn't always the case. In fact, it is almost never the case when your order is executed by a third party through a payment-for-order-flow

Reviews for How to Beat the Market Makers at Their Own Game

[eversuhoshin · Rating: 3 out of 5 stars]

Hard to beat the market maker with this book. But some good insights about minimizing bid-ask and trading on liquid stocks that can give you quick returns with good risk management and due diligence. I hoped for more insights but it wasn't there...

[sufyan minhas · Rating: 5 out of 5 stars]

Very simple and straightforward.Best one i have read on trading as a begginner so far.