Rich Lepis founded “Ahead of the Charts Trading” (ATC) to train students to become successful day traders.

Richard Lepis.

5 Things You Must Know to Day Trade Like a Market Maker

Richard Lepis, AheadOfTheChartsTrading.com

It is no surprise that we are in a time of financial uncertainty. The Fed has been kicking the can down the road with regards to interest rates, the stock market has been reaching all-time highs, and lest we forget, we have a major presidential election mere weeks away. As a trader, we want to be able to take advantage of this uncertainty and its attendant volatility, trading the market long and short, adapting to the strategies used by smart money in the market.

One of the main benefits of day trading is that it eliminates the exposure to the overnight swings and the attendant overnight volatility, which can cause large losses. Unfortunately, these days swing trading and investing don’t often follow the traditional fundamentals that most of us are used to. Stocks will crush their earnings estimates and subsequently drop the following day. Other stocks will disappoint their shareholders one minute and gain 5% the next minute. However, by focusing on a stock’s movement during the intraday, it allows us to not only protect ourselves from these situations, but at the very same time, make a significant profit.

The one thing that we have to realize is that the market makers have been controlling stocks for many decades. By thinking like a market maker, it enables us to follow their exact movements and gives us high percentage trades, otherwise known as “following the smart money.” Most importantly, to think like a market maker, we must first know what got them there in the first place.

1. Having the right tools

Market makers use a specific set of tools as they trade. You cannot day trade like a market maker if you are not looking at the same things that they are. First and foremost, you must be able to place an order directly to the market. This is known as direct execution. If you are routing your order through an online broker, by the time your order is filled the stock will have most likely made its move, leaving you with either no entry or a very poor entry.

2. Picking the right stock

One of the most important aspects of day trading, is selecting the correct stocks to trade. On a longer term trade, the specific volume being traded per minute is not always that important. However, while day trading, volume is the most important factor you will be looking at. Market makers do not actively trade low trading volume stocks because it hinders them from being able to enter and exit their very large positions. One of the best ways we’ve found to calculate this is by using a 20 minute moving average on your volume bars on a one-minute chart. This will show us the average volume per minute it is trading over the last 20 minutes. For any stock trading under 10,000 shares per minute, my suggestion would be to avoid it as a day trader.

3. Following Orders

One of the main tools that a market maker uses is called Total View. Total View aggregates every single order at each price on the bid and ask, giving the day trader a complete picture of orders waiting to be executed. This allows them to see when a certain price level has an abnormal amount of orders in comparison to the other price levels. An abnormally large order on the bid will indicate someone is looking to buy an exorbitant amount of shares, causing it to act as a potential support order. An abnormally large order on the ask will mean just the opposite, as they are looking to sell a large amount of shares causing it to act as a potential resistance order. However, keep in mind these are just limit orders, as such orders have not been bought or sold, as of yet.

4. Tape Reading

Tape reading is the most important tool a day trader has. Indeed, we would call this a lost art, at this point in time. Market makers have the ability to read time and sales to know where the direction of a stock will go and quite literally be “ahead of the chart.” Furthermore, these traders have the ability to move the stock toward a price target of their choice. This makes it critical for us as day traders to accurately and in real time, interpret time and sales. This allows us, quite literally, to follow the so-called Smart Money in the market with high degree of confidence that our own trades will succeed a high probability of the time.

Time and sales can best be described as a receipt for all transactions within a stock. If a buyer initiates a transaction with a seller, this order being bought on the ask is commonly shown as a green color; conversely, if a seller initiates the sale with a buyer on the bid, the color will be shown as red. Unlike the orders that are put on the order book as discussed in point 3, all the orders seen on time and sales have actually been executed in the market. Of course tape reading is in no way this simple, but if you saw that Goldman Sachs bought 100,000 shares of a stock, where do you think it’s likely to go.

5. They had a mentor

One of the prerequisites in becoming a consistent, solid, high probability trader is to find an experienced mentor. Although it is certainly possible to become a consistently profitable trader by oneself, it is highly unlikely and (perhaps far more importantly) exceedingly expensive. Reading books is a great way to expand your knowledge as a trader, however, nothing will ever expedite your learning like someone who already is a good, consistent and profitable trader. For example, Warren Buffett was taught at Columbia by the great investor Ben Graham, and subsequently worked for Mr. Graham for many years in New York. Buffett did not become the world-class investor and financial guru he is today by himself, on his own. Indeed, before I was successful I had a mentor that really helped me reach my potential. Before my mentors reached their pre-eminent level of success, they had the same. It is by far the most important part of learning to trade like a market maker. It is not just enough to make a good trade, when the market is moving. It is imperative to make a trade that has a high probability of success based upon an understanding of Market Maker tactics.

Regardless of one’s current level, or ultimate trading goals mastery of these variables will be imperative in getting there. By breaking down the things we need to become proficient in, it allows us to understand the things we should be focusing on, and the areas we are lacking in.

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