(continued from 10 Traders You Encounter in Prop)

May 30th 2013. 11:11am eastern time.

It’s happening again. They’re crushing the stock price on Fannie Mae. Deja-Vu.

My fingers hover over the keyboard. My right hand fidgets around the arrow keys, tapping the limit price lower in sync with the bid dropping. My left hand is ready to triple tap the buy button for all the buying power in my account. It’s just a matter of waiting for the signal.

Entire account all-in at the exact bottom. 5k to NITE. 5k to CSTI. 5k to ARCA. Don’t fuck it up.

The stock flushes $3 without a hitch. The market makers print the minimum tick size and then cowardly back away rather than provide any liquidity. It looks like it will never stop falling but I know there’s a bottom price where it will bounce 100% from the bottom tick. It could be $2. It could be $1. It could even be $.01 for all I know. I don’t want to assume anything and be early. I just know the buyer is there, somewhere.

I wait. Fannie keeps plummeting.

At 11:35, it reaches $2.30. Sellers are still encroaching. There are market orders ticking through the best bid at 2.25. But the last remaining 2.30 bid on NITE doesn’t drop. There’s a pause.

The bid starts to print much more rapidly. 2.30. 2.30. 2.30.

Millions of shares changing hands at 2.30–the largest volume candle of the day. That’s him, that’s our buyer. He’s awake!

Can’t hesitate. Send in the buy orders.

I get filled my entire 15000 shares. I exhaust what little I have on my retail trading account. My heart’s pumping at 200 mph. I’m living through a life-changing moment. Within seconds, the direction of liquidity completely changes. They’re now rapidly printing the ask for the first time. Then the bid starts to thicken as all the market makers join the top market and form a giant wall. On the ask, the last remaining sellers finally back off. The NITE bid steps up to 2.31 while market orders start to pile in over the ask.

The first 5-minute green candle closes at 11:40, preceded by what in real time had felt like ten thousand red candles raining from above. There are now no sellers in sight and all the late buyers start to chase as the price springs higher. FNMA trades to 2.60 within 10 minutes. I have an unrealized profit of $4500. There’s no reason to sell.

In another 10 minutes, FNMA finds the whole at $3. I’m up $9000, double what I was up 10 minutes ago. 2.30 to $3, that’s a pretty good trade with no drawdown. There hasn’t been a single downtick or dropped bid since the $2.30 bottom. There’s no reason to sell.

15 minutes later. 3.60. Close to $20,000 unrealized. The buyers are marching up the stock penny by penny, just as smoothly as when it went down. Still no reason to sell but my adrenaline is off the charts. I take a few breaths and direct my entire focus towards watching the tape for any signs of momentum slowing down. I am just trying to do the right thing and wait for my sell signal. It’s the same as the buy signal except the inverse. He will tell me when he’s done.

As FNMA trades close to $4 again, our buyer starts to wobble. The same rapid printing that occured on the 2.30 bid is now occuring on the 3.95 ask. Sellers are soaking for the first time since the upswing move started and forming a wall. The buyer drops. Thank you, whoever you are. His work is done and so is my trade. I sell it all in the 3.90s. $24,000 gain. Add it to some scalps made prior to the big move and I am now up over $30,000 on the day, shattering my prior best $6000 day on the March FNMA trade. I just doubled my retail account in a day. Time to take a deep breath.

All I can feel is relief as the tension fades. You didn’t fuck it up. You secured the bag.

Me: Hey. Check this out.

Clockwork: What’s happening?

Me: I’m up $30,000 trading Fannie Mae.

Clockwork: Holy shit. HOLY SHIT. $30,000?

Tuco, who now sits behind me, picks up on the conversation.

Tuco: Great job P-To. I saw twitter chirping FNMA, glad you crushed it.

Word starts to spread that I made $33k in a day. All of a sudden I’m the guy–the guy who showed the rest of the desk that yeah, you can actually make serious fucking money in this daytrading racket.

Everyone wanted to know the secret sauce. How did OTC-Bandit Pete pull it off? As much as I wanted to prop up this image of myself as a brilliant super trader who picked the bottom through sheer guts and intuition, the truth is you could teach a child how to spot the bottom on FNMA. They held the bid at 2.30–it’s that simple.1Those of you reading unfamiliar with tape reading will not understand the significance of that statement–but if you stay with me until the end paragraph, I’ll try to add as much context as possible and hopefully you’ll get it. It should never be that easy to buy the bottom tick in a so-called “efficient market” but sometimes the Gods give you a gift and all you can do is graciously accept it.

The May 29th, 2013 FNMA & FMCC bounce trade lives on as a watershed moment for many underground small-cap traders–a massive bankroll builder for smaller accounts and a career day for experienced veteran traders. There was so much more liquidity on this day relative to the same move in March when FNMA traded in the $1 range. There’s a good chance that your favorite retail trader, if they were trading penny stocks in 2013, made an outsized profit on this day. Just off the top of my head, I can name 3 traders from the ChatWithTraders podcast, not including myself, who played it.

Max aka Madaz, CWT episode 124, made $38,000.

Tim Grittani aka Kroyrunner89, CWT episode 10 made over $80,000.

Bao Nguyen aka ModernRock, CWT episode 100: made $1.4 million.

I even found an obscure FNMA trader from Copenhagen, Denmark while reading a book called “Traders of the New Era”–a trader named Flemming Kozok. He made $800,000.

Just a guess–I think there’s probably 50 other traders who made 5-6 figures flipping FNMA this day. Maybe a handful made 7. I felt extremely fortunate that I was able to trade this incredibly easy, slam-dunk trade setup. I think my colleagues knew that they missed a big moment. Any decent MBC trader who took the training program on tape reading could understand the setup. Tuco, Eagle, Clockwork, Jimmy–any of them. If I could go all-in and double my account when had I struggled to risk even $1000 on my MBC account, it must have been the easiest play ever. The other traders, they know Pete isn’t the type of guy who bets big on a falling knife unless he absolutely knows it will work. They would’ve crushed it too, I have zero doubt.

So then Victor comes to congratulate me on my breakthrough trade. He tells me he’s always believed that I could make this level of money. He’s beaming like a proud coach. And then Tuco interjects.

Tuco: Vic, what are we doing not having access to OTC stocks? P-To just made $33,000 on it in one day. You and Mr. West have to sit down and figure out how to get us an OTC platform ASAP.

That would be that. MBC Securities was going to trade OTCBB penny stocks for the first time ever.

Fannie Mae: A Trade breakdown

The following Friday, Victor assembled a small room of our top junior traders, the ones who would first get OTC access. I would go over the Fannie Mae trade and explain how the OTC market works. A trade review is supposed to have 3 key components, according to MBC protocol.

  1. Intraday Fundamentals — the news and story of the stock
  2. Technical Analysis — price action, volume, indicators
  3. Reading the Tape — the level II and the time & sales

The first two components aren’t as vital but they provide meaningful context.

Intraday Fundamentals or ‘The Story’: Back in 2008, the GSEs2government state enterprises guaranteed too many toxic home loans and they stood precipitously on the edge of insolvency. The government had to take control of them to stabilize the market. FNMA and FMCC were taken into conservatorship–this meant dividends were suspended indefinitely and future earnings went straight to the Treasury. FNMA declined into a 20c penny stock–basically bankruptcy levels. But eventually, the economy improved and earnings rebounded to pre-08 levels. As the years went by, speculation fueled in the GSE’s on the premise that conservatorship would end and the stock would recapture its own earnings. In May 2013, FNMA paid a whopping $59 billion dividend to the U.S. Treasury. Investors, like hedge fund manager Bruce Berkowitz, argued that enough was enough. They paid their debts, why not let the shareholder eat again?

What news came out that drove FNMA down so much that day? Nothing. Absolutely nothing.

The Chart: There’s no need for any advanced chart analysis. Just ask yourself: are there 30 consecutive red candles and a huge -50% collapse occuring? Yes? Then the bounce play will be on. The reason you can’t trade the reversal on the chart alone is because it’s a lagging indicator and it will have you lead-footed on your executions (more detail below).

The Tape: It’s ALL about the tape on the FNMA bounce play. I feel like I have to explain 3 different semi-complicated things here, so please try to stay with me.

OTC-market mechanics:

The first thing to understand is that OTC stocks trade different than “listed” stocks on the NYSE or NASDAQ. The listed market is run on ECNs–you point and click on the liquidity you see and it will fill instantly3we can have a convo about HFT’s backing away on large orders but that’s a problem for institutions, for which 99.99% of you are not. The OTC is market maker driven. There is one ECN (ARCAEDGE) but most quotes are posted and filled by market makers like Knight, Citadel, E-Trade, and smaller broker-dealers. There’s no NYSE matchmaking or NASDAQ Super Montage to facilitate superior price execution. There are no dark pools or HFT. You just trade directly with the market maker. Liquidity is opaque as market makers will often only display the minimum tick size. Executions have a lag time–you hit a market maker’s open order he might fill you or he might not. There’s no obligation to honor a quote. Quotes are often late to update–you’ll think you hit an order but someone already took it 10 seconds ago. Orders will get held up during volatility and they are not guaranteed to be filled–feel-based timing and execution are vital. Waiting too long for price confirmation might leave you unable to get filled until much later. While your orders are held, you can try to cancel them but there is no guarantee of that either. It’s very easy to get stuck in a large position with no way out other than to absorb monster slippage. The OTC is an archaic market still stuck in 1991 and it sounds horrible but all these inefficiencies actually contribute to why tape reading and proper execution is a such huge edge. You get to trade against shitty infrastructure and slow, unsavvy investors.

Catching a Falling Knife

The FNMA trade, broadly speaking, falls into the category of Catching Falling Knives–that is, trying to buy stocks that drop 30% or more in a single day. It is not easy and usually reserved for advanced and deep-pocketed traders. Most stocks are usually down that much for a good reason. I’ve seen two approaches a trader can take: 1) The Take Pain approach and 2) The Papercut approach.

The Take-Pain approach is this: you buy when you think it’s “down too much” and you just hold it. And if it doesn’t work out… you lose a lot. Think of Mr. West’s VRX trade in the last chapter. The take-pain method is unpalatable for quad-3 traders like myself, it requires a tremendous amount of pain tolerance and conviction.

Then there’s the Papercut approach, where you use “price action” as a framework to measure a bottom and then use reasonable stop. There’s less risk to this approach but you might miss out on the trade if you’re too delicate and fine about the entry. It’s also easy to get shaken out and well, take a lot of papercuts losses. You’ll never buy the dead low without 5-6 tries first. Some monster bounces can occur without an obvious intraday exhaustion pattern, like via intraday halts or overnight gaps.

Then there’s FNMA trade. You can be a total donkey and just buy the dead bottom on one try. It’s an anomaly, a unicorn. It’s the only trade setup that even a piker like me could feel confident enough to size in on.

MBC Securities Tape Reading Program:

It’s funny. Since the end of 2009, MBC went through all this internal hand wringing over how HFT has destroyed scalping and tape reading as an edge. Traders would go through the training, look for tape plays on the demo, and then when they go live, you hear the excited HELD BID at $33.10 on ___! HELD OFFER at $25 on ____! on day 1. Then they slowly learn it’s not what it’s cracked up to be.

Let’s define a held bid for those who don’t know: It’s when a buyer holds the exact price on the bid for an unusual amount of volume. Example, there’s 5000 shares bought at other levels but at $10, a buyer is absorbing for 80,000 shares without dropping. It represents demand at a price. The inverse concept is the held offer (ask), which is the same thing but someone selling the stock.

95% of all held bids we observed would just eventually drop and stop out anyone trying to play a tight stop against it. It’s just noise and it would have no impact on where the stock would eventually go by the closing bell. Maybe it was more meaningful 5 years ago but not after the rise of HFT in the market. The algo’s got too good at posting held bids, shaking out frontrunners with tight stops, and then ripping higher on low liquidity. Tuco would rhetorically ask why are we even trading like this still? We should revamp the program.

Then comes this stock FNMA, which no one at MBC can even trade yet, and it’s the dead perfect stock for a trained tape reader. The pattern is so simple.

It started to dawn on me that I was grossly underutilitzing this huge edge. I’m only trading this one setup, the big bounce play, with size. I could be using this entire concept as a more expansive strategic foundation. Why am I not crushing the short side, which is just as clean? Why am I not scalping the smaller turning points that swing off of held bids/offers? Why am I not playing the pullback plays and the opening drive plays?4I was trading some of these, but for much smaller size Why don’t I try to look for tape edges on other in-play OTC names? It’s the perfect style for a trader like me who can’t tolerate excessive drawdown. I dropped everything I was working on–trying to figure out imbalances, trying to backtest for automated strategies, trying to trade support and resistance on large cap stocks, that’s all on the backburner now. Now I have to be the Penny Stock Trader. I have to find a way to go back to the well.

(to be continued in Consistently Profitable Trader)

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