day trade your way to financial freedom 2nd e - chua 2007

Sammy Chua
John Wiley & Sons, Inc.
Sammy Chua’s
DAY TRADE
Your Way to
FINANCIAL
FREEDOM
2 ND EDITION
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Copyright © 2007 by Sammy Chua. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
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Library of Congress Cataloging-in-Publication Data:
Chua, Sammy.
Sammy Chua’s day trade your way to financial freedom / Sammy Chua.—2nd ed.
p. cm.
Includes index.
ISBN-13: 978-0-471-74558-7 (cloth)
ISBN-10: 0-471-74558-8 (cloth)
1. Day trading (Securities) 2. Electronic trading of securities. 3. Investment analysis.
I. Title: Day trade your way to financial freedom. II. Title.
HG4515.95.C49 2006
332.64′2—dc22 2005031909
Printed in the United States of America
10987654321
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CONTENTS
PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
CHAPTER ONE
An Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
•
The Stock Markets
•
The Exchange System
•
NYSE Time Lines

•
Listed Stocks
•
The Specialist System
•
Who’s Who on the Exchange Floor
•
The SuperDOT System
CHAPTER TWO
The Big Board and Nasdaq . . . . . . . . . . . . . . . . . . . . . . . . . 13
•
The Over-the-Counter Market (OTC)
•
NASD and Nasdaq
•
Nasdaq Is a Negotiated Market
•
Understanding Market Makers
•
Information Is Power
•
Nasdaq Service Levels I, II, and III
•
Comparing the NYSE and Nasdaq
•
Electronic Communications Networks (ECNs)
•
Regulatory Framework
•
Quick Quiz

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iv CONTENTS
CHAPTER THREE
Brokerage Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
•
Selecting a Brokerage
•
Execution Speed
•
Reliability
•
Order Routing
•
Price
•
Service
•
Other Online Brokerage Features
•
Types of Accounts
•
Types of Positions
•
Types of Trading Orders
CHAPTER FOUR
Direct Access Order Entry System . . . . . . . . . . . . . . . . . . 39
•
Nasdaq Direct
•
SuperMontage

•
TotalView
•
ECNs
•
SuperDOT
•
Order Execution Systems Review
CHAPTER FIVE
Elements of Successful Trading . . . . . . . . . . . . . . . . . . . . . 47
•
Minimum Requirements to Begin Trading
•
Psychology of Trading
•
Risk Management
•
Trading Methodology
CHAPTER SIX
Trading Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
•
Scalping
•
Intraday-Trend Trading
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CONTENTS v
•
Swing Trading
•
Long-Term Trading

•
Back Testing
CHAPTER SEVEN
Technical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
•
Charts
•
Identifying Support and Resistance
•
Trading Strategies
•
Trendlines
•
Gaps
•
Basic Chart Patterns
•
Volume Analysis
CHAPTER EIGHT
Candlestick Charting Techniques . . . . . . . . . . . . . . . . . . 115
•
Spotting Heavy Buying and Selling Pressures
•
Comparing Buying and Selling Pressures
•
Spotting Indecision with Candlesticks
•
Understanding Intraperiod Activity
•
Candlestick Positions

•
Bullish Patterns
•
Bearish Patterns
CHAPTER NINE
Spotting Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
•
Technical Indicators
•
Key to Using Indicators
•
Moving Averages
•
Moving Average Convergence Divergence
•
MACD Histogram
•
Stochastic Oscillator
•
Relative Strength Index
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vi CONTENTS
•
On-Balance Volume
•
Accumulation/Distribution
•
Futures and Pivot Points
•
Conclusion

CHAPTER TEN
Preparing for the Open . . . . . . . . . . . . . . . . . . . . . . . . . . . 177
•
The Trading Day
•
Do the Research
•
Manage Risk
•
Set Alerts and Trading Screens
•
Intraday Trading
•
Market Indices
•
Other Market Indicators
•
Direction of Market Trends
•
Keep a Trade Journal
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193
INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195
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PREFACE
W
HEN SAMMY CHUAASKED ME to edit his new book on day trad-
ing, I jumped at the chance. As a reporter for Investor’s Business
Daily, I had covered day trading for several years. Too many of the
day trading gurus I wrote about were interested only in getting novice traders into
their shop, bleeding them dry, and then shoving them out the door when their cap-

ital had run dry.
Sammy Chua was an exception. He has made a fortune using trading methods
that I believe to be superior to the many other methods I have covered. Now he
wants to teach others how to succeed in this miraculous profession. There is no
hidden agenda with Sammy. His zeal to teach is genuine and heartfelt. He wants
to teach beginners to protect their capital and to avoid the psychological traps that
often spell disaster for new traders. Sammy Chua wants you to have the same suc-
cess he has had.
Day trading has come a long way in the past 10 years. It is a risky occupation,
but a small group of talented people have developed ways of lessening the risk
and increasing the potential for profit. Sammy Chua is number one on this list.
Here’s a short version of his strategy: The controlling factor in day trading is,
according to Sammy, supply and demand. If demand for a stock is great, the sup-
ply will decrease, driving the stock price upward. If demand is poor, supply will
increase, driving the stock price down. You don’t need a broker or an army of
research analysts to tell you when the laws of supply and demand are pushing a
stock up or down. Just pay attention to what Sammy has to say in this book.
Concentrating on supply and demand is liberating. It frees the trader from the
onerous chore of picking stocks based on the industry they represent. Sammy once
drove this home to me in a phone conversation. He talked about making a good
profit the day before on Corning. I remarked that I liked Corning, because the
company was in the rapidly growing fiber optics business.
Sammy took a deep breath and said, “Pete, I don’t know what Corning does. I
don’t care what they do. I don’t know anything about any of the companies I trade.
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viii PREFACE
All I know is the stock generated a strong buy signal based on several indicators.
Institutions are jumping in big-time, which means supply is dwindling. That’s all
I care about.”
And that’s all day trading should be about. It’s about supply and demand,

learning to read indicators and volume trends, and sticking rigidly to a loss pre-
vention program. But I’ll let Sammy Chua explain this to you. He is a proven win-
ner in the fine art of day trading. Learn and enjoy.
Peter McKenna
Editor
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INTRODUCTION
D
AY TRADING IS THE MIRROR OPPOSITE of the buy and hold strat-
egy. It means trading frequently, trying to capture small profits while
limiting risk. You do not buy a stock and hold it for years. Good
traders learn what makes stock prices move up or down, and they use this knowl-
edge to make money on a daily basis.
Consider, for example, just one of the important bits of knowledge this book
will teach you: the theory of supply and demand as it applies to stock prices. When
institutions such as brokerages and mutual funds buy huge amounts of a stock—
IBM, for example—the available supply of that stock will diminish. This in turn
will drive the price of IBM stock upward. A day trader who learns to spot stocks
that are under heavy accumulation can use that knowledge to catch a ride on IBM
as its price goes up. The same is true in reverse. If institutions are selling a stock,
it’s supply will increase, driving the price down. An alert day trader will short this
stock for a brief time as its price falls.
When done correctly, day trading can help investors avoid the periodic losses
that come with the traditional buy and hold strategy. Since the first stock was
traded more than 200 years ago in New York City, the overall direction of the mar-
kets has been upward. For this reason, the buy and hold strategy makes sense if
you want to hold stocks for several years.
However, the market does not make this upward climb in a straight line. There
are periods of months and sometimes years when prices come crashing down or
move sideways. This is the classic bear market. Long-term investors who get

caught in these downdrafts can be badly hurt.
Suppose, for example, that you put a lot of money into Lucent Technologies
when it was trading near $20 in 1999. The stock soared to nearly $80 by January
2000. Everything was rosy. Many long-term investors held onto tech stocks such as
Lucent, thinking they would go up forever, providing the money for retirement or
college tuition or a new car in the years ahead. Lucent was their nest egg.
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2 INTRODUCTION
But things turned nasty in 2000 and 2001. The tech sector collapsed and the mar-
ket came tumbling down. It bears repeating that the market cannot go up forever.
Something always brings it down. Lucent now trades at about $3. Investors who
bought Lucent in 1999 and held on have been left with next to nothing.
When the tech bubble burst, a day trader who understood the supply and
demand theory mentioned previously would have spotted Lucent, or any num-
ber of other tech stocks. They would have seen the selling pressure and shorted
the stock, making money immediately. The rewards and risks of the day trading
strategy are immediate; they are not long-term promises that may or may not
materialize.
This is a great time to be a day trader. Although day trading has been around for
several years, recent changes in technology and securities laws have opened it to
simple folks like you and me. Today, we can trade from any location. All we need
is an Internet connection and a computer. We also have the ability to place orders
directly into the stock exchanges, which is almost like buying a seat on the
exchange itself.
Day trading is not for everyone. To be successful, you have to love what you do.
If day trading does not fit your personality, you will not last long. For example,
day trading can be risky. You can lose money in a few seconds. Risk taking comes
naturally to some people but shakes others to the core. If you feel comfortable buy-
ing only companies with strong, long-term fundamentals, then short-term trading,
particularly day trading, is not for you. But if your desire for financial freedom is

strong enough, if you are willing to develop the discipline it takes to trade success-
fully, you have the right mentality to be a frequent trader.
Before we continue, let me make an important point: This book covers many
different trading strategies. You do not have to master all of them to be successful.
Traders who concentrate on just one or two strategies almost always become suc-
cessful faster than traders who want to know everything before they take the
plunge. The same is true in all professions. Both general practitioners and heart
surgeons, for example, are doctors. But heart surgeons are specialists and enjoy
more success than general practitioners. Be the heart surgeon and learn to special-
ize in one strategy before moving on.
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INTRODUCTION 3
As you read this book, try to decide whether you have the type of personality it
takes to be a trader. Remember, trading is an ongoing process of learning. You
must be willing to constantly adapt to the ever-changing market. Trading requires
constant reading, picking the brains of those who have already succeeded, and a
bulldog tenacity to learn your craft. It can be exciting, even exhilarating, when
things go your way. There is no limit to the profits you can earn. Your success
depends on how much effort you are willing to commit to learning. Let’s get
started.
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CHAPTER
1
An Overview
• The Stock Markets
• The Exchange System
• NYSE Time Line
• Listed Stocks
• The Specialist System
• Who’s Who on the Exchange Floor

• The SuperDOT System
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You will not be able to execute these strategies
unless you learn how the stock markets work.
Every day, millions of shares move back and forth
from one investor to another. How is this done?
Who are the people who execute these trades for
investors? How do you get the best price on your
order? Which electronic routing systems are the
best for day traders? What does all this back-and-
forth mean to the day trader? These are the basics.
Learn them well.
In the United States, stocks are bought and sold
in two different venues: stock exchanges and over-
the-counter markets (OTCs). This chapter explores
the differences between the two systems, particu-
larly the differences that will affect your career as a
day trader.
THE EXCHANGE SYSTEM
The largest stock exchange in the world, trading
more than 3,000 stocks, is the New York Stock
6 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
Exchange (NYSE). The NYSE is situated on Wall
Street in New York City. It is also known as the Big
Board and is considered the center of the stock-
trading universe. The NYSE was created in 1792 by
24 traders who got together to trade a few shares in
two small, local companies. From this humble
beginning, the stock market grew into the beast it
is today. Most day traders, however, never set foot

inside the NYSE. Including the NYSE, there are
seven stock exchanges in the United States, but the
NYSE is the granddaddy of them all. The others
are smaller, regional exchanges that look to the
NYSE as the leader.
An exchange is a place where buyers and sellers
physically get together on a central trading floor to
buy and sell. Floor trading is essentially an auction
in which price is determined by supply and
demand. The trades may be routed by computer,
but they all eventually come to the market floor for
execution. The exchanges are membership organi-
zations. The members trade securities on behalf of
THE STOCK MARKETS
D
AY TRADING INVOLVES THE FINE ART of finding stocks that
will come under buying or selling pressure. This pressure makes
the stock price move significantly up or down. That’s the first
step. Knowing when these stocks are likely to make their move is the second
step. The final step is executing a trade to capture a brief portion of this
move, making a profit in the process.
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AN OVERVIEW 7
their clients or for themselves. Both individuals
and big securities firms are members of the NYSE.
NYSE TIME LINES
HISTORIC MILESTONES
1865 The average daily volume is about 34,000 shares
traded for 141 companies.
1900 Volume grows to 505,000 shares per day for 369

companies.
1920 Volume is 825,000 shares per day for 689
companies.
1940 Down to 750,000 shares per day for 862
companies, volume explodes.
1960 Average daily volume rises to 3 million shares for
1,143 companies.
1980 Volume is 44 million shares per day for 1,570
companies.
1987 Largest one day percentage drop occurs.
1990 Volume is 157 million shares per day, 1,774
companies.
1997 Volume is 525 million shares per day for 3,028
companies.
1997 All-time record 1.2 billion shares are traded on mini-
crash day, October 27.
2000 Both the biggest point jump (499.19) and the
biggest point slide (617.78) occur.
2001 Trading in fractions ends.
2003 NYSE Composite Index is relaunched using revised
methodology.
2005 ARCA and the NYSE merge.
TECHNOLOGICAL ADVANCES
1878 The first telephone is installed.
1978 The first electronic linkage to other exchanges is
installed.
1984 Orders are electronically routed to the floor using
SuperDOT system.
1995 Hundreds of old TV-style monitors are replaced with
modern flat-panel displays in the world’s largest

installation of this technology to date.
1996 Floor brokers start using handheld wireless
information tools.
LISTED STOCKS
Stocks traded on the NYSE are called listed stocks.
This means the underlying company has met the
requirements necessary to list its stock on the
NYSE. One requirement, for example, is market
capitalization. To be listed on the NYSE, a company
usually must have a market capitalization of at
least $100 million. (Market capitalization is deter-
mined by multiplying the stock price times total
shares outstanding.) These rules were designed to
prevent the Mafia from getting money-laundering
companies listed on an exchange.
Stocks with a large market capitalization are
called large-cap stocks. They are usually estab-
lished companies. For example, IBM, founded in
1911, has a market capitalization of $124.64 billion
and is a large-cap stock traded on the NYSE. Other
large-caps traded on the NYSE include DuPont,
Ford, Coca-Cola, General Electric, Alcoa, and
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AT&T. It is important to remember that large-cap
stocks traded on the NYSE are not as volatile as
OTC stocks. This can be an asset or a liability to the
day trader. However, some large-cap stocks, even
though they trade on the NYSE, are volatile.
Energy stocks and pharmaceuticals are examples.
Before I discuss how these stocks are traded,

here is a list of terms you should know. They apply
to the workings of both the NYSE and the OTC:
Best bid. The price a buyer is willing to pay to buy a
stock.
Best ask. The price at which someone who owns a stock
is willing to sell it.
Broker. One who arranges the sale of a stock.
Dealer. Usually a brokerage,such as Charles Schwab. Bro-
kers sell the stocks that dealers keep in their inventories.
THE SPECIALIST SYSTEM
Exchange trading is carried out by a person called
a specialist. Specialists control the auction process.
Their job is to match buyers with sellers. The spe-
cialist looks at an electronic order book of bids and
asks and matches them according to price and
quantity. The specialist, for example, will match a
person willing to buy 100 shares of IBM at $80 with
a person willing to sell 100 shares of IBM at $80.
Specialists are the people you see running around
on the floor of the NYSE. The specialist and his or
her clerks are assigned responsibility for one or
two stocks. They handle all bids and offers for
these stocks.
8 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
There is more to a specialist’s job than matching
buyers and sellers. They are expected to maintain
an orderly and fair market. When there is an excess
of buy or sell orders, making it impossible to
match orders evenly, the specialist steps in. There
may be 1,000 people who want to sell IBM at $80,

for example, but only 100 people who are willing
to pay this price. This situation, called an order
imbalance, sometimes causes trading to be tem-
porarily suspended. An opening delay usually
happens when a news event or extreme imbalance
of orders prevents the stock from trading when the
market opens. The specialist has 15 minutes from
the opening bell to determine a price range at
which the stock will begin trading.
Aspecialist can delay an opening or halt trading
until a proper balance of buyers and sellers is
achieved. Usually, the stock will start trading at a
price far different from its previous price. Some
day traders try to profit from these imbalances,
which occur frequently.
Specialists profit from the spread, the difference
between the bid price and ask price, for each
market-order transaction in which a spread exists.
A market order is an order to buy or sell a stock at
the market’s current best displayed price.
A good specialist will be assigned responsibil-
ity for more stocks than the usual one or two. Spe-
cialists may trade for their own firm’s accounts as
well, buying low and selling high to make a
profit.
Specialists are predictable. Novice day traders
who want to trade stocks on the NYSE should
get to know the habits of the specialists they are
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AN OVERVIEW 9

dealing with. There are several day trading firms
whose members make a good living just by follow-
ing the actions of the specialists. Their aim is to
capture small profits several times a day, just like
the specialist.
WHO’S WHO ON THE EXCHANGE FLOOR
In addition to the specialist, here are the people
who make the NYSE hum:
Specialist’s clerk. The clerk sits next to the specialist.
They stand ready to maintain the electronic order book
and report executions. The order book contains buy and
sell orders at different prices, including the current market
price. These are the orders and prices that must be
matched.
Floor brokers. Brokers usually represent big-name bro-
kerage firms. They handle large (block trades) or sensitive
orders. The brokers deliver these orders to the specialists.
They are allowed to negotiate orders with the specialists or
other floor brokers in the presence of a specialist.
Floor clerks. These people deliver orders from the floor
brokers to the specialists.
Member firms. A big-name brokerage firm that has a
seat on the NYSE. If your brokerage firm is not a member,
your order will pass through another firm that is a member.
Floor traders. These are independent traders. They trade
for their own accounts and can represent institutions when
contracted.
Customer. A customer can be a day trader, an investor, or
a large institution. Generally, they are not present on the
floor, but their orders are the cause of all the activity you

see on the floor.
There are 17 trading posts on the trading floor.
Each post is semicircular and about 15 feet across.
Each post trades an average of 150 securities. The
specialists are stationed outside the trading posts
in designated spots. The clerk sits inside the post
and communicates with the specialist through a
window. Display monitors hang above the post
windows so the clerk and the specialist can watch
the floor broker and the order books at the same
time. Huge conduits rise up from the trading floor,
carrying data lines to the exchange computers.
THE SUPERDOT SYSTEM
Buy and sell orders on the NYSE are routed to the
exchange floor by an electronic system called
Super Designated Order Turnaround, or Super-
DOT. The best way to understand the miracle of
this system is to compare it with the routing meth-
ods used before the SuperDOT was implemented.
Figure 1.1 gives you an idea of the long process
needed to route orders in the old days. As you can
see, getting a trade executed in the old days took
time. The trader called a stockbroker and placed the
order. The stockbroker called the order in to the
trading desk. The desk relayed the order to a floor
broker at the NYSE. The order was then passed to a
floor clerk, who would give it to the specialist for
execution. After the order was executed, a confir-
mation (or trade report) would flow backward
through the same process until it reached the trader.

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Every transaction required multiple pieces of
paper, which were crumpled up to distinguish
them from paperwork that might have been acci-
dentally dropped. That was why, in the old days,
the floor of the stock exchange was littered with
small scraps of paper. The SuperDOT system has
eliminated most but not all of the paperwork.
10 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
Paper is still used for negotiating large and special
orders.
SuperDOT is fast and reliable. Orders go
directly to the specialist. This minimizes the time
involved, and trade reports are made within sec-
onds, except on the busiest days. Brokers who
trade on this system have what is called direct
Customer Places Order
Trading Desk
Floor Broker
Floor Clerk
Customer Gets Confirmation
Trading Desk
Floor Broker
Floor Clerk
Specialist Executes Order
1.1 Historical Buy and Sell Order Routing System Used on the New York Stock Exchange
ᮣ
WHEN THERE IS AN EXCESS of buy and sell orders, the specialist steps in.
Customer Places
Order

Specialist
Executes Order
Customer Gets
Confirmation
1.2 SuperDOT System (Super Designated Order Turnaround System)
ᮣ
COMPANIES WITH SMALL MARKET CAPS are handled on the Bulletin Board and the Pink Sheets.
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AN OVERVIEW 11
access to the NYSE market. If you are a day trader
and your broker is a NYSE member, your order
will most likely be delivered through SuperDOT.
A quick look at the flowchart in Figure 1.2 gives
you an idea of how streamlined this new process
is. It is important to note that SuperDOT is not an
automatic-execution system. Orders are routed
electronically through SuperDOT, but they are still
executed by specialists. If there is an order imbal-
ance or if you have placed a limit order, SuperDOT
will automatically deliver your order, but that
doesn’t guarantee that your order will be exe-
cuted. If there is no match, the trade will not be
filled.
●
$
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CHAPTER
2
The Big Board
and Nasdaq

• The Over-the-Counter Market (OTC)
• NASD and Nasdaq
• Nasdaq Is a Negotiated Market
• Understanding Market Makers
• Information Is Power
• Nasdaq Service Levels I, II, and III
• Comparing NYSE and Nasdaq
• Electronic Communications Networks (ECNs)
• Regulatory Framework
• Quick Quiz
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While the NYSE trades large-cap stocks, the
OTC is home to smaller companies. Many technol-
ogy companies with small market capitalization
trade over the OTC. They are often less established
than companies found on the exchanges. For
example, eBay, a seven-year-old tech company
with a market capitalization of $17 billion, trades
on the OTC.
Over-the-counter trading is done by people
called market makers. You never see these men and
women, because they work out of sight at com-
puter terminals across the country. In contrast to
the NYSE, where stocks are put up for auction,
market makers buy and sell from their own inven-
tory of stocks.
Numerous types of securities are traded on the
OTC, including but not limited to the following:
●
Corporate stock

●
Corporate bonds
●
Municipal bonds
●
U.S. government securities
●
U.S. government agency securities
14 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
Of these, day traders are mainly interested in cor-
porate stock.
NASD AND NASDAQ
Market makers trade through an electronic system
run by the National Association of Securities Deal-
ers (NASD). It is called the National Association of
Securities Dealers Automated Quotation System,
or Nasdaq. It is the NASD’s equivalent of the
NYSE’s SuperDOT system.
Nasdaq began operating in 1971. The purpose
of Nasdaq is to collect and provide real-time, firm
quotes on selected OTC stocks through its auto-
mated quotation system. This system was a major
advance for OTC trading. Previously, if dealers
wanted to sell a stock for $35, they had to get on
the phone and find another dealer willing to pay
$35. They had to keep calling until a buyer was
found. The process was cumbersome and slow.
Essentially, Nasdaq is a real-time classified ad.
Traders post their buy and sell orders for the rest of
the trading world to see. It also provides a means

THE OVER-THE-COUNTER MARKET (OTC)
T
HE OTC DIFFERS FROM THE NYSE in important ways. However,
it, too, uses a state-of-the-art computer system to route trades.
There is no central trading floor in the OTC market. Transactions
move from computer to computer, over the Internet, or over electronic trad-
ing platforms.
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THE BIG BOARD AND NASDAQ 15
to get orders executed. Nasdaq trades some of the
biggest names in technology, such as Intel and
Microsoft. The Nasdaq system allows large institu-
tional buyers, market makers, brokerage houses,
electronic day traders, and online investors to
come together to communicate their trading inten-
tions in real time. It is a high-speed, state-of-the-art
computer network bazaar.
Securities traded on Nasdaq are grouped into
the following three classifications:
●
1 The National Market Securities (NMS) are the highest
classification, or tier, of Nasdaq stocks. There are more
than 4,000 NMS stocks. These stocks meet the highest
standards with regard to annual net income, price per
share, number of publicly held shares, and so on. They
are considered large-cap stocks.
●
2 The small-cap market is the next group, comprising more
than 1,300 securities. They have smaller market capital-
ization than do large caps.

●
3 Companies with very small market capitalization are han-
dled on the OTC Bulletin Board and the Pink Sheets.
Day traders are mainly interested in the NMS
tier of stocks—the large caps.
NASDAQ IS A NEGOTIATED MARKET
While the NYSE requires a specialist to act as an
auctioneer or intermediary, the Nasdaq allows
buyers and sellers to interact directly without an
intermediary. That is why Nasdaq is called a nego-
tiated market. The buyer who offers the best price
will get taken care of first. The seller offering the
lowest price will likewise get a faster response
from buyers. Nasdaq is automated and simplified.
Remember, at the NYSE, stocks are sold at auction
by an intermediary. Nasdaq stocks are bought and
sold on a best-price basis.
UNDERSTANDING MARKET MAKERS
Market makers make day trading exciting. They
are dealers who buy and sell stocks on behalf of
their clients or for their own firm. They provide
liquidity for their customers and make the Nasdaq
market viable. When a stock is liquid, it means the
price will not be greatly changed by heavy buying
or selling.
Market makers make money by capturing
momentum moves. They also make money captur-
ing the spread, just like NYSE specialists. Market
makers also act as commissioned representatives
for large financial firms or mutual funds. As reps,

market makers become brokers acting on their
client’s behalf to buy or sell a security. When market
makers act as intermediaries for a big firm, they get
paid a commission. The commission is usually the
spread between the inside bid and the inside ask. In
most cases, small orders from traders like you and
me come from a market maker’s own inventory.
The term market maker refers to a securities firm
as well as an individual. Examples are Goldman
Sachs and Morgan Stanley, firms that are regis-
tered to buy and sell specific securities. As market
makers, they abide by Nasdaq rules when making
a market. Market makers are required by Nasdaq
to maintain a two-sided market. This means they
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are required to post both a bid price and an ask
price at the same time.
Unlike specialists and floor brokers, market
makers work in offices, using computers and the
telephone to make the market. One market maker
may handle a single security or 25 at a time. There
are approximately 60 market makers trading the
6,000 securities on Nasdaq. Usually, the big-name
stocks have 40 or more market makers, while the
smaller-name stocks have just a few. Tracking and
understanding their methods is vitally important
for the day trader.
The Three Main Responsibilities of Market Makers
●
1 Execute transactions for their clients. The most impor-

tant function is to execute orders for clients at the best
possible price.They do this by interacting with other mar-
ket makers online or by telephone.
●
2 Keep an orderly market. This means they must prevent
dramatic fluctuations in the price of a stock that comes
under heavy buying or selling pressure. To create this liq-
uidity, market makers must provide a two-sided market
within the market bid/ask price. Liquidity happens as
market makers fulfill their obligation to make markets
throughout the trading day.They must advertise to sell at a
certain price whenever they make a bid to buy a stock at
a certain price. That’s why it’s called a two-sided market.
●
3 Trade for the firm’s proprietary account. Market makers
use inside knowledge, experience, and technology to
make profits on a daily basis. They take profits on the
stocks they make a market in, but they also take specula-
tive positions on the possibility of future price movements
of those stocks—depending on the time of day, the market
conditions, and the existing order flow.
16 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
Different Types of Market Makers
It is important for day traders to be aware of the
different types of market makers and understand
the trading patterns they create. Here’s why.
Market makers do the lion’s share of trading on
the OTC. Big market-making firms, such as Gold-
man Sachs, Paine Webber, Salomon Brothers, and
Merrill Lynch, represent large institutions, such as

pension funds and mutual funds. They buy and
sell for these clients. They also trade for their own
retail customers and their own trading accounts.
The sheer volume of this trading can have a dra-
matic impact on stock prices.
You can watch market makers trading on
what’s known as Level II computer screens. Pat-
terns will emerge if you watch them over time.
They repeat certain actions throughout the day,
giving you insight into their true buy and sell
intentions and market direction. Keep in mind that
market makers do not always make the right deci-
sions. The market as a whole is always more pow-
erful than any single market maker.
The following will help you recognize the vari-
ous types of market makers as you watch Level II
screens. Trading symbols are given for each firm.
The information available on Level II is discussed
in detail later in this chapter.
INSTITUTIONAL FIRMS
GSCO Goldman Sachs & Co.
SBSH Salomon Smith Barney
LEHM Lehman Brothers
MSCO Morgan Stanley & Co.
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THE BIG BOARD AND NASDAQ 17
These worldwide firms do the largest underwrit-
ings. They cater to big institutions like mutual
funds and pension funds. They have well-financed
research departments. They are the most powerful

market makers and can set the market on fire
when they trade.
WHOLESALERS
MASH Mayer & Schweitzer, Inc. (Charles Schwab)
HRZG Herzog, Hein & Geduld
SLKC Spear, Leeds & Kellogg
SHWD Sherwood
NITE Knight/Trimark
MHMY MH Meyerson & Co.
These firms do no retail business and provide no
research. They simply make a market for other
firms.
WIRE HOUSES
DEAN Dean Witter Reynolds
PAIN Paine Webber
PRUD Prudential Securities, Inc.
MLCO Merrill Lynch & Co.
These are big, full-service brokerage firms. They
provide financial advisors and brokers. They make
commissions from order flow and a growing cus-
tomer base.
REGIONAL FIRMS
PIPR Piper Jaffray
SWST Southwest Securities, Inc.
DAIN Dain Bosworth Inc.
WEAT Wheat, First Securities
These are smaller brokerage firms with less expo-
sure to the markets. They are cautious traders.
INVESTMENT BANKS
HMQT Hambrecht & Quist, Inc.

MONT Montgomery Securities
COWN Cowen & Co.
These are strictly underwriting firms. They help
companies complete initial public offerings (IPOs)
and secondary offerings. They are not primary
market makers, but they will trade stocks they
underwrite to help create market activity.
Market Maker Recap
To recap, the market maker must:
●
Execute orders for their firm’s clients.
●
Keep an orderly market.
●
Trade for the firm’s proprietary accounts.
INFORMATION IS POWER
Day traders need as much information as they can
get. At the very least, they need to see who is buy-
ing, who is selling, and the prices offered by each
buyer and seller. Both the NYSE and the OTC pro-
vide information about the trades taking place on
their systems. The information is flashed on a Level
II computer screen. But the information provided
on NYSE Level II screens is basic, not nearly enough
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to be used to day trade. If you look at a NYSE Level
II screen, for example, you will see large gaps in the
bid and ask prices. On a Nasdaq Level II screen, you
will see no such gaps (see Figure 2.1).
Figure 2.1 compares the details shown on a

NYSE Level II screen with the information shown
on a Nasdaq Level II screen. Remember, for day
traders, who rely on Level 2 information to make
decisions, information is critical. The Nasdaq pro-
vides far more information than the NYSE.
NASDAQ SERVICE LEVELS I, II, AND III
NASD is a self-regulatory organization. Its mem-
ber firms use Nasdaq terminals that display real-
time bids and offers, size of quotes, and other
information. Nasdaq sends this information
electronically to all market participants on three
levels.
Level I
Available to stockbrokers and most online
investors, Level I provides the following basic
information:
Highest bid and lowest offer at any given time
(called the inside market)
High and low for the day
Volume for the day
Price change from previous day
Direction of last trade (uptick or downtick)
Size of highest bid and highest ask
Last transaction price
18 SAMMY CHUA’S DAY TRADE YOUR WAY TO FINANCIAL FREEDOM
Level II
Level II not only shows the size of the best bids
and offers, it also shows the depth. Depth is the
market that exists behind the best bid and offer,
also called the outside market. Level II shows the

next bids and offers for several levels up and down
from the best price. This is very important to the
day trader. It’s like sonar for a submariner or field
maps for Napoleon. It is the best crystal ball you
can have to determine the short-term direction of a
stock price.
Here’s another way of looking at the depth
offered by Level II. Let’s say Buyer A is bidding
$65 for a stock on Nasdaq. On Level II, sellers
are offering the stock for $65.25. Buyer A’s bid
and the sellers’ offer is the best bid and offer at
the time. Also listed on the screen are the out-
side market bids and offers, the next levels of
bids and offers down from the best bids and
offers. In the outside market, Buyer B is offering
to buy the same stock for $64.75 while another
seller is offering to sell at $65.50. In order for
Buyer B’s order to be executed, Buyer A’s order
has to get filled first and stock prices have to fall
to $64.75.
Level II shows the names and quotes of all regis-
tered market makers in each Nasdaq security. Day
traders and online traders can access Nasdaq’s
Level II through electronic communications net-
works (ECNs), which are explained later in this
chapter. Each of these systems has its own name,
which appears on the Level II screen.
The following information is displayed on the
Nasdaq Level II screen:
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THE BIG BOARD AND NASDAQ 19
Which market makers are playing
Which ECNs are participating
Bids and offers
Size of the market (for both market maker and ECN)
Time that the market maker placed orrefresheda bid or offer
Time of each executed trade
Price of each executed trade
Size of each executed trade
Level III
Level III permits market makers to enter bid and
offer prices into Nasdaq. It also provides a means
by which the trades are reported to Nasdaq. Level
III is to the market maker what ECNs are to the
day trader. It’s a system by which they can adver-
tise to buy or sell securities that appear on Level II.
Market makers use Level III to advertise on the
national system (Level II).
2.1 NYSE Level II versus Nasdaq Level II Information
THIS SECTION GIVES THE ACTIVITY ON THE STOCK:
The change in price from the previous day, the highest and the lowest price of the day.
Previous closing price, volume, spread
the ratio of the sizes between the bid and ask price.
NAME OF
THE STOCK
If you look at
the first 7 levels
on the bid side
and compare
the two, you will

notice that the
prices of IBM
goes from ?
down to ? (a
difference of
$?) while INTC
only drops from
? to ? (a differ-
ence of $)
THIS IS THE TIME AND SALES COLUMN
aka “prints.”Any transaction that occurs will show up here.
ᮡ
NYSE LEVEL II SCREEN
IBM is a listed stock that is traded on the NYSE
ᮡ
NASDAQ LEVEL II SCREEN
INTC is an over the counter stock traded on the NASDAQ
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