The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

(sohrab1953) #1
THE HAnDbOOk Of TECHnICAL AnALySIS

between the bid and ask price, is $0.20. The moment we see price on the bid‐based
chart test the $10 level, we enter a market order to short at $10. Ignoring the
possibility of negative slippage for now, we are filled at $10. There seems to be
no difficultly in establishing a short at the intended price. The outcome is similar
to using a pending order to initiate a short entry. If we placed a sell limit order at
$10, we should also be filled at that intended price or better. Even if the short rep-
resented an exit such as a stop loss or profit target, we would still be able to exit
at the intended price. This is because we are shorting (i.e., selling to open or close
a position) at the bid (i.e., sell) price. There seem to be no difficulties associated
with initiating short entries or exits at the intended price on a bid‐based chart. See
Figure 3.24.
Now let us turn our attention to long entries. Let us assume that we intend to
go long on an upside breakout, initiating an entry $0.05 above the $10 breakout
level. We see prices test the $10.05 level and we immediately initiate a market
order. We then find out that we had actually entered at $10.25, instead of $10.05.
This is because when we enter an order to buy, we need to accept the ask price,
which is $0.20 above the bid price. Hence, even though we have initiated a long
position at precisely the right time of entry based on a bid‐priced chart, we never-
theless bought in at a higher price that we had intended. This is referred to as the
problem of the expensive longs. See Figure 3.25.
Assume now that we initiate the same entry, but this time using a pending
order in the form of a buystop entry order. We place a buystop order to go long
at $10.05, just as before. We later find that we were filled at exactly $10.05.
Unfortunately, when the buystop order was filled at the ask price of $10.05, the
bid price was still below the $10 breakout level, being $0.20 below the ask price
at $9.85. This essentially means that we have bought into a position before the
breakout, based on the resistance level on bid‐priced chart! This is referred to as
the problem of the early longs. Traders therefore have no choice but to buy in at
a relatively higher price, which reduces the profit potential, or to buy in too early
at the exact intended price. Either way, the bid‐ask spread adversely affects both
long instantaneous and pending order entries. Let us now look at how the bid‐ask
spread affects long entries in declining markets.
Let us now imagine that we intend to buy at the prior support level of $10. We
see price test the $10 level and we immediately enter a market order to go long.


figure 3.24 Shorting Resistance at the Bid.

Free download pdf