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How I Trade for a Living by John Carter
Copyright © 2004 John Carter
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DISCLAIMER Neither TradingMarkets nor its content providers are registered investment advisors or brokers/dealers. The Subscriber understands and acknowledges that there is a very high degree of risk involved in trading securities. Past results of any individual trader are not indicative of future returns by that trader, and are not indicative of future returns which be realized by the Subscriber. TradingMarkets and its content providers assume no responsibility or liability for the Subscriber’s trading and investment results. The Subscription service is provided for informational and educational purposes only and should not be construed as investment advice. The analysts, employees, affiliates and content providers of TradingMarkets may hold positions in the stocks or industries discussed here. The Subscribers should not rely solely on the Information in making any investment. Rather, the Subscriber should use the Information only as a starting point for doing additional independent research in order to allow the Subscriber to form his/her/its own opinion regarding investments. The Subscriber is also encouraged to seek the advice of a qualified securities professional before making any investment. Factual statements provided as part of the service are made as of the date stated and are subject to change without notice. The NFA requires us to state that "HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN." 2
Part I: Introduction
Overview: What is This About?
Taking advantage of short-term price movements in the financial markets to produce steady profits Staying profitable despite yourself Utilizing the right trading methodology for the market you are trading Trading the best markets for your personality Formulating a business plan that suits your style and keeps you trading for the long haul 3
Specifics: What We Will Cover
Attitude of a Trader: The make or break factor Basic Mechanics of the markets I trade Daily Market Prep Indicators and Internals: How to Read Them Multiple Trade Setups for the Stock Indexes:
Gap Plays, Bunny Trail EMA Plays, Pivot Plays, Scalper Buys and Scalper Sells, Tick Plays, Squeeze Plays Plus Doldrums Bond Trade and Euro Currency Box Trade Plus Reversal Breaks for swing trades on SSFs and indexes
Trader’s Business Plan Live Trading: Bringing it all together 4
Getting the Most From This Seminar
Stay focused and pay attention. There is going to be a lot of material. Each section builds on the other and they all “tie in” together at the end. Don’t feel overwhelmed. Just listen and let it sink in. Once this is over you will be able to contact me with questions. It’s more important to understand the big picture than every little detail, so don’t get bogged down. Take lots of notes on your manual: You can refer to these later after your brain forgets. It’s okay to ask questions, but it’s usually better to wait until the end of a section. Most likely your question will be answered at some point during the section, especially if it is about trade parameters. There is a method to the madness! 5
My Background
I have traded actively for 17 years, starting as a sophomore in high school when my father, a broker for Morgan Stanley, showed me how to trade options Full Time Trader Since 1996 A large part of my trading is my nightly preparation. Started posting nightly research in 1999 as it helped bring discipline to my own trading CTA and Principal in Razor Trading, a private money management firm Started working with www.tradingmarkets.com 11/03 Started off as stocks and options trader, now trade mostly futures 6
First 5 years were tough; no consistency Big wins and big losses: I wanted more consistency This caused me to go on “the trader’s quest.” I threw out all of my indicators and started fresh with a clean chart. I visited with other traders, many of whom were profiled in Market Wizards. The thing that struck me when visiting their offices is that they all had very simple systems, but where they excelled was in their trading methodology. During these visits, there were two things that were pounded into me: You can know what you are doing, but if you apply the wrong methodology, you will lose. You can know what you are doing, but if you are trading the wrong market for your personality, you will lose. 7
This was a real eye-opener on both counts, and I will talk more about this later. Took what I learned from them and developed a style that suited me. Today my trading is more calm and consistent, as opposed to having chaotic ups and downs. In addition to pure trade setups, I will discuss the habits that most consistently cause traders to lose money. Quick Review: Seminar Participant Trading Histories 8
How I Trade for a Living
Part
II: Trader Psychology
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Psychology: Rewire Your Brain
Emotion is the enemy of successful trading. The markets are set up to naturally take advantage of and prey on human nature. The tactics you use to achieve your goals in everyday life do not work in trading, and in fact are one of the main reasons for failure. Traders who “play the markets” with a mental framework oriented towards how external society rewards and punishes “good” and “bad” behavior are set up to lose. “Making money good, losing money bad.” 10
This “society focus” on money instills the very habits that cause traders to lose money. For example, “Cutting losses short” is difficult when there is the possibility of the market coming back to the breakeven point. At breakeven, you are not a “loser.” HOWEVER, removing a stop in the hopes of getting out at breakeven is a LOSING HABIT in trading. The rest of the world views losing as a bad thing. This is true in many parts of your life. If you bring this same mindset to trading, you will never win. In trading, small losses are awesome! 11
After losing consistently in the beginning, traders start making trades based on a fear of losing money, fear of being wrong, or fear of missing an opportunity. This “start of phase II” also does not work. By focusing on not losing, you will naturally take small profits, and let losers run in the hopes that they come back to breakeven. At this point traders realize trading isn’t easy. They then go on the search for “The Holy Grail.” That is the “fail safe indicator” that never generates a losing trade. 12
Presenting . . . The Holy Grail
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Financial Networks Are Entertainment Only!
If You Heard It First on CNBC, Then You Are The Last to Know
This is usually a big problem for newer traders. If anything, look to “fade” news coming off the financial networks as it is already old news. 14
After “Fear of Losing” both Greed and Euphoria are a trader’s worst enemies. Fear of missing a move also causes lots of mistakes. (Jumping in too late.) $500 a day is very reasonable. But, when you then go for $750 or $1000, greed takes over and mistakes kick in: overtrading, not sticking to parameters, rampant emotions, yelling at screen. “Home Run” mentality is the downfall of all losing traders. This is where you refuse to take a $500 profit because you “want a bigger trade.” This is how winning trades turn into losing trades. Market is an all-you-can-eat buffet: no reason to overload your plate on 1 trip; you can keep going back 15
Euphoria is worse than Greed You had a great day yesterday, so today you are over confident and you throw out your trading rules. Things are going great – so double up! Triple up! Keep adding to your position! This is like being in a fantastic relationship with a significant other. It’s going really great. So, to make your life even better . . . You start to date someone else as well. This will only end in one way: Badly Develop a business plan and stick to it! 16
Set up your parameters before placing the trade Before the trade you are at your most objective After the trade is in place, you can talk yourself into anything: like the alcoholic rationalizing one more drink . . . the one that leads to the ditch Successful traders have a habit of ringing the register. Get in and start scaling out. Overly bullish or bearish a bad idea: Do not try to impose your will on the market. Discipline before Vision: know your exits 17
Professional traders focus on limiting risk and protecting capital. Amateur traders focus on how much money they can make on each trade. Professionals always take money away from amateurs. Amateur traders turn into professional traders once they stop looking for the “next great technical indicator” and start controlling their risk on each trade.
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Embracing your opinion leads to losses. When a traders rationalizes a decline by saying things like, “They are just shaking out weak hands here,” or “I’m staying in because it’s just the market makers fishing for stops,” then trader is embracing his own opinion instead of listening to the market. This is also called “being an amateur” and leads to a one-way revolving door called financial ruin.
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Professional traders actively take small losses, and they do so because they know their most important job is protecting their capital. After all, reentry is only a commission away. Amateurs resort to hope to save their trades. In life, hope is a powerful and positive thing. In trading, hanging onto a trade based on hope is very similar to staying inside a burning car in the “hope” that the fire will go out. The end result won’t be pretty. 20
In reality, traders are not trading stocks, futures or options. They are trading other traders. Be aware of the psychology and emotions behind the person who is taking the opposite side of your trade.
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The most important lesson of becoming a successful trader is learning how to accept a loss without any frustration, anger or shame. The key is to have two specific sets of rules: Trading Methodology Rules and Money Management Rules. By following the rules, you learn to trust yourself. Once you trust yourself, you can then focus on the market’s opportunities (instead of focusing on trying to not lose money). 22
Focus on developing your skills instead of focusing on the money. The markets move endlessly, with zero regard to you. They are not “after you.” Traders become consistently profitable once they learn self-discipline, emotional control, and the ability to submit their will to that of the market. The less you care about being right or wrong, the easier it will be to enter and exit positions, to take losses, and be ready for the next opportunity. 23
How I Trade for a Living
Part III: Hardware and Software –
Tools for Traders
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The amount of trading equipment you have, and the type, will largely depend on your financial resources and the amount of money you are trading. Too much information is usually a bad idea. Many traders I know have been doing this for over 20 years and they have 1 computer monitor, and call in their orders. They are watching 1 market and are looking for 1 to 3 setups. I trade a variety of markets and time frames, so I need more tools. 25
For software, I use Trade Station and eSignal. You can do more with Trade Station, but eSignal is a little easier to use. Both are very powerful. Others vendors are fine too. I have Trade Station setup on a stacked quad monitor with 4 19-inch flat screens. (Two on top, two on bottom). I watch 233 Tick Charts on 3 of the screens, then my internal indicators on the 4th screen. I run eSignal on a Tri-Monitor setup. I watch bonds, euro, daily and 60 minute charts of the indexes. Also quotes on options and stocks. 26
I have a 3rd computer that I use only for Trade Execution. For execution I use a platform separate from my quotes vendors. I like to have that separation in case one goes down. I use a platform called Strategy Runner which runs on top of J-Trader. I like it because you can put in your parameters before you trade. This way I can hit “buy YM at the market” and it will automatically place an order for a 20 point stop and a 40 point target, or whatever you want. 27
This is an “Order Cancels Order” placement so when one is hit, the other is canceled. I can adjust the stop and target, and, if I want, set up an auto trailing stop. This way it saves me a ton of time in entering a lot of different orders for stops and targets. It also addresses one of my trading weaknesses: Looking for more than a move can give. I can’t second guess it because the orders are already placed. I’m also covered if the market moves against me rapidly. Any order I place automatically has a stop so there won’t be any markets getting away from me due to a sudden news event. 28
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4th computer is for email, Internet, and Instant Messaging. Have a 5th computer as a backup: It’s a laptop attached to a phone line in the event broadband goes down. Have land lines and cell phone. For land lines, be sure to have an old-fashioned “corded” backup. In the event of a black or brownout, a cordless phone won’t work. Battery backup on the computers. 31
EMAIL
233 Tick Charts of ES, YM and NQ and Intraday Indicators
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Hourly & Daily Charts of the Stock Indexes
Bonds & Euro Charts
Stock & Option Quotes, Portfolio Manager
Single Monitor PC for execution
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Tradestation Email
eSignal
Execution
Backup Laptop with fully charged battery and regular phone line (also used to work on this PowerPoint during the doldrums) 34
Trading is the first priority. I don’t answer the phone or generally talk to people between 9:00 AM and 11:00 AM Eastern. I tell friends and family I am not available during these hours. They know to email me. In the Trading Room, I will talk about what I’m doing in the markets, but that’s it. For my brokers, I expect them to answer the phone and/or be available by Instant Message. Have a TV but I turn off CNBC after 10:00 AM Eastern. 35
How I Trade for a Living
Part IV: Basic Mechanics of the Markets I Trade
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In my experience, once you understand and then trade futures, you never go back to day trading stocks. However, if you have traded only stocks, the futures markets are probably a mystery and a little scary. Yet if you have already learned the importance of strict money management, you will really appreciate what futures trading has to offer. Typically, once people try trading futures, they simply stop trading stocks. The ease of entry, ability to focus on 1 market instead of 2,000 stocks, and the lack of market maker games makes them a refreshing change to the world of stocks. Here is how they work: 37
First off, there are many types of futures contracts: Stock indexes, metals, grains, meats, bonds, currencies, etc. Don't worry about most of these for now. During this seminar we are going to focus on four stock index futures, bond futures (30 year), Euro Currency, and Single Stock Futures (used for swing plays). Each contract has different parameters, which you will want to become familiar with. They are as follows: 38
Emini S&P 500 (ES) $50 per point Emini Nasdaq (NQ) $20 per point Emini Russell 2000 (ER) $100 per point Mini-Sized Dow (YM) $5 per point Bonds (US) $31.25 per tick (Regular, not mini) Euro Currency (EC) $12.50 per tick Single Stock Futures (QCOM1C) $100 per point To access these quotes, you will need data feeds for the CBOT, CME, and One Chicago. You have to be aware of the P&L implications of price movement for correct position sizing 39
Emini S&P 500 Futures (ES)
Daily Range is typically between 8 to 15 points 40
Mini-Sized Dow Futures (YM)
Daily Range is typically between 80 to 150 points 41
Emini Nasdaq Futures (NQ)
Daily Range is typically between 20 to 35 points 42
Emini Russell 2000 Futures
Daily Range is typically between 5 to 9 points 43
30 Year Bond Futures (US)
Daily Range is typically between 25 to 50 ticks 32 ticks = 1 point
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Euro Currency Futures on CME (EC)
Daily Range is typically between 80 to 150 ticks or “pips” 100 ticks = 1 full cent 45
In general, if the S&P moves 1 point, the Dow will move 10 points, the NQ will move 2 points, and the Russell will move ½ a point. Pay attention to which index is strongest or weakest on the day. To buy 1 futures contract, you need $2,000 to $4,000 in your account, depending on the contract. This is called “margin” and it is very similar to putting down 5% to buy a house. With a down payment of $4,000, you can control an asset worth $50,000 to $100,000. 46
When you buy a futures contract, you are not physically buying anything. This is simply a way to participate in the price movement of the market of your choice. If you think a market is going to move 10 points, you can buy a futures contract, long or short, and make money on the move if it goes in your direction. Also, if you own a contract that expires, you are not going to get a bunch of stock certificates dumped on your doorstep. The expired contract will be converted to cash, and you will see the cash in your account. (This is true except for Single Stock Futures, as they are a deliverable.) 47
You can short on a downtick--this makes a huge difference in trying to get filled during a breakdown. If you short KLAC "at the market" on a breakdown, you may not get filled for 50 cents until it has an uptick. If you short the futures "at the market" on a breakdown, you get a quick fill at the current market price. With stocks, you had “bullets” for a while where you could set these up with your broker and short a stock on a downtick. These were recently removed. I used to be a big trader of OEX options. After trading futures, I stopped trading OEX options. The spreads and premium of options now looks ridiculous. You can do most of your trades "at the market" and get good fills, unlike stocks and especially unlike options. 48
There are now futures on stocks. Using Single Stock Futures as swing trades in combination with index futures is a great way to trade and hedge your bets. Although some of the symbols have low actual volume, the “real volume” is based on that of the underlying stock. If you want to buy 100 contracts (1 contract = 100 shares of stock) and you put in a limit order in between the bid and the offer you will get a nearly instantaneous fill. The margin is 20% of the value of the stock. With futures, at the end of the year you don't have to list each individual futures trade like you do stocks for your tax return. You get a 1099 from your broker with your total profit or loss for the year. All you put on your tax return is that number on the 1099. On this, 60% of the money is treated as long term gains (lower tax rate) and 40% at the short term rate. This is the “60/40” rule. This is even if you go flat at the end of every trading day. 49
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You can trade futures in your IRA. This means you can short stocks (Single Stock Futures) in your IRA or the Indexes, which you are not allowed to do in a regular IRA. To set up your IRA for trading futures, you need to first go through a Trust Company set up specifically to do this. What you then do is open an account with the Trust Company, and then they will wire the funds to your futures broker. This way it stays classified as an IRA and you don’t have to pay taxes on any gains. Not every futures broker is experienced with this. If you are interested in doing this, be sure to work with a broker that has done this before. It is one way to bring diversification to a portion of your retirement funds. 50
Each futures contract that we are discussing has 4 contracts that are traded each year: March (H), June (M), September (U) and December (Z). You will want to trade the closest month, as that is where the volume is concentrated. For example, if today is October 15, 2003, then the closest month is the December, 2003 contract. If it is January 14, 2004, then the closest month is March 2004 contract. SSFs trade each month just like options.
To get a quote for the March 2004 contract on the mini-sized Dow, you would enter in the symbol, month and year. In this case, that would be YM (symbol), H (Month = March), 04 (Year = 2004).
TIP: The emini futures expire the same day as options expiration, on the 3rd Friday of the month they are being traded in. However, you will want to start trading the next month out about a week before expiration, as all of the volume will switch to the next month a little early. Also, because these are futures contracts, there is always a price difference between 2 contracts. While the March contract will say 1032.50 for the Emini S&Ps, the June contract will say something like 1031.25. Keep this in mind as you are switching contracts and calculating pivots. This only comes into play as you near options expiration and start to trade the next contract before the current one expires 51
How I Trade for a Living
Part V: Determining Short Term
Market Direction and Creating a Game Plan for Trading It
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Each day I go through an “MPS” (Market Prep Session) to determine short term market direction. This is a big part of my daily plan. This is where you develop a plan so the market cannot beat you. Without a plan, you will be heading into the markets like a cowboy. Without a plan, you don’t know what is going to happen when you jump into the water, and you will not be prepared for the unexpected. The market is a swamp and there are alligators waiting to make a meal of you. The prepared trader doesn’t get eaten by the alligators. 53
Daily market prep should be treated as if it were part of your job, and it is a report that is expected by your boss each and every trading day. It is easy to get lazy and go back into “gun slinger” mode. Gun slingers do not survive in this business. This is a good way to know whether or not you are staying disciplined. Part of your daily plan is knowing what to do if you start questioning a trade. The best thing to do here is reduce your position size. This keeps you objective and keeps the “alligators” at bay. 54
For me Market Prep starts on the weekend, where I can take a few hours and look over the markets in a very detached state of mind. I start off with a “top down” approach and view the key markets starting with the largest time frames and drilling down to the smallest time frames. For me this means starting off with the monthly charts, then working my way down through the weekly, daily, and 60 minute charts. 55
S&P 500 Cash Index Monthly Chart
Moving Averages & Oscillators 56
S&P 500 Cash Index Monthly Chart
Fibonacci Levels 57
S&P 500 Cash Index Monthly Chart
Support & Resistance + Trendlines 58
Monthly Chart Analysis: S&P has rallied into the 50 EMA, which is decent resistance. The 13 is below at 1050 and the 20 is at 971. Stochastic went into a buy in March 2003 and the MACD went into a buy in April 2003. The last signals on these were sells in April/May 2000, so this was significant. Stochastic appears to be rolling over. Key Fibonacci Level is 50% at 1163.80 and this has been tested. 59
Key structural resistance at 1175 Current high used to construct a new downward channel. This is now “active” until and unless we get new closing highs. Any rallies to this level are shortable. Current upward channel is very steep and narrow and easy to break on the downside. Want to focus on setting up swing shorts into rallies into key resistance levels. Note on Oscillators: Overbought and Oversold not important. Looking at where they are pointing. Rolling up or rolling down. 60
S&P 500 Cash Index Weekly Chart
Moving Averages & Oscillators 61
S&P 500 Cash Index Weekly Chart
Fibonacci Levels 62
S&P 500 Cash Index Weekly Chart
Support & Resistance + Trendlines 63
Weekly Chart Analysis: Cash index has fallen through the 13 and is trading near the 20 EMA. If we get a close below the 20, look for a move to the 50 EMA at 1032.51. The Stochastic and MACD have both recently crossed over into sells. The first key Fibonacci Level is the 25% retracement at 1070.63. If this falls the key 38.2% level is at 1021.24. 64
For support and resistance, there is key support near 1060, which is a good downside target. The current upward trendline is being violated. The Monthly downward channel is also drawn on the weekly chart to show a close up of significant upside resistance.
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S&P 500 Cash Index Daily Chart
Moving Averages & Oscillators 66
S&P 500 Cash Index Daily Chart
Fibonacci Levels 67
S&P 500 Cash Index Daily Chart
Support & Resistance + Trendlines 68
Daily Chart Analysis: On the daily charts we are through the key 13, 20 and 50 EMAs. In addition, the 13 has crossed below the 20 and the 50, and the 20 is in the process of pushing below the 50. Any rallies to these MAs can be shorted until we get a close above them. 200 EMA is looming below at 1060.78. Stochastics and MACD are oversold. Sets up perfect “short the rally” play into the 1128 to 1138 level. 69
On the Fibonacci Levels we have moved through the 25% level off the September lows. Key 38.2% level is coming up at 1097.76. If this fails look for a quick move to the 50% level at 1077.34. For key support and resistance, there is a key support level at 1075 coming up. The market is currently trading below its upward trendline off the September lows
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S&P 500 Cash Index 60 Minute Chart
Moving Averages & Oscillators 71
S&P 500 Cash Index 60 Minute Chart
Fibonacci Levels 72
S&P 500 Cash Index 60 Minute Chart
Support & Resistance + Trendlines 73
60 Minute Chart Analysis: All of the key moving averages trading below each other, with the 13 leading the way. Stochastics and MACD have slight bullish divergences. 200 MA will act as significant resistance on any rallies. Key 50% retracement is 1133.46. Key resistance is 1134.43.
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Themes across the 4 times frames? Key numbers that stand out on multiple time frames? 1060 to 1075 level offers a lot of different support zones. There is a weekly support level at 1060, the 25% retracement off the March 2003 lows is 1070.63, 1075 is a daily support level, 1071.96 is the monthly 38.2% level 1130 to 1140 offers a lot of resistance. The daily 50 EMA is 1138, the 200 EMA on the 60 minute chart is 1137. 1133.46 is the 50% retracement level on the 60. 1134.43 is a key level on the daily chart. 75
When doing the “top down” drill down, I am looking for two main things: What are the “pressures” on each time frame? To determine “pressure” I look at the relationship of the key moving averages as well as what the stochastics and MACD are doing. The first thing I look at is the relationship between the 13 and 20 EMAs. Are they in an upward cross or downward cross on these time frames? I will then put them in a box like this: 76
13/20 EMA Pressures Time Frame
Pressure
Comments
Monthly
Higher
Weekly
Higher
Daily
Lower
60 Minute
Lower
13/20 higher but below 50 EMA Prices have fallen to 20 EMA 13/20 lower and through 50 EMA 13/20 lower and through 50 EMA 77
Oscillator Pressures Time Frame
Pressure (Stoch/MACD)
Comments
Monthly
Higher/Higher
Weekly
Lower/Lower
Daily
Lower/Lower
60 Minute
Lower/Lower
Stochastic trying to roll over Fresh sell signals on the weekly Getting stretched on the downside Slight bullish divergence 78
Key Support & Resistance Levels Time Frame
Support/Res
Monthly
1072/1164
Weekly
1060/1164
Daily
1075/1135
60 Minute
1097/1135
Comments Hit 50% of 2000 highs: top? Support is 25% Fib Would like to short a rally Play long side up to 1135 79
Key Moving Average Levels Time Frame
EMA Levels
Comments
Monthly
13: 1050, 20: 972, 50: 1135 13:1121, 20: 1109, 50: 1058 13: 1129, 20: 1139, 50: 1138 13: 1109, 20: 1112, 50: 1125, 200: 1137
1135 coming up a lot as resistance Testing support at 20 EMA Extended below these MAs 200 MA lining up with 50 on daily and monthly 80
Weekly Daily 60 Minute
Once you have this information, the next step is to formulate a trading plan for the next day. Based on this setup, the weekly charts are rolling over, while the daily and 60 minute charts are oversold and ready to bounce. Intraday I would be looking to focus on the long side, i.e., looking at buying breakouts through pivot levels. On a swing basis I would want to add shorts on any rally to the 1135 level for a potential move to 1070. 81
It is nice when a plan works out perfectly, but it doesn’t happen all of the time. But by having a plan, you will be able to react better when the plan “goes awry.” Once you have your plan, you then want to review your pre-market checklist:
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How I Trade for a Living
Part VI: Daily Pre-Market Checklist
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Once I have my game plan based on my “top down” approach, I have a checklist that I review. The first thing I do is take my “top down approach” analysis and put it into a one page format that I can glance at:
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Monthly, Weekly, Daily, Sixty Minute Time Frames
Key Support & Resistance Zones: (Write them in here)
Key Support & Resistance Zones: (Write them in here) 85
Once this “top down” analysis is summarized, I then look at the following to help set me up for the next trading day: 1. Volume: I like to view and compare the NYSE and Nasdaq volume day over day, plus compare it to their average volume levels over the past 50 days. Volume is the “gas” of the market. A move without volume is like a car on an empty tank.
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2. Key Levels: 3-Day Highs & Lows, Key Weekly and Monthly levels, and Open Gaps:
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3. Key Levels: Daily Pivots and Midpoints on the S&P 500, Dow, and Nasdaq Futures:
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4. Key Levels: Weekly and Monthly Pivots on the S&P 500, Dow, and Nasdaq Futures:
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5. Key Sentiment Readings:
• CBOE Put/Call Ratio (10 day MA): Over 1.00 is bullish, under 0.70 is bearish • Sentiment Readings: Contrary Indicators – Do the opposite of the crowd • Daily Arms Index:: Over 2.0 is bullish, Under 0.50 is bearish for the next day
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5. Key Sentiment Readings (cont): • 10 Day Moving Average of combined equity/index put/call ratio: • Extreme put/call readings precipitate tops and bottoms in markets • Why? At 1.00 there are too many bears and no one is left to sell, so markets reverse • At 0.70 or below there are too many bulls and there is no one left to buy, so we rollover
Chart provided courtesy of www.decisionpoint.com 91
5. Key Sentiment Readings (cont): • Investor Sentiment: • Extreme Bullish or Bearish readings typically precipitate a larger picture market turn.
Chart provided courtesy of www.decisionpoint.com
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6. NYSE Member Net Buy/Sell: • When NYSE members are acquiring spikes in inventory, the market is going higher. • When NYSE members are dumping inventory, the market is going lower.
Chart provided courtesy of www.decisionpoint.com
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7. Pre-Market Volume: Generally over or under 30,000 shares for each of the key stocks? This shows the “gas” behind the move and let’s you know if its real buying or a stop fishing expedition. We’ll cover this more when we look at gap plays.
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8. Miscellaneous Key Points:
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Other things I’m looking for: Key Sectors: Banks (BKX), Brokers (XBD), Semiconductors (SOX), Retail (RLX), Transportation (TRAN) Markets cannot have a sustained move without the Banks, Brokers, and Semiconductors. Look here for early warning signs or divergences. Monthly, Weekly and Daily Pivot Levels: Do any of these correspond with any of the key levels from the “top down” approach process? 96
How is the market reacting to news? It doesn’t matter if the economic or earnings news is good or bad. What matters is how the market reacts to the news. If a market rallies on bad news, it is telling you that it is really strong. If a market sells off on good news, it is telling you that the good news is already priced in, so you should be selling the news. Words away from Wall Street: Are non traders happy or scared when it comes to the market? You are now prepared for the day, and the market is about to open. Now what do you look at? 97
How I Trade for a Living
Part VII: Intraday Indicators
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A large part of what dictates my intraday trades is determined by the action of the key intraday indicators that I watch. They are as follows: TICK (measures net buying/net selling NYSE) TIKI (measures net buying/net selling DOW) Put/Call (measures the ratio of calls vs. puts) TRIN (measures up/down volume on NYSE) TRINQ (measure up/down volume on Nasdaq) Sector Sorter List (measures sector performance) 99
TICK 5 Minute Chart
Audio Alerts at +/- 600, 800, 1000 and 1200 Ticks 100
TICK TIPS
+ or – 400 is noise and can be ignored Pay attention over +600 or -600. If you are on the opposite side of this close your position If you are long and you get a +1000 tick reading, close out your trade and take your profits If you are short and you get a -1000 tick reading, close out your trade and take your profits Use +1000 or -1000 readings to open new trades in the opposite direction of the tick Look for higher highs/lower lows to confirm trend 101
TIKI 5 Minute Chart
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TIKI TIPS
+ or – 20 is noise and can be ignored Pay attention over +26 or -26. This is indication of a buy or sell program. Highest are + or – 30. If you are long and you get a +28 or high reading, close out your trade and take profits If you are short and you get a -28 or lower reading, close out your trade and take profits Use +28 or -28 readings to open new trades in the opposite direction of the tick TIKI is faster than the TICK. Early indicator. 103
Put/Call Intraday Chart (over 5 days)
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Put/Call TIPS
Look for extreme readings: Over 1.0 will put a “floor” in the market – look to cover shorts and go long. (Extreme put buying: Too many bears) Under .50 will put a “ceiling” on the market. Look to close longs and go short. (Extreme call buying: Too many bulls) Trend is important: You want the Put Call to move in the direction of the market in order to confirm it. Rising put/call in a rising market confirms the trend (traders buying puts into a rally, gives fuel for short covering), while falling put/call in a rising market sets up a reversal (Vice Versa). TS symbol is $WPCVA Wait until 10:00 a.m. to get an accurate reading as the listed stocks need to all open for trade. 105
TRIN 15 Minute Chart (4 days)
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TRINQ 15 Minute Chart (4 days)
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TRIN & TRINQ TIPS
$TRIN measures up/down volume (buying/selling pressure) of NYSE, $TRINQ measures Nasdaq General: Over 1.0 is bearish, under 1.0 is bullish Not Important! What is important is the trend. Is it moving higher (increase in selling pressure) or moving lower (increase in buying pressure) from where it started the day? The “trend of the trins” is critical. $TRIN close over 2.0 results in bounce next day 9 times out of 10. No bounce? Market is in trouble. Close under 0.50 results in selling the next day. No selling? Bears are in trouble. 108
SECTOR SORTER LIST
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SECTOR SORTER LIST TIPS
Watch number of sectors that are green vs. red (up vs. down) at any given time. Often times while indexes consolidate, the number of sectors up or down on the day will change. This is a heads up as to the direction of the next move. Any move without the Banks (BKX), Brokers (XBD) and Semiconductors (SOX) most likely will not last. Sort on a Net % change basis Very useful when playing gaps (see gap plays) 110
Intraday Indicator Screen Setup
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How I Trade for a Living
Part VII: Intraday Trading Setups
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How I Trade for a Living
VII-1: Gap Plays
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Gap Plays: The Right Way
“Gap” in prices from 4:15 p.m. to 9:30 a.m. Gaps are like open windows: At some point they will be closed Best gaps are in indexes and in opposite direction of previous day’s move Best gaps are over 20 and under 80 points 114
Why Indexes and Not Stocks?
Stocks that gap “with the index” and don’t have any stock-specific news are good gap candidates. However, stock specific news gaps should be avoided. Enron won’t be filling its overhead gaps anytime soon. Gaps in stocks that are not part of a major index should be avoided. Playing gaps on specific stocks that receive upgrades and downgrades is not consistent. 115
Why Index Gaps Get Filled
When an index gaps higher, there will be many sectors and stocks that move higher with the gap, but there will also be sectors and stocks that are down on the day (vice versa for gaps lower). The initial pullback, combined with the already negative pressure on some sectors, causes the index to fill its gap (vice versa for gaps lower). Many larger funds won’t commit until a gap is filled. This lack of commitment often causes the markets to drift to their gaps at some point during the day. They like to “get the charts cleaned up” before committing more money to the current market. 116
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Live Gap Example
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When Gaps Don’t Fill
There will be times when the gap doesn’t fill. This is called a “pro gap” and is designed to keep ordinary investors out of the move, as it happens overnight when they are sleeping. When it doesn’t fill, write down the open gap price. The markets will usually take out that gap within the next 5 to 10 trading days. Think of it as a “black hole” that will attract prices until that gap is filled. Useful for setting up swing and intraday targets. 122
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Gap Play Methodology
Watch pre-market volume in key stocks to get an idea of the “power behind the move.” KLAC, MXIM, NVLS, AMAT, and other active stocks. (I watch all the SSFs.) Less than 30,000 shares each, gap has a 90% chance of filling If these stocks are trading over 80,000 shares pre-market, the chances of the gap filling that day fall to 30% (Use as a breakaway gap signal.) PASS: When 95% of sectors moving with gap! 125
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Gap Play Methodology
Watch sector list at the open. On a gap down, if every sector is red, you want to wait until at least 5 are green to show that there is some buying interest before adding a full position. On a gap up, if everything is green, wait until at least 5 sectors are red before adding a full position. Gap down and more than 5 sectors green, and the volume pre market is light, take full position right away. Gap up and more than 5 sectors are red, and the volume pre market is light, take full position right away. 127
Gap Play Methodology
Trading methodology is critical: Ten traders will play the gap, and 7 will lose money. Risk Reward Ratio: 1 ½ to 1. Gap up 30 YM points, then stop is 45 points from entry (not from previous close). Don’t trail stops. Not all gaps fill on the same day, but 85% do. Treat this position like a kid you are sending off to college: Set the parameters and leave it alone. 128
How I Trade for a Living
VII-2:
Bunny Trail Plays (Or “How to Use Exponential Moving Averages to Stay on the Path of Least Resistance”)
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The finely tuned art of technical analysis involves a process similar to a jury weighing the presented evidence during a trial and then deciding upon an outcome. By the same token, my final trading decisions must be backed by evidence, not by emotion. The stronger the evidence, the greater the likelihood that a specific price action may occur. By contrast, the stronger the emotion, the stronger the likelihood that a trader is about to imprint the dead high or the dead low of the day. Based on this, I use a series of moving averages to make sure I’m on the right side of the trend. I always start my day looking at the “bigger picture” and then drilling down to the 5 minute charts. 130
8 Period Exponential Moving Average (EMA) and 21 EMA on Daily Chart
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8 Period Exponential Moving Average (EMA) and 21 EMA on 60 Minute Chart
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8 Period Exponential Moving Average (EMA) and 21 EMA on 15 Minute Chart
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8 Period Exponential Moving Average (EMA) and 21 EMA on 5 Minute Chart
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8 Period Exponential Moving Average (EMA) and 21 EMA on 1 Minute Chart
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Before the trading day starts, I always like to glance at the larger time frames first. The key to consistent profits is to trade on the path of least resistance. The path of least resistance starts from the larger time frames and moves down through the ranks to the smallest time frames. Think of the weekly chart as a thousand pound weight on your chest. Then think of the 5-minute chart as a 2-pound weight on your chest. Which is going to create more pressure on your body? It is ridiculous to try to move the two-pound dumbbell without taking into account the larger 1,000- pound weight bearing down on top of it. Moving averages measure simple supply and demand 136
But how can this information be used, heading into the trading day? If we had demand (upward crossovers) across the board, I would focus more on long setups off the 5-minute chart, passing on most of the short setups. However, when the daily is pointing one way, and the 60 is pointing in the opposite direction, I will focus on both the long and short setups. With the daily charts down in our examples, and the 60 minute charts turning higher, I know to play both sides of the market. I also have a heads up that the shorter term pressure has turned higher and I will be looking for potential moves through resistance. On a day like this, I would take both long and short setups off the 5-minute chart. 137
While moving averages keep a person on the right side of the trend, they are lagging indicators. This means that if you only follow moving averages, you will be getting in late and exiting late. On days where the markets are moving in a wide range, you can follow just the moving average crossovers and make great trades. On an upward cross, I will go long on the YM, and use a 50 point stop. I stay in the trade until the MA’s cross back down again. I’ve actually never been stopped out. The MAs will cross back down well above the 50 point stop is hit on a 5 minute chart. Once my exit signal is hit, I get out of my position then reverse. By cutting out the noise, turning off the TV and focusing on the current supply and demand situation, the trader will be on the path of least resistance for the great majority of the time.
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Wednesday, March 10: On strongly trending days, the EMAs will keep you in the market for the entire move (8, 21 & 50):
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The Key to Moving Averages is to use them in conjunction with other tools. By understanding the nature of moving averages, that they keep you on the right side of the trend, you can use other indicators to help you anticipate market reversals before they occur. This way the moving averages become “confirmations” after you are already in the trade. Moving averages will play a role in most of the remaining setups we will study. 140
Using EMAs with Fibonacci Levels
8 Period EMA 21 Period EMA
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Using EMAs with Pivots Pivot & Bunny Trail Friday, 2/13/2004
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Using EMAs to gauge the strength of the trend in the current market MAs Trending Market
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Using EMAs with Trendlines
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EMAs with Fibonacci and 7 period RSI 145
To catch bigger moves in the market, I like to use a combination of the following:
Daily & 60 Minute Chart 8 and 21 Period Exponential Moving Averages Fibonacci Levels measuring swings highs/lows 7 Period RSI (Relative Strength Index)
What I’m looking for are major turning points in the markets. These usually take weeks or even months to unfold, but once they do, they result in very powerful moves. 146
The first thing I noticed is that by the end of February prices had advanced on to higher highs, but the 7 period RSI was making lower lows. This sets up a bearish divergence. This by itself is not an entry signal, but it is a heads up. The next thing I’m looking for is the 8 and 21 period moving average to cross and confirm a rollover. They do this nearly 5 weeks later on March 8. I go short the next day at 10525. For a stop I use the highest prices of the past 3 days, which is near 10640. 147
For targets, I will be watching how the markets act at the key 38.2% and 50.0% retracement levels on the daily chart. Then I will “drill down” to the 60 minute chart to look for bullish RSI divergences as a sign that it is time to exit the play.
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On the 60 Minute chart, the move to the 38.2% level doesn’t generate any bullish RSI Divergences. At the 50.0% level, the chart is showing very clear bullish divergences. This tells me that the 50.0% level is going to hold and I exit my position near 10155, for a total of 370 points on the trade, or $1850 per contract. The key with Moving Averages is to use them in conjunction with other tools. 150
Bunny Trail Trade Recap
Visual reminder to go with the flow Snapshot of current supply and demand Keeps a trader from fighting the trend Keeps a trader on the path of least resistance Gets rid of emotions and bias Prevents a trader from catching a falling knife or holding back a freight train Use with other indicators for maximum impact 151
How I Trade for a Living
VII-3: Pivot Plays
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The good news about this strategy is that the trades are clearly setup before the day begins. The majority of the time is spent waiting for a particular price level to be reached in order to initiate a trade. It is very useful if your weakness as a trader is making “impulsive trades.” The key is to get all of the details right. Which formulas to use to calculate the pivots? Which time frames? How to enter and exit and trade? Where to place stops? What to do before an economic report? When to use the Daily Midpoints and when to avoid them? We will cover that here. 153
First off, let’s talk about the pivots: how they are created and how I use them. There is no big mystery or secret to the pivots. They are readily available and have been around for a long time. These are support and resistance levels calculated by floor traders using a simple mathematical formula. These levels became widely known and have moved off floor. Today many traders are aware of them and try to use them, but in my experience they are using them incorrectly. To add to the confusion, there are different formula versions and different time frames that are used when calculating pivots. So, to get started, let’s look at what I use: 154
Formula I Use to Calculate Pivots
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We’ll go through and make some calculations shortly so the formula makes sense. Once you have the formula, then the key data that you need is the high, low and close of the previous session. With this information you will generate 7 important levels for the next trading day: a central pivot, then 3 levels above (R1, R2, and R3) and 3 levels below (S1, S2 and S3). The central pivot has the most weight of the 7 levels. The process is repeated for weekly and monthly pivots. 156
Where many people get this wrong is they use the incorrect set of numbers for the high, low and close. There is the cash session from 9:30 a.m. to 4:00 p.m. ET that will create one set of numbers. Then there is the regular session on the mini-sized Dow from 8:20 a.m to 4:15 p.m ET that will create another set of numbers. And then of course there is the nearly 24 hour electronic session. I use a combination of the both the regular and electronic sessions to get my high, low, close numbers. Specifically, I look at the following time frames based on the exchange trading times for the electronic and regular sessions: 157
To calculate the daily pivot numbers for Friday, I will use the following data to generate my high, low and close numbers: YM: Start Wednesday at 8:15 p.m. ET, end 5:00 PM on Thursday ES: Start Wednesday at 4:30 p.m. ET, end 4:15 p.m on Thursday NQ: Start Wednesday at 4:30 p.m. ET, end 4:15 p.m on Thursday This gives me nearly 24 hours of price data, and allows for both pre and post market price action to be factored into the next trading day’s numbers. The times are slightly different on the above contracts due to the times they are traded on the exchange. 158
The easiest way to do this on Tradestation is to use the continuous symbol on a daily chart. For the Mini-Sized Dow, I have a daily chart with the @YM symbol. The daily bars are then created with the settings I described. Then, after 5:00 PM, I take the high/low/close of that day’s bar. Once I have the high/low/close, I apply the pivot formulas and I get my levels for the next trading day.
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High: 10578 Low: 10458 Close: 10552 R3: 10720.67 R2: 10649.33 R1: 10600.67 Pivot: 10529.33 S1: 10480.67 S2: 10409.33 S3: 10360.67
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Pivots play a role in a strongly trending market: they mark points of consolidation. The markets will rally or fall to a pivot level, consolidate, then continue moving in the direction of the trend. Pivots also play a BIG ROLE in sideways markets, as floor traders gun for these levels. On choppy days, you fade the pivots, and on trend days, the pivots act more as targets in which to scale out of a position. Also use pivots in conjunction with any gap plays that might be happening that day (i.e., did we gap down into a pivot level?) 161
It is rare when a market hits its daily R3 or S3 levels, as that is the extreme of the range. This is important to know because if you get a rally to R2 or a sell off to S2, that usually ends up being the dead high or the dead low of the day. This knowledge will help temper a trader’s emotions. When a market is going up, it is easy to think that it will go up forever. On this same note, when the market is heading down quickly, it is easy to assume it’s the end of the world. These emotions of greed are a disaster to your trading, causing you to pile up a bigger position and disregard stops all because of a surge of adrenaline running through your body. 162
The pivots help to keep a trader grounded. Instead of getting over-excited and hoping for a market crash, the pivot trader knows there is a 90% chance that the markets will not close above R2 or below S2 on any given day. A move to that level signals a time for the trader to take profits instead of pyramiding into a bigger position that will lead to disaster. Even on days of extreme volatility, the daily S3 and daily R3 levels will stop a move.
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The Central Daily Pivot is important for determining my bias on the day. If we open above this level, I will be looking for prices to head down and test the daily pivot. Thus if we open above this level, I’m generally looking for short setups back to this level. If we open below this level, I will be looking for prices to head higher and test the daily pivot. Thus is we open below this level, I’m generally looking for long setups back to this level. 165
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Weekly and Monthly Pivots are calculated in the exact same fashion as the daily pivots, but they only change every week (for the weekly pivots) or every month (for the monthly pivots). I take the previous week’s high, low and close, and use it for the current week. I also take the previous month’s high, low and close, and use those levels all through the next month. These levels do not come into play as often, as they are more widely spaced. However, they are just as important as the daily pivots. Many traders do not watch these levels. When they don’t they wonder why the market suddenly stops and reverses at some “invisible” support or resistance level in the markets. When that occurs, it is usually because the markets have reached one of their weekly or monthly pivot levels. 167
In addition, sometimes the weekly or monthly levels overlay some of the daily levels. When this occurs, these levels become that much stronger. Finally, for days on which the daily pivot levels are spaced widely apart (this happens when the markets traded the previous day in a wide range), I will also incorporate the “midpoints” between the daily pivot levels. The midpoints provide areas to enter trades and also scale out of positions. 168
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The important thing to know about midpoints is you don’t need to use them all of the time. I use them on days when the distance between two YM daily pivot levels is greater than 40 points (or ES greater than 4 points). This is a general rule, and it is ok to use them if it is only 30 points. If the pivots are closer together than 30 points, the midpoints don’t play as much of a role as the markets will move straight to the next pivot as they are so close together. When placing them on the chart, I use different colors and styles so I know at a glance what the lines represent. I use a thicker, solid line for the pivots, and then dashed lines for the R1-R3 and S1-S3 levels. I use a dotted line for the daily midpoints. I use different colors for each to distinguish them from each other. 171
To calculate the pivots, just plug the formulas into an Excel spreadsheet. (If you want to use mine, you can email me and I will send it to you). For an example of this, see slides 87 and 88 on this presentation. I have screen shot here of what my Excel spreadsheet looks like. All I do is enter in the high/low/close and everything else is calculated automatically.
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The next painful process is placing the pivots on your chart each day. It can take a while to do this on all of the different charts. There are auto-pivot programs, but I don’t trust the data as on some days it will take bad ticks into account. I recently had a programmer set up a pivot program for me that would do it automatically, but would also give me the option of changing the high/low/close manually. 173
This is the basic chart setup I use to trade pivots (more information on next slide) 174
I like to use a 233 Tick Chart for Pivots. Each bar represents 233 Trades. Not a particular reason except that I like how the charts setup and how the indicators I use on them work. On the YM, its similar to watching a 3 or 5 minute chart. On the ES, its similar to watching a 1 minute chart (more trades than on the YM). It is fine to use a 1, 3, or 5 minute chart instead. 175
I personally like to use a black background. My daily pivots are yellow, with the central pivot as a thicker, solid line. The S3 through R3 levels are a “dashed” line. The midpoints between the daily levels are a white “dotted” line. The weekly pivots are just like the daily pivots, except the color I use is light blue. The monthly pivots are just like the daily pivots, except the color I use is purple. This way I know what level is in play at a glance. 176
For indicators, I watch a 7 period RSI. I’m looking for bullish and bearish divergences. I will also watch an 8/21 EMA, usually on another chart, such as a 1 or 5 minute. You can also place it on this chart. There are a few other indicators I use in Tradestation that I will go over a little later. I’m also taking into account any open gaps that are on the chart from the morning’s open. Initially I want to play any pivots in accordance with the gap play we discussed earlier. 177
Why Do Pivots Work? The first reason, and most obvious, is that a lot of traders watch these daily levels, so there is a self-fulfilling prophecy involved. The same can be said for Fibonacci Levels, but they do not hold nearly as well as the pivots. Why? I elaborate on this in the next two points.
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On the floor, it is a trader’s goal to grab two points in the S&P 500 and get out, or 20 points in the Dow and get out. The floor traders all operate in a big circle, with the longer term players in the center of the circle, and the newer players on the outskirts. In its purest form, the traders in the center will get in on a trade, let’s say it’s a long, and then sell their position to the guys on the outside of the circle. What happens is that the traders on the outside, by the time they see the market moving, are the last ones in the pit to get in on the move. If they are lucky, they will then be able to turn around and sell it to the public, as the public is typically late in “jumping on a move.” As the guys on the outside are selling to the public and closing positions, the guys in the center are selling to the public and opening new short positions. And the cycle renews itself like this throughout the day. This causes a specific dynamic in the markets, generating specific cycles of speed and rest on an intraday basis. They focus on the pivot levels to base their entries and to also gauge market action. The pivots play on this in that they are spaced out to catch these “patches of momentum.” A Dow Pivot is usually 30-50 points apart, and this is the type of movement that perpetuates the cycle I just described. Like a hawk, the floor traders in the center of the circle are catching half this move, dumping it, and waiting for the next level to be hit.
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One of the main reasons these pivots work has to do with the vast majority of inexperienced traders out there. The floor traders start a trade, and the inexperience of most traders causes the momentum that finishes a trade. How? Because the average trader relies on a lot of different “indicators” they are getting in and out of their positions way too late, which causes losing trades and a specific cycle of market movement as their stop placement slowly and steadily increases the velocity of market movement in the direction of their stops. Indicators are just that, an “indication.” This is like your girlfriend slapping you across the face, and you taking it as an “indication” that she might be angry with you! If it takes a slap across the face to realize this, then you are following the wrong indicators. By the way, all market indicators are the wrong indicators, as they are all lagging. Price action is pure. This over reliance on indicators by the majority of traders is what helps this system to work. By the time the average trader gets a buy signal, the pivot play is almost over and users of this system will be selling their position to the indicator-based trader. Then the subsequent reversal that takes place is because of all the stop losses sitting out there, like trout sunning themselves on top of a lake . . . easy targets for the hawks who come swooping down from overhead. The market pauses, drifts down, and picks up steam and rips through all of the stop losses, pausing when the run is over. This “pause” generally happens at a pivot level. It’s where the floor traders are beginning to accumulate their next position for the next cycle of play. 4 points on the S&Ps and 40 points on the Dow is usually the “maximum pain threshold” for day traders. When they can’t take the pain of losing any longer, only then do they close their position. This also falls in line with the average distance between the pivots. 180
To sum it up, the pivot levels work mainly because of the psychology pain/pleasure cycle that perpetuates the markets each day. Traders who follow indicators will buy a position when it is halfway to three-quarters the way off its pivot, and it is these traders who provide the stop losses to perpetuate the next cycle of market movement. If you rely on indicators for your entries, instead of using the price action of the pivots, you will get in and out of these cycles too late, and you won’t make any money trading. That said, let’s take a look at my rules for trading the pivots. In general, I am looking to fade moves against these levels, BUT NOT ALWAYS! This is where watching the intraday indicators we discussed earlier come into play. 181
In discussing these rules, I am going to use the Mini-Sized Dow futures for consistency purposes. You can also use these with the Emini S&Ps and the Emini Nasdaq. Remember, a move of 10 points in the YM is like 1 point in the ES, or 2 points in the NQ. You can convert targets and stops accordingly.
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I’m usually looking for “fades” against the pivots, but this depends on what the internals are doing. When the $TRIN is trending higher, for example, this means an increase in selling pressure. On these days I will fade rallies to pivots, but I will not fade declines to pivots. Instead, I will short breaks of pivots. If we are rallying up to a pivot level, then I am either already long and am looking for an exit, or I’m flat and I’m looking to initiate a new position. This new position will be guided by the internals we discussed earlier. In a choppy market, these internal readings are less important, and you can generally fade rallies and fade declines to pivot levels. When there are TRENDS in the TRIN, you trade in the direction of that trend. 183
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As the markets rally to the midpoint near 10565, I set up a short, with my target being the daily pivot that is sitting below at 10529, “plus 3 points” – something I will talk about in my next trading rule.
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On a move to the pivot, I close out my short, and end up going long, with my target being the midpoint.
3. After hitting the midpoint, I close out my long, and reverse and go short, with my target being the daily pivot once again. 184
I get in and out of trades by placing limit orders or buy stops/sell stops + or – 3 points from the multi pivot levels. (For ES use 0.25 and for NQ 0.50). I will use limit orders when buying a decline or shorting a rally, and I will use limit orders to exit a position. I will use buy stops to buy a rally through a pivot, and a sell stop to short a break through a pivot. For the daily midpoint levels, I do not add + or – 3 points and use the level as it stands. I never use market orders with one exception: to exit plays I am still in at 4:10 p.m. ET that have not hit my stop or my target. 185
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At point #1, the markets fall to one of the weekly levels, but don’t quite touch it. I get into the market long because my limit buy order is the weekly level +3 points. The weekly level is 10532, so my limit order is place at 10535.
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At point #2 we come up and ease just through the daily midpoint. I am out of my long on a limit order to this level. I try to reverse and short, but the market moves too quickly and I miss the short. 186
3. For point #3 I am bidding long for a decline back at the weekly level +3 points. The weekly level is 10532, so my bid is that plus 3 points, which is 10535. When two levels like this are close together (at least by 10 points -in this case a weekly level and the daily pivot) I will place my bid with the level closest to the price action. I am filled on my long. The market eases through and trades around this level for half an hour. My stop is not hit (that is the next topic of discussion). We rally and it is not until over 3 hours later than my target is hit at the midpoint. This is an important note: Some of these trades will last a few hours in duration, while others can last 10 minutes. The key is to just wait for the levels to be reached and not trying to hurry things along or get out because you are getting anxious or bored. Although human emotions are a good idea in building relationships with other people, in trading, ignore them!
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4. I am out of the long over 3 hours later, at a daily midpoint level. I reverse and go short. Since we have already rallied to this level, I use a sell stop to get back in. My target is the next level below + 3 points. (For midpoints, you use the exact price, for all others you use the price + or – 3 points, in front of the level). 5. We come down to the level but don’t touch it. I’m filled because I’m “in front” by 3 points. I try to go long, but miss. 6. This is a good example of what to do into the close. I hold onto the position until 4:10 p.m.
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My initial stop is always 20 points, never less than that (2 points for the ES, 4 points for the NQ). Sometimes I will make it a little larger if it is near the overnight lows or another key level. The stop is based on the entry level, not the pivot level. In trading multiple contracts, I am looking to sell half at the midpoint level, then sell the rest at the next pivot level. Once I sell half, I move my stop up to the next pivot level, + or – 3 points “on the far side of the pivot.” 189
In this trade, I enter At point 1 and place A 20 point stop. When we get to the Midpoint at point 2, I exit half, and trail my stop up to the “Pivot -3 points” which is 6 points beneath my entry.
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On days where the pivots are greater than 40 points apart, I treat the midpoint as an equal weighted level to the pivots and set up plays against it. When the markets are less than 40 points apart, I use the midpoint more as a frame of reference. (4 points for ES, 8 points for NQ). On days where we have, for example, a TRIN that is trending lower (buying pressure) and the markets are trading in between two levels, and I am flat, I will place two orders. Since this would be a long, I will place a BUY LIMIT on a decline to the next level below (+3 points), and a BUY STOP at the next level above (+3 points). This way I just let the market take me back into the action of the day. 191
After 2 losers in a row I quit using this strategy for the day. With this system, I trade 1 contract for each $12,500 in my account. You can increase or decrease the volatility in your account by adjusting this number. (1 per $5,000 will give you more volatility, 1 per $25,000 will give you less volatility). Take advantage of the opening gaps to peel off contracts. Pivots and Gaps work very well together. Buy the gap down, then scale out as pivot levels are hit on the way up. 192
Ignore new trade setups between 12:00 Noon ET and 2:00 p.m. ET. It is ok to manage existing positions through this period, but in general this is a slow and choppy time to be trading. In sum, this is a great set up to play if you don’t like staring at computer monitors all day, or if you have a problem with “impulsive trading.” This setup forces the market to come to you, instead of forcing you to jump into the market. 193
How I Trade for a Living
VII-4: Scalper Buys and Scalper Sells
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I use the “scalper buys” and “scalper sells” in the trading room chart I post during the day. This is a visual way to use tradestation to help determine whether to buy or sell against a pivot level. White Paint bar marks a “pivot high” or “pivot low.” This is done after 3 higher highs or 3 lower lows. Red dot above the bar marks a continuing downtrend confirmation. Blue dot below the bar markets a continuing uptrend confirmation. 195
Scalper Buys and Scalper Sells
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Useful when the markets move into a pivot level. Can use the signal to enter and exit the trade. It measures the price action of the market. I program alerts for the white bars. This way if I am doing something else I can “hear” that a pivot point has been produced. Ignore signals that are not against a pivot level. Great signal for picking market turns Undergoing continued tweaking and refinement 197
How I Trade for a Living
VII-5: Tick Plays
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This is a very easy play and will only take a few slides. As we discussed in the intraday indicators section, there are times when the TICKS reach extreme levels of over 1000. When this happens, the market is expending all of its energy and is running out of gas. When I see a +1000 or -1000 TICK reading, I fade the market. For example, with +1000 I am shorting, and with -1000, I am going long. 199
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For TICK plays, here are the parameters: YM: 30 point target/45 point stop/30 minute time limit ES: 3 point target/4.50 point stop/30 minute time limit NQ: 6 point target/9 point stop/30 minute time limit If my stop or target is not hit after 30 minutes, I exit the trade at the market. TIME LIMIT IS IMPORTANT! 201
How I Trade for a Living
VII-6: Squeeze Plays
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Squeeze Plays are ways to measure the strength and direction of the next market move. Markets spend the day contracting and expanding in terms of volatility. Squeeze lets you know when the contraction is ending, when the expansion is about to begin, and in general which direction that expansion will take place. When I get a Squeeze Play, I will generally stay in the play until the Squeeze is over – meaning I will ignore the pivots for exit levels until the squeeze STARTS TO RUN OUT OF GAS. 203
The Squeeze is a measurement of the relationship between the Bollinger Bands and the Keltner Channels with their standard settings. It looks for the times when the Keltner Channels trade in between the Bollinger Bands. They work on all time frames. I like the Two Minute and Five Minute time frames the best. Five minute signals are more powerful than two minute signals, but happen less often. 204
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On these charts, the black dots are the “heads up” that the Keltner Channels are now trading inside the Bollinger Bands. The next “blue dot” is the signal that the Keltner Channels are now back outside the Bollinger Bands. This is the entry signal. Go short if the Histogram is negative, go long if it is positive. Stay in the trade as long as the histograms keep making lower lows or higher highs. 206
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When a squeeze play hits, I will disregard the pivots for targets as the market is setting up for a potentially bigger move. When the signal starts to run out of gas (histogram isn’t expanding or even starts to contract) I will then exit the position. Most of the time there isn’t a squeeze play on, so in these cases I just use the pivots “as normal.” When there is a squeeze play on, I will stay in the trade as long as the play is valid. 208
How I Trade for a Living
VII-7: Doldrums Bond Plays
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This is similar to the TICK play in that it is very simple and easy to use. Bonds trade in movements of 1/32. 1/32 is called a “tick.” 1/32 = $31.25 per contract 32/32 = 1 full point. If bonds are at 117 31/32, then the next uptick would take it to a price of 118. 1 point = $1,000 per contract Don’t trade the “minis” as there is little volume. Bonds trade methodically during a specific period of each day. 210
I trade the bonds between 12:00 Noon Eastern and 2:00 PM Eastern. For this time zone to be valid, they need to have traded within a range of ½ a point (16/32) over the previous half hour (from 11:30 to 12:00). If the range is wider than that, I don’t play the bonds that day. I am looking to use the quarter point levels in much the same way as I use the pivots.
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Quarter point levels in bonds are as follows: 8/32, 16/32, 24/32 and “zero.” Example: 117 8/32, 117 16/32, 117 24/32, 118 I fade sell offs to a quarter point level by using “quarter point + 1 tick” as my entry. I fade rallies to a quarter point level by using “quarter point -1 tick” as my entry. Stop is 7 ticks, target is 4 ticks. 4 ticks = 25 YM points ($125 per contract) If my first trade is a loser, I’m done with bonds 212
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How I Trade for a Living
VII-8: Box Plays on the Euro
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I trade the Euro Currency on the CME. You can also use this with Forex, but frankly most people will only get hurt trading that kind of leverage. There is plenty of leverage on the CME contract, and it trades with a tighter spread. Forex is “commission free” but you are paying for it by paying wider spreads. This is a great contract to trade when the stock indexes are quiet. 215
The Euro moves in increments of 1/100 of a cent. There are 100 “ticks” or “pips” in a 1 cent move. 1 tick = $12.50 per contract 1 full cent (100 ticks) = $1250.00 per contract Great market for playing breakouts and breakdowns. The Euro is doing the exact opposite of the dollar. If the dollar is rallying, the Euro is falling, etc. 216
For the Euro, I look for “box plays.” A box play occurs when a market has been trading in a horizontal channel, and has at least 3 tests of the highs and lows of this channel. When this happens, the market is building up energy for its next move. If there is economic data coming out, I wait until the reaction is done before entering a box play. The target is the “width of the box.” 217
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If there is no economic data, I take the initial breakdown or breakout of the box. Target is the width of the box. Stop is a move back below the box. Can be used on any time frame. One minute boxes are more narrow and are better for beginning trades because the stops are not as wide.
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How I Trade for a Living
VII-9: Herding the Cattle: Swing Plays
Using Single Stock Futures
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Mechanics: How SSFs Work
Traded on Two Exchanges: Use One Chicago One Chicago backed by CME, CBOT & CBOE One Chicago is where the volume is Monthly Contracts: F, G, H, J, K, M, N, Q, U, V, X, Z (January through December) February EBAY Futures: EBAY1CG04 No “$25,000 Minimum” for Day Trading Rules No Margin Interest No uptick rule for short selling 221
Mechanics: How They Work
1 SSF contract = 100 shares of stock 1 point move = $100 per contract 5:1 Leverage (20%) -- Buy 100 shares of IBM at $100 ($10,000) for $2000 per contract Buy 10 contracts IBM1C at $95 ($95,000 worth of IBM) for $19,000 Sell at $100 = 5 points on 10 contracts, or 5 points x $100 x 10 contracts = $5,000 gain $5,000 gain on $19,500 = +25.7% 222
Mechanics: How They Work
Volume – in some contracts it’s heavy (Dow Diamonds, MXIM1C, QCOM1C) and other contracts it’s light. Fills have nothing to do with contract volume! “Real Volume” is based on underlying stock If you are trading 1 contract or 1000, you will get filled Spread widens when no orders are present This is a “deliverable” futures contract. If you don’t sell it by expiration you will get shares of stock. 223
General Trading Tips for SSFs
Use Limit Orders Only Split the difference between the bid/ask $70.10 x $70.14 use $70.12 Use the underlying cash security to chart Cash charts are going to be much cleaner and give more accurate signals To chart EBAY1C, just chart the cash stock of EBAY, then have a bid/ask of EBAY1C The closer you are to expiration, the closer the futures price reflects the cash price 224
CASH SSF BID ASK 225
Herding the Cattle
Using the 13, 20, 50, 100 and 200 Day Exponential Moving Averages to find plays in SSFs that last a few days to a few weeks. Start off with the main indexes: Dow, S&P 500, and Nasdaq, then drill down to the individual stocks. Takes about 20 to 30 minutes a night to manually scan through the charts 226
Herding the Cattle Trading Rules
Key Moving Averages act as a “fence” Stock prices bounce along a fence during an uptrend or downtrend Stock prices back and forth between their fences, testing their strength Once it breaks a fence, it will come back and “kiss it goodbye” before moving on Goal is to “fade” a move to a fence 227
Goldman Sachs (GS) Weekly Chart
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Herding the Cattle
Live Trading Example
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Herding the Cattle
First Play: (Hold time is 4 weeks) Entry $74.70, exit $89.64 for +14.94 points, or +$1,494 per contract. Margin $1,495 per contract (20% of $7470)= 100% gain. Second Play: (Hold time is 5 months) Entry is $83.00, exit $99.60 for +16.60 points, or +$1,660 per contract. Margin is $1,660 per contract (20% of $8300) = 100% gain. Can Buy SSF a few months out or roll the contract 230
Herding the Cattle
Stochastic: Ignore overbought in an uptrending market, and oversold in a downtrending market When 13 EMA crosses below 20 EMA on weekly chart, focus on short side: otherwise it’s a futile effort With over 100 SSFs to choose from there is always something setting up Best scan with weekly buys is to search for low Stochastic readings (below 35) readings on daily charts, then use closest EMA below current price as an entry For shorter term plays, exit when stochastic goes overbought and flips back over into a sell 231
Herding the Cattle
Positions plays that last a few weeks to a few months Trade in direction of trend on weekly charts in terms of the 13 & 20 EMA crossover On daily chart view Slow Stochastic 14, 3, 3 And EMAs: 13, 20, 50 Goal is 20% gain in stock price, starting with an 8% stop At +10% move stop to breakeven 232
How I Trade for a Living
Part VIII: Business Plan for Traders
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2004 Business Plan Why am I trading again in 2004?
1.
Financial Rewards Freedom to work from anywhere Freedom to choose who I want to work with Freedom to dictate my own schedule Continuing mental growth and new challenges Would miss it if I stopped
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2004 Business Plan Markets to Trade
2.
Mini-Sized Dow Emini S&P Emini Nasdaq Emini Russell 2000 Bonds (30 Year) Euro Currency (CME) Grains Single Stock Futures
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Why These Markets?
Mini-Sized Dow (YM): First choice for intraday trading. Setups to use are Pivots, Gaps, and Squeezes. This contract offers a better spread than the other mini contracts, and it is very easy to get a handle on the Dow by watching the 30 stocks on an auto sorting list.
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Why These Markets?
Emini S&Ps (ES): Intraday plays use Tick Fade and Moving Average Crossovers. Also use for swing plays. Emini Nasdaq (NQ): When this index is the strongest or weakest on the day, use pivot setups. Emini Russell 2000 (ER): When this index is the strongest or weakest on the day, use pivot setups. Also use for swing plays.
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Why These Markets?
Bonds: 30 Year (US): Intraday trades, Doldrums Play Euro Currency: CME (EC): Intraday trades, Box Play Grains: Corn (C) , Soybeans (S), Wheat (W): Swing Plays Single Stock Futures (QCOM1C, etc): Swing Plays 238
Notes on Markets to Trade
Parameters are never to be changed once a trade is entered. An intraday trade does not turn into a swing play. Parameters are determined before a trade is entered. For intraday trading, do not use all 4 stock indexes at once. If the Nasdaq is the strongest market of the day, focus longs in that market. If the S&P is the weakest, focus shorts in that market. 239
3. Account Size: Based on multiples of $100,000
Withdrawal 50% of profits at the end of each quarter. Why? This is the best way to protect profits. This is also a reminder that the numbers on the screen are real and represent real cash. Never add money to your account or meet margin calls. “Feeding the Beast.” OK to add money to a positive % account.
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Number of Contracts to Trade (per $100,000)
4.
Mini-Sized Dow: 6 Emini S&P: 6 Emini Nasdaq: 6 Emini Russell 2000: 3 Bonds (30 Year): 3 Euro Currency (CME): 3 Grains: 3 Single Stock Futures: $10 - $30 = 7, $40 - $60 = 5, $70 - $100 = 3 241
Allocations for $15,000 account would be 1, for a $1,000,0000 account would be 60, etc. Contracts specified are full positions Maximum total contracts for indexes, currencies and bonds: Intraday: 12 Overnight: 6 Maximum total contracts for grains: Overnight: 6 Maximum total contracts for SSFs: Overnight: 20% Margin or $20,000. $100 Stock = 10, $50 stock = 20, etc. 242
5.
Execution Methods
Gap Plays, scale in 2, 2, 2 and exit all at once at the gap. Pivot Plays, in all at once, scale out 2, 2, 2 on range day greater than 100 YM points, 3, 3 on range day between 50 to 100 points and 6 (all out) on range days below 50 points. Squeeze, all in, all out on signals Tick Fade, scale in 2, 2, 2 and exit all at once.
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6. Drawdowns: Rules & Regulations
If you are down 12% for the month, cut position size in half for the rest of the month. If you are down 16% for the month, stop trading for the rest of the month. If you hit a 30% total drawdown, it is time to take a 4 week break from trading. Maximum overnight exposure is 1/3 lot size.
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For overnights and swing trades, hard stop is = to 2% loss in equity. Daily drawdown max is 2% or $2,000 per $100,000. If at the end of the day you exceed this level beyond slippage (down $2100, then you take another trade and lose), you don’t trade the next day. If you exceed this level again that week, you are done trading the rest of the week. This is punishment for not following your trading rules.
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7.
Profits: Rules & Regulations (per 100K)
After winning days and losing days, focus on making an average of $500 per day. $500 per day = $120,000 per year, or +120%. Slow and steady wins the race. T, W, TH are your best trading days, focus on making $1,000 on these days. If you are up over $2500 before 12 noon, stop trading for the day. If you made over 10% for the week, take Monday off. If you are up 20% for the month, take the rest of the month off. Track daily profit & loss on a spreadsheet
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8.
Rating Your Performance
Write down the trades in a journal as you take them. Track results of each trade. Note if you followed the parameters or changed them while you were in the play. If so, why? The results of each trade will add up to the total P&L for the day. Any trade you take that is not listed label as an “impulse play” which is your weakness. Track its performance.
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9. Tracking Your Daily Ups & Downs
Goal is consistent profits and smaller drawdowns. How many days did you start off losing and end up in the plus side? How many days did you start off strong only to give it all back? What was going on today in terms of interruptions, phone calls, family stuff? 248
9. Tracking Your Daily Ups & Downs
You get in trouble when you are doing well, then you go for that “bigger plate at the buffet.” Keep track of the days were you let greed get the best of you, then word on reducing the amount of those days.
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10. Office Setup
1 Computer for Tradestation 1 Computer for Esignal 1 Computer for Execution 1 Computer for Email, Internet, Instant Messaging Broadband access with phone line backup Land Lines and Cell for telephone 250
10. Office Setup
Battery Backup Comfortable Chair Virus protection software Spyware protection software Commercial Free music No phone calls till after 11:00 AM Eastern.
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11. Rewards for Performance
When you hit 60% for the year, take the next 4 weeks off. Take 2 weeks in Europe, 1 week in Bahamas Upgrade home theatre system Buy more land
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12. Peak Performance
When you have a 10% week, go do something to tame your Euphoria by taking Monday off and doing something that humbles you such as golf, flying a plane, working out with black belts in Tai Kwon Do, etc. Leave the markets between 12 PM and 2 PM Eastern and take a mental break.
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12. Peak Performance
Quit trading after 12 Noon on Fridays. Trade lighter during the last 3 days of options expiration. Consider not trading at all during this time. Focus heavily on the first two trading weeks of the month. Then take a 3 day weekend to get away and recharge. If you reach $2500 per 100K by 12 Noon, continue to trade until you have a losing trade.
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12. Peak Performance
Don’t answer the phone, Instant Messages, Emails, etc., between 9:00 AM and 11:00 AM. Stay focused on the markets. Do not initiate trades during the overnight sessions. Better yet, don’t watch the action either. If you are taking a day off as a reward day, physically get away so you can’t trade or watch the markets. 255
12. Peak Performance
Take off the entire week of Thanksgiving. Take off the last two weeks of the year. Do something physical at least 4 times a week and 6 is better. Tai-Kwon Do, Cardio, Weights, Core Strength Training, Waterskiing, Jogging, etc. The more the better. Traders and Vices don’t do well together: Watch intakes of caffeine, alcohol, etc. Stay healthy with good eating habits and vitamins 256
How I Trade for a Living
Part
IX: Conclusion
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Conclusion
Trading the markets is the greatest job in the world. There are no bosses offering contradictory instructions and, even better, no employees to baby sit. Each year thousands of people flock to the markets like lemmings to the sea. Yet, many fewer than that manage to avoid flinging themselves over the proverbial cliff. How does a trader break away from the herd and ease into a consistently profitable trading routine? The key to staying profitable consists of sticking to the following concepts:
Staying in the right frame of mind Finding the best market to trade Keeping on the path of least resistance Knowing what to do when things go wrong Focusing on a handful of setups 258
Conclusion
There is a ton of information out there, and many traders get easily confused on what to use and how to use it properly. By getting in a professional state of mind and by focusing on trading a handful of proven setups, a trader has the best of both worlds: Simple setups to focus on in order to block out the noise, and the right mindset with which to execute those trades. These plays and methodologies will keep the trader from second guessing his or herself, will keep a person on the path of least resistance, and will keep losses small while allowing winners a chance to run. Feel free to contact me with questions:
[email protected] And that's about all the trader needs to make a living at this greatest business in the world. Good luck with your trading. 259
