The Fractal Futures Trader » daytrading

E-mini Trading Professor: Sunday Night Briefing (12-4-11)

trader7757 — Mon, 05 Dec 2011 02:35:24 +0000

The television “talking heads” are all over the map in their discussions as to what the coming week holds for our economy. The usual discussions concerning the job market (improving), federal budget (weakening), and consumer sentiment (improving) have dominated the prognosticators predictions.

Here is a synopsis of what to expect for next week:

DATE	REPORT	CONSENSUS	PREVIOUS
Dec. 5	ISM Services	53.9%	52.9%
Dec. 5	Factory Orders	-0.3%	0.3%
Dec. 8	Jobless Claims	395,000	402,000
Dec. 9	Trade Balance	-$42.2 B	-$43.1 B
Dec. 9	Consumer Sentiment	66.0	64.1

On the hand, I suspect the market will continue to focus, to some degree, on the evolving debt crisis rippling through the southern tier of countries on the European continent. Yes, I realize the Central Banks, in a concerted effort, have opened the spigot of cheap money for the European banking system, but the systemic problems in the troubled European economies have not changed since last week. I have a hard time believing that the average institutional investor will consider the problem solved. To be sure, I don’t think anyone who is seriously involved with the European economic woes sees the latest round of “cheap money” as anything more than a band-aid on an ever deepening problem.

In short, I think that even the short memories of traders will completely dismiss the European situation. Then again, I never underestimate the neurosis of the trading community.

On the domestic front, I think the number to watch might well be the ubiquitous trade balance number. According to John Lonski, chief economist at Moody’s Analytic’s capital markets, “The positive is the trade gap has been narrowing, but make no doubt about it, one of the reasons we have lost so many manufacturing jobs is because of the heightened competition from overseas.”

From January to September, the U.S. imported $552 billion more worth of goods than it exported, with roughly 40% of that gap coming from China; and the imbalance has long been a source of tension between the two countries.

Anyone who has spent any amount of time in the trade room has been forced to listen to my rants about China’s monetary policy and failure to let their currency float, like the rest of the world’s major economic powers. They have consistently used their “non-floating” currency position to their advantage, and put an awful lot of money in their treasury. Falling interest rates and troubled economies have now made their economic policy the catalyst for major losses in their currency trading. I, for one, won’t be shedding a tear for them.

Finally, the market has been very reactive to the news, and it is difficult to predict what sort of new economic issues may rear their head. I would count on the unexpected, as the world is currently in a state of flux.

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E-mini Trading Question from Individual: Understanding Risk in Day Trading

trader7757 — Sun, 11 Sep 2011 02:05:32 +0000

Hi David,

Hello, hope your well, quick questions on your ES trading, may I ask how big are your stops? And are your targets? do you use range bars? what times do you trade? what is your max loss ofr a single day?All this will help me determine if it fits my risk profile:) thanks!!

Paul (spelling and sentence construction unchanged)

I wrote back this portion regarding the risk and stop placement in my response:

Hello Paul,

I have been an institutional trader, in various capacities, for nearly 30 years, most on the NYSE, the latter years in trading rooms for a the same investment bank. Were it me, I avoid trading the ES at all costs. I think there are much more profitable contracts to trade than the ES where there is less professional, institutional, and computerized trading activity. I am fond of the YM, 6E, NQ, and the ten year treasury.

Stops are sometimes calculated on the ES (or any contract) by using the Average True Range, obviously if the average true range is 12+ (which it has on most days of the week), it means that the previous bars have a range of 12 ticks, it really doesn’t make any sense to enter a trade with a 5 point stop, or an 8 point stop. Random noise in each bar (or the level of random noise) will increase your losing percentage/trade.

But let’s talk about that silly notion of risk as it relates to trading, as it is very difficult to quantify in futures trades. For example, assuming your favorite trade profits more than it loses; risk is usually defined as stop-loss/profit target. So the average guy would tack a 10 tick profit target with a 10 tick stop loss and think he has flattened his risk some.

On the other hand, I set an 8 point profit and 25 point stop/loss, very unbalanced and carrying a higher degree of risk than your trade. Right? Let’s assume an average true range of 10; mathematically I have a 30% better chance of succeeding than you. I had a student challenge me on this, so for one week I trade the 8-25 and he traded the 10-10. We both traded 6-8 trades a day for 5 YM contracts. By Thurs of the week, I was up more than a $1000 he asked to be excused from the trade, which I did.

The point is simple matter of mathematics; there are too many variables in every trade to fully understand the probability, in the exact sense, of the market doing this or that. However, when you try to control just one variable you can increase you probability significantly. In the above example, which is a more likely event? Will I hit my profit target of 8 or stop loss of 25? In pure mathematical terms I have a 79% chance of hitting the 8 tick stop and a 21% chance of hitting my 25 tick stop loss. I initially chose 10 as your profit target and 8 as my profit target, because there is a significant difference in the probability of moving 8 ticks and 10 ticks. Just think about the math behind what I am describing and quite possibly you will rethink your understanding of risk. Risk, in a pure sense, is based on probability and probability in, in most ways, a non-linear component. You might refer to some of Murphy’s books, as he has done some nice work in this area, though I disagree with him in a host of other areas.

Of course, there are many other factors you could try to control. For example, supply/demand in the actual contracts offered is an interesting area of study. Zero sum games can have convoluted outcomes in trading when a move to the long side simply runs out of supply, in other words, there are no sellers left to supply the buyers.

In short, I usually place emergency stops at 25, and logical exit within my own loss parameters will be my mental stop. Don’t ever trade without a stop-loss and contract count potential loss that is more than, say, 5% of your account. But for sake of argument, maybe I could get your to rethink your understanding of risk as a function of probability rather than a straight 1:1 linear relationship, which has always been the traditional line of thinking.

Finally, I think that you may have a certain risk profile…but when you enter the market, our risk becomes the same. So the game comes down to picking the right set-ups, at the right time (usually with the trend), and style. Those are the variables you can control, along with some lesser variables. I held your view of risk for many years, on a much larger scale, of course, and have only started to consider risk in the last ten years. Come visit my room and watch me trade. I win a lot, and work hard at managing the downside on my trades.

Day Trading: Knowing When to Exit a Losing Trade

trader7757 — Sat, 01 Jan 2011 19:36:38 +0000

I am guilty of it; you are guilty of it; the very best traders are guilty of it-sometimes it is very difficult to know when to fold. There are a plethora of explanations to the irrational desire to hang on to a losing position in the misguided hope that your trade is going to make a dramatic turnaround. It rarely happens, and most traders end up riding the trade too long and smashing into their stop loss. The loss is always painful, and most of us (if we can be honest with ourselves) can usually identify a point in the trade where we should have exited with a minor loss. Yet, we often fail to take advantage of this early exit and incur a substantial loss.

Why?

A great deal time and research have been spent on trading, especially the emotional and psychological aspects in trading decisions. As a group, people have a strong need, and desire, to be right; and in the opposite sense, people have a strong aversion to being wrong. Bailing out of a potentially disastrous trade is an admission that you, as a trader, have made a bad trading decision. In short, you were wrong. No one wants to be wrong. To be sure, I don’t want to be wrong. Yet, as day traders there is usually a point in a trade were we would be well advised to admit we are wrong and save a bundle of money. Most day traders seldom avail themselves of the early exit option.

When a trade is obviously going the wrong way it would seem obvious that a wise trader would be anxious to minimize his or her loses. I have looked at some of my worst trades and been able to accurately pinpoint several exit points that were obvious. Unfortunately, hindsight is 20/20. Our emotions control much of our thinking in relation to trading, and once I (or any other trader) is convinced the trade is a good one it is no small task to change your mind quickly and accept that the trade is a terrible one. As I said earlier, we like to be right; we dislike being wrong, and admitting we are wrong on the selection of a trade often leads to disastrous results.

Many texts and noted authors claim that leaving your emotions on the sideline is absolutely essential for successful trading. I don’t know about you, but my emotions are an integral part of my personality and the notion that I can carte blanch abandon them is wishful thinking, at best. On the other hand, I do think we, as traders, can learn to minimize our emotions in the trade selection and trade management process.

What is the secret? There is no secret; but developing the ability to see things as they are rather than as we hope is a skill to be developed. The market is an emotionless, mechanical device and does not take your emotions into consideration in its day to day operations. What we, as traders, think is completely irrelevant. The skill that I work on constantly is seeing the market from a realistic point of view; not my point of view, but what is really going on in the market price action. Reality can be a very painful teacher, especially when you are on the wrong side of a trade. But it is reality that we have to work with, and traders must learn to trade from the perspective of what is really occurring in the market, not what we wish the market to do, or how we think the market should move.

In summary, I have noted that removing your emotions from trading is basically wishful thinking. On the other hand, we can learn to develop a realistic view of how the market is moving and trade accordingly. It’s no easy task, but with practice reality can become your primary viewpoint, not your wishes.

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YM E-Mini Stop Loss, Risk/Reward Ratios

trader7757 — Thu, 28 Oct 2010 02:18:52 +0000

You hear a lot of talk about risk/reward ratios in trading, and as an individual who enjoys math I find myself baffled at the methodology many employ to arrive at their risk/reward conclusions. For example, some traders firmly believe in keeping their stop loss and profit targets roughly equal. After all, they say, it is important to keep your risk on the upside the same as the risk on the downside. Is all risk the same?

For example, let’s assume an example where a trader establishes a 30 tick stop loss and a 20 tick profit target. Many would assume that this trader is letting his losses run and his or her profit targets stay finite. It’s an interesting argument, but I don’t necessarily agree with it.

Why?

Well, in this argument you have to assume that it is equi-probable that the market will rise or the market will fall. With so many variables under consideration, I don’t believe that the probability for an YM e-mini to rise or fall is equal. Further, what is the probability that the YM e-mini will rise 20 points versus it falling 30 points? In most trading situations, long or short, small measured moves in the market are far more likely than large sweeping moves. In short, the market is far more prone to equilibrium or movement contained to movement one or two standard deviations from the mean. Which is not to say that large moves in the market do not occur, they do. The important question to ask yourself is, how often does the market move in dramatic fashion versus how many times does the market move at a very measured pace?

This attitude allows trades to develop and gives a trader the time to allow them to develop. Further, because a trader sets his or her stops to 30 does not necessarily mean that he or she is required to allow the price action to plow into the stop loss. At any time during a trade it is the trader’s prerogative to shorten his or her stops. (As a quick aside, I would also point out that it is essential to only shorten your stops, it is never a good idea or sound trading practice to expand your stop loss). However, if the fundamentals of a trade change during the execution of the trade, there is no problem with making a hasty exit. It only makes sense to limit your losses, especially if the dynamics of your trade change.

In the last 10 years, it is far more likely for the market to move 10 points than 30 points. A quick back test of this assumption showed that 10 point moves are 32% more common than 30 point moves. Interesting. In this respect, it is difficult to apply traditional calculus probability theory to trading. In short, there is a dependent relationship, especially from a probability standpoint, in calculating the likelihood of a given market move; the market is far more likely to move in smaller moves than larger moves. This is an important concept to understand and can help a trader reassess his or her approach to managing risk. Standard understanding of binary outcomes in assessing risk do not necessarily apply in trading the YM e-mini.

As you might expect, I am a proponent of running wider stop losses than many. In doing this I allow my trade time to develop and understand that the variable most responsible for winning trades is time. You must allow yourself ample time for the trade to develop and running tight stop losses will generally deprive most traders of the time required to trade effectively. Market noise and related factors seem to knock many traders out of their trades before they can realize a profit.

In summary, I have made an argument for running longer stop losses and explaining my criteria for doing so. I base my beliefs on a simple maxim; the market is far more likely to move in small steps than it is in large steps. Further, I can employ this strategy in formulating my approach to trading and run the wider stops to let my trades develop. My enemy in trading is not the price action but the amount of time I give my trades to develop; if I limit my trading by employing tight stops I deprived myself of the time needed for the market move I expect. Market noise can knock me out of the trade prematurely and I will realize losses. I want time in my trading and I am willing to buy time by expanding my stop loss.

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Day Trading: Focus on the Price Action

trader7757 — Sat, 09 Oct 2010 15:22:01 +0000

From the onset, let me explain that I use momentum oscillators and a number of moving averages in my ES e-mini trading. On the other hand, momentum oscillators and rate of change indicators are not my primary focus in trade selection. There are several reasons for this, but my best explanation lies in the fact that most oscillators and indicators are lagging indicators. In short, these tools often lead you into late trade entries and tardy trade exits.

Of course, there are a number of oscillators and indicators that claim to be leading indicators. I would dispute the validity of this claim, and most oscillators and indicators that claim to be leading indicators display dubious performance, at best.

This leaves us with a problem; most day trading is in the business of making real-time decisions and lagging indicators do not perform adequately. That being said, there are trading methodologies that can give you insight, and real-time information, as to the directional movement of the market. One caveat though, like all things that are related to the market, there are no guarantees or 100% accurate methods for predicting market movement.

During the course of my daily day trading, I focus primarily on price action as it relates to support and resistance. Throw in a bit of volume analysis, and you have a basic methodology for analyzing the market in real-time. I use my momentum oscillators and indicators to confirm or disprove my thinking about the directional movement of the market. Oscillators are, in essence, a filtering device I employ to increase the accuracy of my trading. It has become very popular in recent years to discount the importance of momentum oscillators and rate of change indicators. Further, there are several traders who treat these instruments with disdain. I think this is a mistake. Momentum oscillators and rate of change indicators perform a very valuable function in filtering out trades that I initially identify as profitable, but after some further analysis using momentum oscillators and rate of change indicators I find divergences from my price action analysis and avoid the trade.

There are number of ways to determine support and resistance on a trading chart and each method has its strengths and weaknesses in market analysis. Many day traders are firm believers in daily pivots which have been use for decades to predetermine where potential support and resistance may occur. I am not especially fond of using a pivot-based system. I find that the market will generally indicate where support and resistance occur. These areas of support and resistance are relatively easy to identify and are typically more accurate than pre-determined levels of support and resistance which are the result of calculating pivot values. Of course, there is nothing wrong with using pivots, especially if you adjust the pivots as you trade to the levels of support and resistance the markets identify.

One of the least used methods of market analysis in day trading, especially in recent times, is analyzing the behavior and placement of individual price bars. In my trading, I find that price bar analysis gives me a distinct advantage over the pure momentum oscillator and rate of change indicator traders. There are a number of texts written on price bar analysis, and going through a detailed explanation of price bar analysis is outside the scope of this short article, though I highly recommend traders study and learn how price bar analysis can give you a unique insight into potential pricing levels and directional movement in the market. To be sure, there are many traders who rely solely on price bar analysis to determine the trades they plan to initiate. For me, I like to have as many tools as possible (without overloading my brain with extraneous information) at my disposal. Momentum oscillators and rate of change indicators are the perfect filtering device for trading. When I notice a divergence in my price action analysis and momentum oscillators and rate of change indicators I avoid the trade. On the other hand, when my price analysis and oscillator analysis indicate the same directional market movement, I feel confident that I have discovered a valid and potentially profitable trade.

In summary, I highly recommend employing price action analysis and momentum oscillators and rate of change indicators into your trading style. All of these analysis techniques will help lead you to sound trading decisions and hopefully, profitable trades. While it is popular to dismiss oscillators and indicators as inadequate lagging indicators, they are very effective filtering devices and impart important and relevant information you can use in your trading decisions.

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Day Trading: High Probability versus Low Probability Trading

trader7757 — Sun, 12 Sep 2010 00:04:27 +0000

There is a natural desire, especially by beginning traders, to want to trade excessively. This is not difficult to understand. A day trader cannot make money unless he or she is in a trade; this is the general outlook of most novice day traders. But this line of thinking has some serious faults, and it is important to learn to select your trades in a systematic and emotion free state of mind.

Of course, selecting high-quality trades is easier said than done. At various times, very unproductive trades form set up patterns that can be very enticing. Low probability trades are like the lure of Medusa, they look great at first glance, but can cause serious losses if systematic analysis of the trade is not undertaken.

How do you know the difference between a high probability trade and a low probability trade?

First and foremost, every day trader must make an assessment of whether the trade is with the trend or against the trend. While many popular courses on trading tout the wisdom of trading retracements and identifying peaks and troughs in trading patterns, these are all unsound trading methodologies and I know of few successful day traders who employ them. Great traders are masters at taking what the market offers, and not trying to create trading opportunities themselves. A novice trader’s ability to effectively identify trending patterns is an essential skill because the very best traders trade primarily with the trend. In my view, less than 10% of your trades should be countertrend trades.

Secondly, many novice day traders and a plethora of trading systems rely heavily upon oscillators and indicators to choose potential trades. On the other hand, most seasoned day traders pay close attention to actual price action when trading. Important principles like support and resistance are prime movers in determining whether a trade has real potential. For example, taking a short trade into a known support is the recipe for a losing trade. Obviously, a successful day trader must have the ability and experience to identify known areas of support and resistance to avoid taking trades into these hazardous trading zones. Most experienced traders can spot support and resistance by glancing at a chart; this skill is learned through observing thousands of charts throughout trader’s career. Of course, there are add-on programs to most charting platforms that can spot support and resistance for a day trader who has not acquired the ability to identify support and resistance on his or her own. For some, these add-on programs can be very effective and helpful. In any event, any trade that will lead a trader prematurely into known support or resistance is often a trade that is doomed to failure and it’s important to realize these trades are very low probability in nature. In short, price action is where the real trade selection takes place, and indicators and oscillators supply filtering information to reinforce the strength or weakness of the trade under consideration.

This is among the most difficult concepts to learn in day trading, as many day traders are looking for a magic oscillator or indicator that will revolutionize their trading results. I am sorry to report that, to date, no such magical oscillator or indicator exists. Look to identify solid trades in the price action of any chart, and then calculate the potential to profit by identifying where support and resistance will affect the performance of your trade. Many traders use pivots and other predictive indicators to calculate support and resistance. For many years, I was in this camp. As I have grown older, I prefer to identify support and resistance as it develops on the chart, not through some artificial predictive means. This attitude is subjective in nature, and his a choice each individual trader has to make.

In summary, we have looked at trading against the trend and concluded that countertrend trading results in low probability trades, on the other hand trading with the trend results in higher probability trades. We have also noted that known support and resistance are prime movers in determining the feasibility and potential profitability of any trade. Price action is the name of the game, and learning to read and interpret what price action is telling a day trader is the real secret to trading success. If you can master reading price action, it is highly likely you can become a successful day trader.

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How Do I Start to Day Trade E-Mini Contracts?

trader7757 — Mon, 16 Aug 2010 06:57:12 +0000

Learning to day trade e-mini contracts has become one of the hottest professions on the Internet. Unfortunately, many people enter the e-mini day trading arena with little or no experience and are disappointed in the resulting lack of success. I need to point out that e-mini day trading is a learned skill and not an innate ability. So it is important to engage in some preparation before attempting to day trade e-mini contracts.

First and foremost, a new e-mini day trader should research and choose a quality day trading system. This is not necessarily an easy job, because there are a wide range of trading systems and some are priced exorbitantly high. Spending time on some of the trading chat boards and asking questions about the quality of various trading systems is a great way to get some feedback on which course is considered successful. Even then, you may need to examine each recommended course and interview the owner of the course. Some great questions to ask might be:

1. What are the owners credentials and trading experience that qualify him or her to advise others on trading methodology?

2. What is the overall success rate for past students of his or her of course?

3. What is the cost of the course and are there ongoing charges to remain an active member?

4. Does the course require the student to purchase proprietary software to trade with the particular system being sold?

5. How long does it take from the start of the course until a trader can safely trade e-mini contracts?

While some trading educators debate the use of demo accounts, I highly recommend them. The problem most people have with e-mini day trading demo accounts is that they tend to not follow the trading system they have learned. They tend to over trade or experiment with ideas they have that are not based upon sound methodology. This can lead to bad habits which may carry over to trading with real money. The answer to this problem is a simple one; you must trade your demo account exactly as you trade your live account, that is, the account you plan to trade with real money.

Sound methodology and a good deal of successful practice time on a demo account is an excellent way to prepare a potential e-mini day trader to trade successfully and profitably. It is important to have a plan before you begin to trade. As I said at the beginning of this article, day trading e-mini contracts without any preparation will generally lead to failure and loss of your capital.

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Three Core Attributes of a Quality Day Trading System

trader7757 — Thu, 01 Jul 2010 17:37:31 +0000

There are a staggering number of day trading systems on the market today, and they range from fully automatic systems to exotic systems based upon astrology. The day trading systems which lie between these two extremes are the ones of interest to the average trader. For a novice trader, choosing a system is complex and difficult because it is tenuous to ascertain which system will actually work in which system is nearly hype. Most good systems, though, are comprised of some time-tested core components that differentiate them from the less than effective systems.

Throughout my career as an institutional trader I have learn to day trade several different systems that are effective and profitable. These time-tested systems usually contain three important characteristics which are worth noting. All contain some emphasis on price action or price movement. Nothing is more basic or essential to a system than what the price movement of the traded equity is doing, and the manner in which price is behaving. Price action analysis is among the oldest disciplines in trading systems, and its importance has not lessened over the years. As a matter of fact, there are systems based solely upon price action. Any discussion of price action methodology would require a discussion the size of a small book, as there are many interpretations of the relationship between price movement and the market prediction. Like all things in trading, some price action analysis is quite effective and other analysis is not as effective. It will take some investigation and research for the average trader to determine which price action methodology best suits the trading style he or she intends to employ.

A second characteristic of a good trading system is the utilization some form of indicator or oscillators. In a recent years, indicator and oscillator based systems have gained great popularity. Again, there are trading systems based solely upon oscillator indications. I caution against using systems employing only oscillators, as there are some inherent weaknesses in this methodology. Of utmost importance and evaluating oscillators is the tendency for them to be lagging indicators. Most oscillators receive information from a data feed and apply a specific mathematical formula or analysis to this data. Therefore, by definition, oscillators tend to lag the market and you may find yourself a step behind the action if you rely solely upon oscillator based trade selection. There are a number of oscillators that claim to be leading indicators, but their effectiveness as leading indicators is generally dubious, at best. On the other hand, it is possible to glean a tremendous amount of information from oscillator and indicator analysis and I do not mean to lessen or demean their importance. My point is a simple one, oscillators and indicators are generally lagging indicators and understanding this weakness is essential in employing their use in your trading system.

Finally, I think it is important to have information or a data feed coming directly from whatever underlying security is being traded. For example, I trade primarily the financial index e-mini futures, so I am particularly interested in raw data from the New York Stock Exchange. To accomplish this goal, I generally like to use the NYSE tick. This particular indicator compares advancing and declining issues on the New York Stock Exchange and gets no information or data from the futures exchanges. Using this raw data, I get a bird’s eye view of what is actually occurring on the exchange. I feel this is a distinct advantage in my trading, as the futures traders have not always reacted to the New York Stock Exchange price movement and I am therefore aware of the trends, or lack of trends, that occur in real-time. Oddly enough, when I have introduced this indicator to traders who have relied solely upon oscillators they are often amazed at the added depth of knowledge they acquire when comparing the NYSE tick and their familiar oscillator based indicators. For that reason alone, I believe it is important to employ data that does not come directly from the futures exchanges. Quite simply, data derived directly from the exchange of the underlying security will supply you with information you might not normally be accustomed to using.

As you can see, I like using trading systems that are multifaceted and give me a broad view of market movement. It is my opinion that trading systems that rely upon a single indicator often result in a skewed market viewpoint. Above all, when I day trade I want to develop the fullest understanding of the market movement possible, and I accomplish this by looking at the market from several points of view.