Short
Term trading the Stock Indexes.
Fundamental (internal) indicators that I
follow LIVE during the trading day.
TICK, A/D, DOW, SPX, NDX, QQQ, PREM, TRANSPORTS, UTIL
I also monitor the VIX
(Option volatility index) as a measurement of over-sold conditions. Generally,
a reading above 36 indicates an oversold condition. The VIX is a longer-term
gauge of market conditions, thus I like to monitor the VIX on an end-of-day
basis. The VIX data will soon be included on the web site!
On
a longer-term basis, I follow the following fundamental data. Below are 11 key longer-term fundamental
indicators I track weekly. My plans are
to add this weekly information to the web site as well. This data is also available in Barrons.
Fundamental Spitfire
data Monitored Weekly
(This is not a requirement. This data
is helpful in understanding the longer-term condition)
1 – Total short sales
2 – Public short sales
3 – Specialist short sales
4 – Total short interest
5 – Short interest ratio
6 – Ratio Odd Lot short sales to total sales
7 – Ratio public to NYSE Specialist Short sales
8 – Ratio NYSE short interest to Avg Daily Vol.
9 – Ratio Price premiums – Put vs calls
10 – Ratio Trading volume in puts vs calls
11 – OEX put/call ratio
Day Trading defined
I define a Day Trade as any
trade which is established during
the course of the day and ends that same day.
There are two distinctly
different types of day-trades.
1 - Scalpers,
Hit & Run or Sniper trades. These
are very quick.
The idea is to hit the
market, grab a few points and get out.
2
- Long term day-trades.
Long-term day-traders are referred
to as "position traders"
by the Floor traders in
Chicago. Floor traders tend to be
scalpers. A long-term position trade is one that is established
early in the day and held for a
good part of the day. These
trades are often exited using MOC
(Market on close) orders.
Suitable Markets for Day Trading
You want a market with a wide range. This is especially important if you
plan on scalping the market for short-term trades. Currently, the stock indexes
have the best conditions for day trading. Currencies have decent conditions for
day-trades; T-bonds also have good conditions. The grains (soybeans) can sometimes also be a good market for
day trading. The important market characteristics are wide ranges and excellent
liquidity.
Stock Indexes of varying risk suitable for Day Trading
S&P500 NASDAQ 100
DOW ES-MINI
Basic
S&P Day-trading guidelines
ü
Daily limits and margins can be
changed by the exchange at any time. Be sure you know the market limits and
margin requirements before you trade.
If the market conditions become very unstable or fast, the exchange can
impose rules such as
not allowing market orders at their discretion.
ü
During pre-holiday sessions, there
is typically fewer floor traders and light volume. This can cause a market to fluctuate more randomly than normal
and whipsaw traders. In addition, the
absence of floor traders can cause the market to over-travel its fair value in
either or both direction. This activity can cause our intra-day indicators to
produce false signals.
ü
Never
lose sight of your personal financial condition. It is important to calculate the financial impact of the largest loss for each trade being considered as a
percentage of both your risk capital and total net worth. The largest loss for
any trade should always be limited to your initial stop plus commission and
slippage. Like position trades, this initial risk is reduced by the trailing
stop as the trade progresses in the desired direction. Never expand the initial stop loss to take
on more risk. This critical rule must
not be broken in day trading as well as position trading. If you break this single important rule, you
basically eliminate your only defense mechanism and loss control. Maintaining control of your loss potential
and exposure to risk is a critical element to successful trading. Temptation to break this rule is a
manifestation of greed and human emotion.
ü
Option expiration days often
introduce extreme volatility in some markets, such as: stock indexes. Because of this added
volatility, your risk as a trader is increased significantly and again this activity can cause our intra-day trading
indicators to fail or produce random false signals.
ü
Stock
indexes can be particularly sensitive to government reports, such as: Producer
Price Index, Consumer Price Index, Unemployment Report, Retail Sales, Durable
goods and Gross Domestic Product (GDP).
These reports are often responsible for setting into motion a chain of
events in the market, which can throw the market off its current cycle and onto
a new one. This is precisely why simply cycle analysis regularly fails. The
good news about these sensitive reports is the regularity of their release,
although the reports themselves can contain unknown random information. A commodity reference calendar containing the schedules for the release of
these important reports can be obtained from your broker.
ü Always trade the nearby month or most active month. In the S&P, this is always the front
month. Your broker should always have this information as well.
How to monitor the PIT activity
(Floor traders)
Ø
The pit traders provide the liquidity for the public
off-floor day-traders to be able to establish and liquidate positions during
the course of the day.
Ø
The PIT traders typically trade counter-trend. Much like the
commercials, they tend to be on the right side of the market at the major
intra-day turns.
Ø
Unlike the commercials, the PIT traders are NOT hedgers. PIT
traders are in the market to profit.
For the most part, PIT traders make their profit from tiny moves on
multiple lot trades. Being in the PIT where the prices are made, the PIT traders have an advantage. They
use the advantage of being right where the prices are being made to buy at
wholesale prices (bid) and sell retail (asking price). The difference between
the bid and asking prices will vary depending upon the volume and market conditions.
When the volume is low and the trading thin, the difference between the bid and asking prices will often be exaggerated
because of the lack of buyers and sellers to make a market. You will see this in pre-holiday trading and during the night.
When the market is trading under fast conditions, the bid and asking price can
widen due to excessive demand on one side of the market. Under bullish conditions (rising prices),
the excessive demand to buy causes the asking prices to inflate rapidly because the PIT traders know they can get it from the
market orders pouring into the market. During times of rapidly declining
prices due to excessive public sellers, market orders pour into the floor to
sell, and at any price! The floor traders will
drop bids rapidly to take advantage of the emotional selling and buy at
extremely deflated prices; however, sometimes this can backfire if the sell
orders continue to come in.
* Many pit traders are also trading for large institutions.
These institutional traders can and often do move the market. Pit traders
will try and get in front of them if they can (by placing their orders to buy or sell in front of a bigger order to buy or sell by a large
institution.
Critical information monitored by the PIT traders
* News
Leading indicators followed by the PIT traders
·
DOW
& NASDAQ
·
Transports
& Utility Index
·
Intra-day
High & Lows in the S&P
·
Bond
Prices (interest rates)
·
Dollar
Prices
¨
Floor traders do not use computers or complex technical
analysis. Since they have the advantage
of being right where the prices are being made and where they can see the order
flow coming into the market, they don't need to look at the lagging indicators watched so heavily by the public. The floor traders will
watch the news and the DOW (New York)
to gain insight on what to expect from the public and the outside orders.
Again, being right there on the floor, they have the advantage of being able to
act quickly should some major news event occur. By the time the public reacts, the floor traders are often taking
profits or they are selling or buying from the public at exaggerate levels (counter-trend).
Stop
running by the PIT traders & other tricks.
¨
The floor traders know where the public stops are. How do they know? Is this information being
secretly divulged by a conspiracy? Certainly not. It does not take rocket
science to figure out where the stops are. They are normally a few tics above
or below the previous days high and low. That is where the brokers tell their clients to put their stops. During the day, off-floor day-traders place
their stops a few ticks above and below the intra-day high & low.
¨ The PIT
traders will try and drive the market to these areas to uncover those stops.
When they uncover the stops, those orders become market orders and suddenly you
have a lot of activity in the market. As the stops are flushed out, the PIT
traders take advantage of exaggerated prices and a widening bid - ask
spread.
Driving the price higher or lower is not a function of size
The PIT traders have another advantage. That is they can
change the prices in the PIT, by trading one or two lots. The prices reported by the exchange and
displayed on every computer screen around the world is that of the last
trade. PIT traders will scout the
market using small lot trades to uncover stops. They often lose money on these
trades. However, once they get the
market where they want it, they then increase the size of their trades (perhaps
100 lots, or 1000) Remember, the PIT trades do not have commissions to worry
about and they do not have margins to contend with. There is virtually no limit on the number of contracts they can
trade. At the end of the day, all accounts are cash settled (credited or debited).
Basic Time & Price theory
(A) From studying all of the
S&P tic data dating back to 1982, we find many relationships based on time
and price.
1 - The market usually has 2 separate legs
1 - Morning Leg 8:30am - 11:00am
2 - Afternoon Leg 1:00pm - 3:15pm
(B) The morning trend can
usually be identified within the first 50 minutes of trading. Aggressive traders will try to identify it
in 30 minutes or less. Don't get disappointed if you missed the morning trend or tried unsuccessfully to fight
it; trend days have a parabolic move in the afternoon.
(C) During normal market
conditions ($chg in the S&P averages between $1000 - $3500 gain or loss a day), you can buy the breakout after the first 50
minutes of trading. The long-term trend in the S&P has been up since 1982
when the contract was first introduced. Therefore, this strategy has worked
well for going long and not as well for going short. However, I've found a very good strategy for short as well.
(D) We simply fade the opening
Gap ups to short the market.
The afternoon trend can be
predicted based on the characteristics of the morning trend in and the status
and intra-day performance of the following indicators.
1 - Tick - The tick indicator
represents the number of stocks ticking up verses the number ticking down.
2 - Prem -The premium can be used to
measure the floor sentiment. On days
the floor is bearish or when they have doubts about the afternoon trend, the
prem indicator will narrow or read lower than perhaps it did in the morning. It is important to watch this indicator in
conjunction with the NY.
3 - Dow -
On days when there isn't a lot of news, the floor tends to take their
queue from the Dow in NY.
High (Price and Time)
Low
The above
is a typical daily price bar in the S&P. Studies of all the S&P data
dating back to 1982 indicate that the S&P closes on or near its high or low
66.6% of the time. The remaining 33.3% of the time it closes towards the center
of the day's range. See figure 1A
below.
On trending days (leg 1 through the dead zone) the
odds begin to favor the one extreme is already in place and the market will
likely close towards the opposite end. Having this knowledge gives one the
confidence needed to add to a position early on or reverse, double up and go
the other direction when the market has been going against a trader. The idea of doubling up and going in the
opposite direction is appropriate for day trading because we never become too
one-sided during the day.
(Figure
1A)
S&P Basic Measurements
The strength of most day-trading systems is
their ability to measure support and resistance. Since patterns tend to repeat endlessly in the market, the idea
of taking periodic "average" measurements to pinpoint support and
resistance is a sound one. The basic measurements are as follows:
The
Rally - This measurement is from yesterday's low to today's high. Averaged over three days, this measurement
tells us how far the market tends to rally ~ in short, where the resistance
will be.
The
Decline - This measurement is from yesterday's high to today's low. Averaged over three days, this measurement
tells us how far the market tends to decline ~ in short, where the support will
be.
Buying
High - This measurement tells us how far today's high exceeds yesterday's
high. It will be a negative number if
today's high is lower than yesterday's high.
Again, averaged over three days, this is a resistance number.
Buying
Low - This measurement tells us how far today's low exceeds yesterday's
low. It will be a negative number if
today's low is higher than yesterday is low.
Again, averaged over three days, this is a support number.
Calculating the support and resistance of tomorrow
(Highs & lows)
The trend reaction numbers are determined by
a simple formula for arriving at support and resistance numbers. The formula is as follows:
High + Low + Close =
X
3
2X - High
= Support (Place to buy)
2X - Low =
Resistance (Place to
sell)
For
example, assume the following:
High =1157.5
Low =1147.3
Close =1151.5
Therefore:
1157.5 + 1147.3 + 1151.5
= 1152.1 (X)
3
2X
= (1152.1 X 2 = 2304.2)
2304.2 - 1147.3 (low)
= 1156.9 (Tomorrow likely
resistance)
2304.2 -
1157.5 (high) = 1146.7 (Tomorrows likely support)
The Average Range
The average
range is an important calculation for determining where the market is
likely to go. The formula for the
average is simple: You calculate the
average range (high - low) over a period of X consecutive trading days and
divide by X. I use ten and we will use
ten here on out for this illustration.
The average range number can be used for a number of calculations, including
stop placement, which is 25 percent of the average range plus or minus the
highest or lowest entry depending on whether you wish to buy or sell. The average range can also be used to
generate a target buy or sell number by taking an intra-day range (after one
hour of trading) and adding to the intra-day low or subtracting from the
intra-day high. This number can be
quite valuable in making intelligent decisions concerning support and
resistance.
First, let's deal with the calculation of the average
range. Take the high and subtract the
low to create the daily range. After
you have ten days of data, take the ten days and divide by ten to generate the
average range as follows:
|
Day |
High |
Low |
Range |
Average Range |
|
1 |
959.85 |
950.90 |
8.95 |
- |
|
2 |
959.90 |
950.65 |
9.25 |
- |
|
3 |
961.75 |
955.00 |
6.75 |
- |
|
4 |
970.80 |
953.15 |
7.65 |
- |
|
5 |
959.25 |
953.10 |
6.15 |
- |
|
6 |
958.90 |
948.00 |
10.90 |
- |
|
7 |
954.10 |
946.60 |
7.50 |
- |
|
8 |
956.40 |
949.50 |
6.90 |
- |
|
9 |
958.70 |
953.10 |
5.60 |
- |
|
10 |
963.00 |
954.25 |
8.75 |
7.85 |
|
11 |
963.85 |
957.80 |
6.05 |
7.55 |
|
12 |
965.50 |
959.80 |
5.70 |
7.20 |
|
13 |
965.10 |
960.20 |
4.90 |
7.00 |
You will find that the ranges will conform to the
average range. Thus, on a day, let's
say, when the intra-day range is 3.10 points after one hour of trading, you can
anticipate another 3.90 points in price action when the average range is 9.00.
These are valuable guidelines to use in
trying to anticipate where the market will stop rising or declining.
The Previous High and Low
The market often finds support above a
previous resistance and this can become an important area. Likewise, the market often encounters
resistance below a previous support level.
The previous day's close is
also an important number in that prices tend to return to a value area.
Overbought/Oversold Oscillator
Stochastic D calculation is a more
complex oscillator for determining overbought & oversold conditions. A more
simple method for calculating overbought & oversold conditions is outlined
here below:
(High
- Open) + (Close - Low)
= overbought/oversold indicator percentage
2 X Range
10
Here are the prices for the March S&P 500
on December 1, 1994:
Open
= 456.45
High = 456.85
Low = 450.90
Close = 451.90
Now, using the formula, here's how that day's
overbought/oversold percentage is calculated:
(456.85 - 465.45) + (451.90 -
450.90) 40 + 1.00
1.40
= =
= 11.76%
2 X (456.85 -
450.90)
2(5.95) 11.90
Accordingly, this is the reading
that was generated at the end of trading on December 1, 1994.
Once you have accumulated X days
of data and daily overbought/oversold readings, you can then average the readings. Thus, after X days of readings, you can
calculate an X-day moving average by simply adding the last X daily numbers and
dividing by X. I use ten here also.
In the following table, I've
listed the Daily Overbought/Oversold Percentages for 12 trading days. On day 10, the first 10-day average is
calculated. After you have accumulated
ten days of data, you are ready to begin the moving average calculations:
|
Day |
Daily Overbought/Oversold |
10-Day Overbought/Oversold |
|
1 |
11.76 |
~ |
|
2 |
90.80 |
~ |
|
3 |
44.00 |
~ |
|
4 |
64.52 |
~ |
|
5 |
51.59 |
~ |
|
6 |
13.61 |
~ |
|
7 |
33.68 |
~ |
|
8 |
96.79 |
~ |
|
9 |
56.73 |
~ |
|
10 |
81.30 |
54.48 |
|
11 |
59.02 |
59.20 |
|
12 |
85.19 |
58.64 |
|
13 |
85.53 |
62.80 |
Using the Oscillator to Pinpoint Direction
There are three key considerations
in creating an oscillator to help you determine market directions. They are:
1. The market
you are trading.
2. The number
of days to average the overbought/oversold indicator.
3. The number
of days the market has rallied or declined.
As with
most good market indicators, the oscillator calculation must take into account
the above factors. The oscillator that
you use on one market will not be appropriate to another market. The reason for this is markets have
different patterns. Currencies tend to
do better with a longer oscillator because they trend so well whereas a more
choppy market, such as the S&P 500, does better with a shorter
oscillator. Markets tend to have cycles
that are unique to those markets. For example, the S&P 500 tends to have a
well-known 11-day cycle between making a sustained rally and decline. Other markets will differ in their cycle
duration.
As a rule,
you need to combine these factors and make intelligent judgments concerning the
market. For example, if the market has
been rallying for five or six days and you have a high reading on the moving
average oscillator (90% or higher), chances are you are near the top day in the
cycle. The same is true as you approach
bottoms, of course. If the market has
declined for five or six days and the oscillator is posting a reading of under
15%, chances are you are getting near the bottom. When the market is not at an extreme, readings above 50% tend to
be bullish whereas readings below 50% tend to be bearish. This oscillator can keep you on the right
side of the bottom during these trending periods.
Position Management
I
like to trade 2 to 3 contracts, taking partial profits when offered and let
part of the position run with the market.
Stops are based on the recent swing lows in the market structure but I
normally do not exceed 500 points ($1250 in the S&P and $250 in the ES-MINI.
Money management is basically the same as with the position trading
system.
If after calculating the risk based on the previous swing high or swing low the
dollar risk is too much (or exceeds 500 points), I pass on the trade. I generally
make it a point to look for the low risk opportunities. Such as when a critical
low was challenged and the market held or was unable to move significantly
below it. I like trades that offer a
logical place for the stop. When a
trade is
moving in my favor, I will at times add to positions. Likewise, when a trade
is moving against me, if the conditions are right, I will at times exit the
entire
position and re - establish a position in the opposite direction (occasionally
double in size).