Day-trading compares to position trading like flying to driving
Day-trading means entering and exiting trades on the same day. Watching money flow from the screen into your account is extremely appealing. Surely we are smart enough to use modern technology to outrun slow-moving folks who follow their stocks through the newspapers.
Every partial truth contains a dangerous lie. Day-trading can bring profits to professionals, but it is also a common last stop for losers who blow what little is left of their accounts. Day-trading offers advantages and disadvantages, while placing extreme demands on its practitioners.
Day-trading offers one of the markets' greatest challenges, but it is amazing how little literature on it exists. There are several "daytrading for dummies" types of books, a few get-rich-quick jobs, but not a single definitive volume on day-trading. Bad day-traders write bad books and good day-traders are too action-oriented to sit down to write.
A good day-trader is a street-smart person with fast reflexes. He is quick, confident, and flexible. Successful day-traders are so focused on the immediate results that they do not make good writers. I hope one of them will rise to the challenge of writing a book, but in the mean time, here are a few notes, even though each of them deserves its own chapter in a thick book on day-trading.
The late 1990s saw an explosion of interest in day-trading. Even housewives and students were pulled in by the bull market and the easy reach of the Internet. Brokers advertise for more people to come in to day-trade, knowing full well most will bust out.
The advantages of day-trading include:
Trading opportunities are more frequent. If you can trade with daily charts, you'll see similar trades more often on intraday charts. You can cut losses very quickly.
There is no overnight risk if a major piece of news hits your market after the close.
Expenses are higher because of more frequent commissions and slippage. Day-trading is a very expensive game, which is why vendors love it.
Day-trading makes several hard demands on its practitioners:
You must act instantly-if you stop to think, you're dead. With daily charts you have the luxury of time, but intraday charts demand immediate action.
Day-trading chews up a great deal of time. You have to ask yourself whether the hourly pay is better in longer-term trading. Day-trading plays into people's gambling tendencies. If there are any gaps in your discipline, day-trading will find them fast.
There are three main groups of day-traders: floor traders, institutional traders, and private traders. They have different agendas and use different tools. Imagine three persons coming to the beach-one goes for a swim, another stretches in the sun, and the third goes jogging and runs head on into a tree. Floor traders and institutional traders tend to do better than private traders. Let us see what we can learn from them.
Lessons from Floor Traders
Floor traders stand in the pit, trading with each other, but more often against the public. They scalp, spread, and take directional trades. Scalping is based on the fact that there are two prices for any stock or future. One is a bid-what the pros are offering to pay. The other is an ask-what the pros are willing to sell for. You may bid below the market, but as a friend said, "You can't excite the market with a flaccid bid." When in a hurry, you buy at the ask and pay what sellers demand. If you want to sell, you may place a limit order above the market or "hit the bid" and accept what buyers are willing to pay. For example, the last trade in gold was at 308.30, but now it is quoted as 308.20 bid, 308.40 ask. This means there are willing buyers at 308.20, while sellers are asking for 308.40. When a market order to buy comes into the pit, a floor trader goes short by selling at 308.40. The outsider has paid the ask price, and the floor trader is now short and needs to buy. When a market order to sell comes to the floor, he buys at 308.20, and pockets 20 cents profit. Floor traders pay no com missions, only clearing costs, and can afford to trade even for single ticks. They stand on their feet all day, yelling to all passersby that they want to buy a tick below the market and sell a tick above. It is the highest paid form of manual labor.
This is a simplified example. The reality is less orderly, as floor traders try to widen the spread and make more than one or two ticks. They compete with one another, shouting, jumping, and getting into each other's faces. It helps to be tall and muscular and have a big voice. You get stabbed with pencils and splattered with saliva. There is a story about a floor trader who died of a heart attack on the floor but remained upright, squeezed in by the crowd.
A floor trader can get stuck if he buys a tick below the tools for trading market but the market falls by two ticks, and puts him underwater. Half of all floor traders disappear in their first year. One of the Chicago exchanges puts red circular badges on the chest of new traders, making them look like shooting targets. Lest you start feeling sorry for floor traders, keep in mind that many of them make a very good living and some make a great deal of money from hitting you for a tick or more on every trade. Before electronic trading became a serious threat, seats on some ex changes sold for a million dollars.
Floor traders also get involved in spreading-buying and selling related markets when their relationships get out of line. Spread traders tend to be more cautious and better capitalized than scalpers. Finally, some of the wealthiest floor traders get involved in directional trading. They put on trades that last days or weeks, closer to the timeframe of public traders.
What lessons can we learn from the floor? If you are a position trader, you should use limit orders whenever possible. Buy and sell at specified prices, and don't let the floor scalp you. Put those fellows on a diet. Another lesson is to stay away from scalping. When a crowd of athletic young men starts fighting for ticks, jumping, salivating, and screaming, you have no business reaching into that crowd to grab a few ticks for yourself because they'll take off your fingers. If you day-trade away from the floor, forget about scalping. Look for the longer-term daytrades, where the competition tapers off a bit. Go to the middle ground between scalpers who chase ticks and position traders with their end-of-the-day charts. Try to find one or two trades a day, longer than scalping but shorter than position trades.
Lessons from Institutional Day-Traders
Institutional traders work for banks, brokerage houses, and similar firms. A company may have more than a hundred traders sitting behind rows of expensive equipment. Maintaining each seat costs several thousand dollars a month, not counting salaries and bonuses. Each institutional trader narrowly focuses on a single market. One may trade only two-year Treasury notes, another only five-year notes, and so on.
Institutional traders generate paper-thin returns on huge volumes of capital. A friend of mine who trades bonds for a leading investment bank in New York has access to essentially unlimited capital during the day, but his overnight positions are capped at $250 million. His standard deviation, the amount he usually wins or loses in a trading day, is $180,000. This is 0.072% of his overnight limit, and only about 0.010% of his intraday size.
His profits appear large until you express them as a percentage of his account and ask yourself what you would earn if you traded as well as him. Suppose your account is $250,000 or one-thousandth of his $250 million. If you could match my friend's percentage gains, you'd earn $180 on overnight trades and $25 at the end of a busy day-trading session. That would hardly cover your costs! Why do institutions do it?
The big boys benefit from economies of scale, but the main reason they stay in the game is to keep themselves visible to potential cus tomers. Their main income comes from commissions and spreads on customer orders. Institutional traders accept paper-thin returns to main tain a presence in the market, which gives them first dibs on lucrative customer business. They work to maintain visibility, and as long as they do not lose money, they're happy.
The main thing we can learn from institutional traders is their rigid system of discipline, with managers forcing them to cut losses. A pri vate trader has no manager, which is why he needs to design and implement a strict system of money management rules. Institutional traders benefit from focusing on a single market, unlike private traders who may jump from cocoa today to IBM tomorrow. It pays to choose just a few trading vehicles and learn them well.
Institutions are busy scalping, and a private trader is better off keep ing out of this area to avoid getting trampled. If you see a trade that offers only a few ticks, it is safer to pass it up because the institutions can barge in at any moment. The longer your timeframe, the less com petition you have from them.
Private traders have one enormous advantage over institutions, but most of them toss it away. Corporate traders must broadcast their bid and ask in order to maintain a presence in the markets. "How are you for 5 dollar/yen," calls a customer, wishing to trade $5 million for yen or vice versa. The bank trader must quote his bid and ask, ready to take either side of that trade. He must trade at all times, while a pri-vate trader has the luxury of waiting for the best moment.
You are under no obligation to buy or sell. You have the freedom of standing aside, but most private traders throw away this awesome advantage. People get sucked into the excitement of the game. They jump in instead of waiting for the best trades. Remember, the idea is to trade well, not to trade often.
Getting the Data
Real-time data tends to be pricey, and you must cover its cost before taking home a dime. Many exchanges make fortunes selling real-time data, forcing vendors to delay free broadcasts to the public. The 20minute delay preserves entertainment value, but trying to use that data for day-trading is like driving a car with cardboard for a windshield, looking out through a side window. Day-trading is a very fast game, played by some very clever people. Trying to compete against them on the basis of delayed data is a joke.
Most day-traders use software to display, chart, and analyze their data. Real-time analytic software has been around for years, but the great NASDAQ bull market led to an upsurge in the popularity of Level 2 quotes, which show who is bidding and offering what stock trading tracking. This is ballyhooed as the new road to riches. Most of those riches go to vendors and brokers who benefit from hyperactive trading. I haven't noticed any improvement in the overall performance of private traders with Level 2 quotes. The early users may have had an advantage a few years ago, when the concept was new, but once it became popular, the edge disappeared. This is a common story with new technologies-early users get an edge, the tool becomes a fad, and the edge fades away.
A day-trader needs a dedicated computer, good analytic software, and a fast connection to the Internet. This setup may cost several thousand dollars, plus a monthly bill of a few hundred dollars for live data and exchange fees. You can reduce the cost of data by following just one market, which is not a bad idea because it helps keep you focused.
Some professional futures traders dispense with computers alto gether. They quit their day jobs and go on the floor. Some move to a city that has an exchange where they buy or lease a seat. Costs are higher on bigger exchanges that handle high volumes in popular mar kets, and cheaper on smaller exchanges in lesser markets. The best way to learn is to get a job as a clerk on the floor and work for some one, but this option is open only to the young-the floor generally doesn't hire people over 25. They want them young, pliable, and with out any preconceived ideas.
Psychology
The great paradox of day-trading is that it demands the highest level of discipline, while attracting the most impulsive, addictive, and gamblingprone personalities. If trading is a thrill, then day-trading provides the best rush. It is a joy to recognize a pattern on your screen, put in an order, and watch the market explode in a stiff rise, stuffing thousands of dollars into your pockets. A former military pilot said that daytrading was more exciting than sex or flying jet aircraft.
Corporate traders are in the market because their companies gave them jobs. Private traders enter for reasons that are partly rational and partly irrational. The only rational reason is to make money, but a prof itable day-trade delivers such a great high that it sweeps most people off their feet. Flooded with pleasure, they go looking for the next high and lose money.
The purpose of any business is to make money. A well-run business also gratifies many of its owners' and employees' psychological needs, but money is the pivot of the enterprise. Traders who become hooked on thrills take their eyes off the money and jump into impulsive trades. Vendors encourage day-traders because losers spend like drunken sailors on software, data, systems, and even coaches, most of whom have never traded or busted out. Go into any port area, and you'll see plenty of bars, brothels, and tattoo parlors. Go into day-trading, and you'll see more vendors than you can shake a stick at. There is money to be made from turkeys whose market life is measured in months or weeks.
Successful day-traders test patterns and systems, measure risks and rewards, and focus on building equity. Winners tend to be emotionally cool. If day-trading attracts you, you must answer several questions:
Are you successfully trading with end-of-day charts? If the answer is "no," stay away from day-trading. You need a minimum of one year successful trading experience before attempting to day-trade. Do you have an addictive streak? If you have a history of drinking, drugs, overeating, or gambling, stay as far away as possible from day-trading because it will trigger your addictive tendency and destroy your account.
Do you have a written business plan? How much money will you trade? In what markets? How will you choose entries and exits? How will you manage risks, use stops, and allocate capital? Do not go near day-trading without a written plan. Be sure to keep separate records for day-trading and position trading. Find out which one is more profitable for you.
Choosing the Market
Day-trading compares to position trading like flying to driving. Comfortably seated behind the wheel of a car you can lean back, listen to music, use a cell phone, and even glance at a magazine while stopped at a red light. Do not attempt that in a jet.
Day-trading demands total concentration on a single market. It is like serial monogamy-you may trade several markets in your career, but only one at any given time. What market will you choose? The two essential features of a good day-trading market are high liquidity and volatility.
Liquidity refers to the average daily volume of your trading vehicle- the higher, the better. It is easy to join a huge crowd and just as easy to leave without drawing attention to yourself and distorting the mar ket with your order. When you place a market order to buy or sell a thinly traded stock or a commodity, you give the pros a license to skin you alive in slippage. If you use a limit order, it may never get filled. Trading a big liquid market, such as IBM or soybeans, allows you to get in and out more easily with less slippage.
Volatility refers to the average daily range of your trading vehicle. The greater the distance between the high and the low of the day, the bigger your target. Shooting at a big target is easier than shooting at a tiny one. Remember our discussion of channels? If you know how to trade, you will get more money from a wide channel, at any level of skill. Someone who trades at C level and takes 10% from a channel will get 1 point from a 10-point channel, but 2 points from a 20-point channel. A C-level trader has no business day-trading, but even an A trader wants as big a target as possible.
You can find good liquidity and volatility in the leading stocks, futures, and currencies. Another important feature of a day-trading market is its personality. Some markets move smoothly, others like to jump. Bonds, for example, tend to spend a day or two in a very nar row range, then explode, moving more in half an hour than in several preceding days, and then fall asleep again. Trading them is like infantry fighting-90% sheer boredom and 10% sheer terror.
What markets should you day-trade? In stocks, look at those that show up on the list of the most active issues of the day. That's where the action is. These stocks' liquidity is very high, and their volatility tends to be good. Explore the list of top gainers and losers for the day. When the same name shows up on that list day in and day out, it is clearly among the most volatile issues, with great day-trading potential.
When it comes to futures, make your first steps in such relatively peaceful markets as corn, sugar, or copper. Once you've learned the ropes, consider moving up to stock index futures or the futures on the German Bund, both among the favorite vehicles of professional day-traders.
Analysis and Decision Making
If you remove price and time markings from a chart, you won't be able to tell whether it is weekly, daily, or intraday. Markets are fractal, to borrow a term from chaos theory. To recall our earlier discussion, the seashore is fractal, since the coastline looks equally jagged from any height. Since charts in different timeframes are so alike, we may analyze them using similar methods.
Coming to day-trading after a year or more of successful position trading gives you a great advantage. You can use the same methods, and only have to speed them up. You can use the principles of Triple Screen to make strategic decisions on longer-term charts and tactical choices on shorter-term charts.
SCREEN ONE
Analyze your market on a longer-term chart, using trend-following indi-cators, and make a strategic decision to trade long, short, or stand aside. Choose the timeframe you prefer to trade and call it intermediate. Let us select a five-minute chart for our intermediate timeframe, with each bar representing five minutes of trading. You can choose a longer chart if you wish, but not much shorter, as that might pit you against insti tutional scalpers. To stand completely apart from the crowd, you may select an unorthodox length, such as seven or nine minutes.
Some day-traders, intoxicated by the promise of technology, use one-minute or even tick charts. These provide the illusion that you are present on the floor, even though it can easily take half a minute or longer for the data to be keyed in, uploaded to the satellite, and broad cast to your screen. You are not on the floor, you are behind. When markets begin to run, time lags get even worse.
Multiply your intermediate timeframe by five to find the long-term timeframe. If your intermediate timeframe is five minutes, use a 25minute chart. If your software does not allow plotting 25-minute charts, round it off to half an hour. A successful trader needs to stand apart from the crowd. This is why it pays to use uncommon parameters for charts and indicators. There are probably thousands of people using half-hourly charts, but only a tiny minority uses 25-minute charts and gets its signals a little faster.
Apply a trend-following indicator to the long-term chart and use its direction to make a strategic decision to trade long, short, or stand aside. Start with a 20or 30-bar EMA and adjust its length until it tracks your market with a minimum of whipsaws. When the 25-minute EMA rises, it identifies an uptrend and tells you to trade from the long side or stand aside. When the EMA falls, it identifies a downtrend and tells you to trade only from the short side or stand aside. Make a strategic decision on this long-term chart before returning to your intermediate-term charts.
Successful day-traders tend to rely less on indicators and more on chart patterns. The gaps between trading days can distort intraday indi cators. Still, some indicators, such as moving averages and envelopes, also called channels, are useful even with intraday charts.
SCREEN TWO
Return to the intermediate (five-minute) charts to look for entries in the direction of the trend.
Plot a 22-bar EMA on the five-minute chart and draw a channel that contains about 95% of price action. Moving averages reflect the average consensus of value, while channels show the normal limits of bullishness and bearishness. We want to get long during uptrends, buying below the EMA on a five-minute chart, and short in downtrends, above the EMA. Do not get long above the upper channel line, where
the market is overvalued, or sell short below the lower channel line, where it is undervalued.
Use oscillators, such as MACD-Histogram and Force Index, to identify overbought and oversold areas. Trade in the direction of the tide, entering when a wave goes against the tide. When the 25-minute trading trend is up, falling prices and oscillators on a five-minute chart reflect a temporary bearish imbalance-a buying opportunity. When the 25-minute trend is down, rising prices and oscillators on a five-minute chart reflect a temporary bullish imbalance-a shorting opportunity.
Day-traders sometimes ask whether they should analyze weekly and daily charts. The weekly trend is essentially meaningless for them, and even the daily is of limited value. Looking at too many timeframes can lead to "paralysis from analysis."
Place SafeZone stops. After entering a trade, place a protective stop, using the SafeZone method (see page 173). Consider making it "on close only"; watch the screen and give an order to exit only if the five-minute bar closes beyond your stop level. This way, a brief penetration caused by market noise will not touch off a stop. Naturally, there is no bar gaining or waiting for another tick. To be a day-trader, you must have iron discipline!
SCREEN THREE
This screen handles entries and exits.
Enter in the vicinity of a moving average on a five-minute chart. If the 25-minute trend is up, buy pullbacks to the EMA on a five-minute chart, especially when oscillators are oversold. Reverse the procedure in downtrends. This is better than chasing breakouts, buying at the highs, or shorting at the lows.
Take profits in the vicinity of the channel line. If you buy near the moving average, aim to sell near the upper channel line. If your five minute oscillators, such as MACD-Histogram, are making new highs and related markets are rallying, you may wait for the channel to be hit or penetrated. If the indicators are weak, grab your profit fast without waiting for prices to touch the channel.
Measure your performance as the percentage of the channel width. You must be an A trader to make day-trading worthwhile. Even then, you have to prove to yourself that you can make more money daytrading than position trading. Try to trade only a few times a day and aim to catch at least a third of that day's range. Enter cautiously, but run fast. Do not trade during after-hours sessions when markets tend to be very thin.
Taking Day-Trades Overnight
If you enter a trade early in the day and the market keeps moving in your favor, should you hold that trade overnight? How about over the weekend? Of course, those questions only apply to profitable trades. Taking a loss overnight is strictly for losers.
A beginner must close his day-trades by the end of the day, but an experienced pro has the option of holding them overnight. When a market closes within a few ticks of its high, it usually exceeds it the next morning. A market that closes on its lows usually flirts with lower lows the next day. Those extensions are not guaranteed, as the market may close on its high, get hit with bad news overnight, and open sharply lower. This is why only experienced day-traders have the option of taking their trades overnight.
Research, knowledge, and discipline put your trades on a cooler, more rational footing. You have to research the past, calculate the odds, and make informed decisions for the future. When you daytrade, there are plenty of hours when the market goes nowhere, leaving you free to crunch the numbers. You may use a single computer or get two machines and dedicate one to trading and another to research.
Get one year's history for the market you're day-trading. Drop it into a spreadsheet and start asking questions. Every time the market closed within 5 ticks of its high, how many times did it reach a new high the next day? How far did it go the next day? What about the days when that market closed within 5 ticks of the lows? How low did it go the next day? Once you get the answers, find out what happened when the market closed within 10 ticks of the high, and so on.
Professionals tend to trade the same market month after month, even though there is a huge turnover of amateurs. Professionals have grown used to trading in a certain way, and to trade like them you must find those patterns and express them in numbers. You must base your trades on facts and probabilities, not on gut feel and hope. You must do your own research. You cannot buy the answers, because only finding them yourself will give you the confidence to trade.
Opening Range Breakouts
People get tips at parties, from the newspapers, and on TV, that gluebox of mass culture. Investment officers at slow-moving institutions may sit in a meeting all day before getting permission to buy or sell. They tend to place orders before the open. Most overnight orders come from casual investors, gamblers chasing hot tips, and brokers who want to leave work early to play golf or make marketing calls.
The two busiest times for professional traders are the beginning and the end of each session, especially the first and last half-hour periods. The influx of overnight orders gives professionals an opportunity to perform a public service by accommodating those who are eager to get in at the opening. They unwind those positions near the close, when one loser after another throws in the towel. Many pros go out for lunch in the middle of the day, which is why many markets tend to become directionless and choppy between 12 and 1:30. The curve of intraday volume tends to be U-shaped, with peaks at the open and the close, and a low in the middle.
Serious traders watch openings because they set the tone for the balance of the day. If the total size of buy orders exceeds that of sell orders, the floor opens the market higher, forcing the crowd to pay up. Pros establish short positions at such high levels that the very first drop makes them money. If the volume of sell orders is higher, the pros open the mar-ket lower, load up on the cheap, and sell at a profit on the first bounce.
During the first 15 to 30 minutes after the open many stocks and futures swing up and down on high volume. As the bulk of overnight orders gets filled, volume starts to dry up, and the swings slow down, retreating from the high and the low of the opening range. What happens next largely depends on the width of the opening range.
When the opening range is very wide, say 80% of an average daily range for the past month, it is likely to have set both the high and the low for that day. The floor loves wide opening ranges because their
extremes provide two good levels of support and resistance. The pros keep buying near the lows, shorting near the highs, and spending the rest of the day unwinding their positions at a profit. A narrow opening range makes it more likely that the market will break out of it and start a new trend for the day.
The high and the low of an opening range are like the feet of a boxer. When they are wide apart, the boxer is stable and in control, but when they are close, it is easy to knock him off balance and force him to move.
Outsiders love trends and chase breakouts, but the floor operates in a reactive mode, selling the highs and buying the lows. It prefers flat trading ranges to runaway trends. The floor usually wins, but once in a while outsiders overwhelm the pros and push the market into a trend. When that happens, smart floor traders cut their losses and run, while the dumb and the stubborn contribute to the mortality rate.
The opening range has several implications for day-traders:
The opening and closing prices, like two poles of a magnet, tend to be at the opposite extremes of a day's bar. If the market opens near the low of a wide opening range, expect it to close near the upper edge and look for buying opportunities. If it opens near the high of a wide opening range, expect it to close lower and look for shorting opportunities.
Breakouts from wide opening ranges tend to be false. When prices take out the high or the low of a wide opening range, be alert to the possibility of the breakout petering out and be ready to trade its return into the range.
When the opening range is narrow, expect a breakout and be ready to trade in its direction.
Successful traders test everything. There are hours in most days when the market is undecided, neither a buy nor a sell. Use that time to research its opening ranges-how many minutes they take to form in your stock or future, how wide they tend to be, and so on. Create a graph linking the height of the opening range with the likelihood of a breakout, and you'll acquire a private tool, a real edge in the markets.
Currencies - Trading the 24-hour Markets The United States is the only country in the world where most people don't think much about currencies. We live in the dollar universe, but the moment an American
sets foot abroad, he realizes that everyone, from executives to taxi drivers, watches exchange rates. When the people outside the United States, and even recent immigrants to the United States, get a bit of trading capital, their first idea is to trade currencies. The bulk of currency trading takes place in the interbank market, directly between dealers. Beginners turn to unscrupulous currency trading shops that bucket their orders (hold their money without executing trades) and kill them with commissions, spreads, and interest charges. Survivors discover currency futures, where spreads are more narrow, commissions more reasonable, and no interest is charged for the privilege of holding a position.
Aside from the horrors of forex shops, the biggest challenge of currencies is that they trade around the clock. You may enter a trade, analyze it in the evening, and decide to take profits the next day. When you wake up, there is no profit to be taken. The turning point you saw coming has already come and gone, not in the United States, but in Asia or Europe. Someone has picked your pocket while you slept! Markets are tough enough without exposing yourself to 24-hour risk.
Big financial institutions deal with this problem by implementing a system of "passing the book." A bank may open a position in Tokyo, manage it intraday, and then transfer it to its London branch before closing for the night. London continues to trade that position and in the evening passes the book to New York, which trades it until it passes it back to Tokyo. Currencies follow the sun, and small traders can't keep up with it. I once visited a wealthy Thai gentleman who was planning to install his two sons and himself in three different cities around the globe to trade currencies, but the boys balked.
If you trade currencies, you should either take a very long-term view and ignore daily fluctuations, or else day-trade, avoiding overnight positions. If you trade currency futures, use two sets of data. Use cash or interbank data for your weekly charts and futures data for the dailies to pinpoint entries and exits. The daily charts of currency futures are full of overnight gaps because those markets are open for only a few hours a day, but the charts of cash are smooth.
S&P 500 - False Breakouts S&P futures are notoriously hard to trade, but newcomers are drawn to them like moths to a flame. "Are you man enough to trade the S&P?!" is the battle cry of those overgrown boys. Most traders are woefully undercapitalized for this expensive contract. It is hard to see how anyone with less than a quarter million in his
account could trade a single contract of this volatile market, which often jumps several points of $250 each within minutes. The floor takes full advantage of the fact that most gamblers do not have enough money to carry overnight positions, place sensible stops, or ride out small adverse moves. The floor has got the art of shaking out inexperienced day-traders down to a science. They use false breakouts to make losers jump like Pavlov's dogs, buying high and selling low.
The floor tries to push prices through several well-known levels on most days, flushing out weak holders. There is always a mass of sell stops below the low of the opening range and the low of the day. Shoving the market through those lows leads to selling by weak holders, and the pros then buy their merchandise on sale. There is always a mass of buy stops at the high of the opening range, the high of the day, and the high of the previous day, placed by weak shorts. Pushing the S&P through those levels sets off panicky buying. That's when the floor sells short, positioning itself for the next downswing. There is nothing uniquely devious about this game, only it works especially well in the S&P because there are so many amateurs and this market is so expensive that they have no staying power.
A day-trader who recognizes the special challenges of the S&P can reach several conclusions:
This is not a good market for beginners; it is too expensive and too fast. Learn to drive an old Chevy before a turbocharged Ferrari. Have a good-sized account if you plan to trade this market. A quar
ter of a million dollars for each contract gives you staying power and allows you to place sensible stops.
Fade false breakouts in the S&P-trade against them. Use oscillators to detect when a false breakout starts running out of steam, and trade for the return into the middle of the day's range.
The Daily Plan
A day in front of a live screen includes many dead hours when nothing seems to happen. People grow bored and restless, and the next thing you know, a day-trader turns his screen into an entertainment center. Professionals tend to follow a timetable to reinforce their discipline.
Your trading day should start before the opening. Give yourself at least half an hour to assemble and analyze overnight data. Watch the first half hour of trading with no interruptions, not even phone calls. If you put on a trade, then manage it. Otherwise dedicate two hours to research, database maintenance, reading a trading magazine or a book, or trolling the net for fresh ideas, all the while in front of the screen. Suspend everything if the market looks close to giving a buy or sell signal. Have lunch at your desk if you are managing a trade. Review trading-related posts on the net and put more time into research. Consider keeping exercise equipment in your trading room, such as a stationary bicycle or a rowing machine. A healthy mind in a healthy body. As the closing approaches, the market again demands your undivided attention, especially if you are exiting a trade.
There are two reasons to have a daily plan. You need to make sure that all the necessary work gets done, trades found, placed, exited, recorded, and research conducted. The other reason is to remind your self that you are day-trading as a business and not for amusement and that you are serious about success.
Remember that your feelings, desires, and anxieties are part and parcel of the game. When feelings are unsettled, trading becomes a problem. I had a client in the late 1990s who had achieved phenome-nal success day-trading just one stock, AOL. He looked at yesterday's closing price, checked the levels at which AOL traded in Europe, and reviewed any overnight news. When AOL shot out of the gate after the open, he traded its first swing, and sometimes two or three more during the first 30 minutes or an hour. He grossed $5,000 almost daily within the first hour of trading, buying and selling 1,000 shares at a clip. Then he spent the rest of day pissing that money away and losing!
When he came to consult me, it was obvious that his system worked well only during the first hour. It tracked an overnight buildup of pres sure, and once that pressure equalized, he had no edge. His system was fantastically effective-as long as he stopped trading an hour after the opening. But he could not stop!
It turned out that his self-esteem was largely based on trying to win his old father's respect. The father was an immigrant who built a suc-cessful business by the dint of hard work, and he only respected men who worked hard and put in long hours. My client felt that he had to keep on "working" in the markets all day rather than turn off his computer and go outside to play golf, drive his boat, or putter in the garden. He did not want psychotherapy. I tried calling him at 10:30 to remind him to stop trading, but then he got caller ID to avoid my calls. A great system is only half the game; the other is trading psychology. The only goal of successful traders is to grow equity. Everything else, including love, respect, and so forth, has to be gained outside the markets.
