In this article I look at some of my favourite intraday trading patterns including naked price action patterns and Japanese Candlestick patterns. Read more »
It was November 2008 and I was a graduate futures trader for a trading house in the UK. I’d been trading full time for only a couple of months.
The credit crunch was in full force and every day presented new challenges and headaches.
Until Lehman Brothers collapsed I had been doing well. Trading a small account, I was happily bringing in a reasonable £300 a day.
Then, everything changed. People thought the financial system might collapse and the markets went into chaos. The FTSE 100 would drop massively in the space of a couple of minutes.
Then, it would reverse almost as fast, for no other reason than traders being too scared to hold on to their shorts. Read more »
Building an intra day trading system for trading futures, stocks, or forex is no easy task and many would say that in today’s markets it’s simply not possible.
For one thing, the markets are not at all like they used to be.
As I mentioned in a previous post, I do not classify day trading as an easy route to riches. However, if you were to ask me what my favourite approach would be, I would say pivot points. In this post I will illustrate how to use pivot points in trading stocks and forex.
Pivot points can be calculated on most charting packages now but it’s still handy to know the exact formula so you can calculate them yourself, so here it is:
In essence, I think pivot points work quite well because they are always adapting to recent price action. They are also watched by lots of professional traders and because of that I think it gives them more significance.
Traders can use pivot points in different ways. Personally, I find them most useful as profit targets because when a market hits a pivot level it nearly always holds up there for at least a short period of time.
I tend to be bearish on a market so long as the price is below the pivot and bullish so long as the price is above the pivot. I also like to combine pivots with other indicators and to watch the news.
For example, if the market drops through the pivot on some significant piece of news I will often short the market and look to buy it back on one of the support levels. Depending on the momentum of the market, I might take all the position off at the second resistance/support or I might take half the position off. Indeed, I might hold out for the third level if price action is really moving.
Rarely, if volatility is dead, I will take a position off at S1 or R1.
Watching momentum is therefore very important when using pivot points and it’s also a good idea to watch the ATR. That way you can see what is happening to volatility. If volatility and momentum are tapering off it’s a sign to exit your trade more quickly.
In order to illustrate how to use pivot points in trading I thought it would be a good idea to show some examples from last week. These charts are all taken from the same period. You’ll notice from these charts that pivot points do get hit a lot of the time.
As can be seen in the next chart, pivot points often produce uncanny levels in which to enter or exit a market.
On the 29th July, the pivot, or just below it, would have been an excellent place to sell and the third support (S3) would have been a great place to close the trade, making around 30 pips.
On the 30th, the market declined and bounced off the second support and on the 31st the market stayed around the pivot for most of the day.
On the 1st August, the currency pair pushed through the pivot in the morning and moved right up to the third resistance, giving a trader 40-50 pips if long.
During the same period, the pivot also acted as a strong level for GBP USD.
On July 29th, the market dropped 60 pips from the pivot to the third support and on the 30th the currency moved up to the pivot before falling back to the second support.
On the 31st, GBP USD hit the pivot in the morning then moved down to the first support where it consolidated.
And on the 1st August, the currency touched the pivot in the morning then moved lower throughout the session, closing right on the second support. The second support (S2) was a great place to take profits.
As you can see from the next chart, a similar story unfolded for the Kiwi US dollar pair.
On most days, the key pivot levels provided great places to enter buy and sell orders and take profits.
On the 29th, the currency fell through the pivot all the way to the second then third support.
On the 31st, the currency turned back off the first resistance to the pivot and on the 1st August the currency moved between the first support and first resistance.
As can be seen, pivot points can work in volatile as well as trending conditions.
In previous articles I have blogged about the high risks involved with day trading. I have also spoken of my preference for trading strategies that combine both technical analysis AND fundamental analysis. Much like Bruce Kovner in the original Market Wizards, I find that fundamentals can add real strength to technical trading systems by first eliminating overpriced companies. In this article I will talk about a simple trading idea based on both value and trend.
The biggest problem that day traders have to overcome is the cost of trading.
Commissions and wide spreads mean that day traders need to stick to shares with high volumes and tight spreads. This narrows the playing field and means traders should stick to the most well known companies such as Apple, Exxon or Google.
The second biggest problem day traders face is psychology. Day trading is inherently stressful and can chew up and spit out even the best traders if they don’t have a strong plan. It’s for this reason that most traders benefit from implementing some sort of system.
There are many important components to a successful trading strategy but I suggest that none are as important as this:
The direction of the long term trend.
Fundamental and value traders can complain all they like but the fact is, markets move in irrational ways, particularly in the short term. Trading the trend is therefore the most reliable method for day traders. In fact, if you can correctly ascertain the long term trend you should be able to make money at least 70% of the time.
Take the S&P 500 for example. How much money would you have made by going long the index every day during the last bull market? A lot, I’m guessing.
Nevertheless, it is true that a buy and hold strategy can outperform strategies that move in and out of the market, especially when costs are taken into account.
I therefore suggest that fundamentals should be used in conjunction with looking at the long term trend.
Specifically, the idea of this strategy is to identify high volume stocks that are good value and moving in a clear direction, up or down.
The first step is to focus only on the stocks that trade the tightest spreads (0.1% or less). We can then do a stock screen on these companies to find those that are cheap on a valuation basis.
For this I will use the stock screener at finviz.com and I will only consider stocks with a PEG ratio of less than 1. This will bring up a list of stocks that we can at least say are not expensive.
Now, get rid of any stocks that have an RSI above 70. We don’t want to be buying anything that is overbought already.
Just these three steps are likely to reduce the list down to only a handful of companies. Look at each one and decide which one is showing the most consistent long term trend.
If all these steps are in place and the 20 day EMA is above the 50 day EMA, then you buy on the open and sell on the close. If the stock happens to go down two days in a row, you wait until it has at least two more up days.
And that’s it. A simple day trading strategy that relies on value and the long term trend (in my view the most important consideration for a trading strategy).
Now I don’t know if this strategy would work or not as I haven’t tried it. But the chart of Apple indicates that the idea might be worth exploring. Setting the strategy up in code and putting into a back tester to test on past data will be the next logical step.
I worked as a futures day trader for a year between 2008-2009. It wasn’t a particularly good time to start in the markets because the volatility from the credit crunch was intense. Having said that, some experienced day traders really benefitted from the increased volatility and made a lot of money.
Nowadays, I do very little day trading. I have the upmost respect for day traders who are able to make it work but it’s a style of trading that just isn’t for me. I have a hard time sitting in front of a screen all day watching price movements which is why I prefer slightly longer time frames.
Day trading is basically very difficult and most of those who try it will fail.
When I first started trading I was given two products to focus on; German Bunds and London’s FTSE. These are popular futures for day traders in Europe as they are highly liquid with tight spreads. On occasion I would also trade the Dow, GBP/USD and STIRs (UK short term interest rates). We had one Bloomberg Terminal in the office and would use E-Signal and Trading Technologies to play the markets. We also had a squawk box, CNBC and 4 screens each.
Of course the simple answer is that not everyone can day trade futures. To be able to trade futures our firm had to have a large margin account with our clearing broker. Upwards of GBP30,000.
Aside from that there are high daily costs with futures trading. To trade at our firm the desk fee was around GBP100 per day and that was cheap compared to most other brokers.
This was the desk fee and included trading software, data, phone line and connections to the exchange etc. Comparatively, the cost to trade was very small at just GBP$1 per trade per contract (GBP$2 for a round trip).
So for the ordinary retail trader it’s not possible to trade futures. But, it is possible to trade futures products in other forms for example as CFD’s, spread bets, spot products or ETFs.
By using a spread betting firm or a CFD provider it’s possible to trade the FTSE100, the Dow, German Bunds, Gold or any of the popular futures products.
It’s worth noting that the spreads on these products are higher than they are for futures traders. But on the flip side, the fixed costs are much lower – no $100 a day desk fee, no huge margin requirement and there’s no concern about rolling over different quarter futures contracts.
Without doubt, day trading is a difficult thing to do. I don’t recommend day trading for most people but from my experience, the most successful day traders are those who possess the following skills:
The best day traders are those who focus on just one or two products. They watch the tape each day (not just the chart) and get to know them inside out. By doing so they are able to trade with a high level of gut feel. That level of intuition can’t be taught, it only comes from studying the product and some traders may never learn it.
One of the keys to successfully day trading futures for a living is having the right mentality. Successful day traders take responsibility for their trades and trade with a huge amount of discipline. Most importantly, successful day traders do not self sabotage. They have a high level of self confidence and make sure that they are compensated for the risk that they take on. They don’t gamble and they understand the relationship between risk and reward.
Number of trades
If you’re a futures trader on a desk you can place more trades because the cost per trade is smaller (although that doesn’t mean you should). On the other hand, if you’re trading CFDs, spot products or spread bets, you need to seriously cut down on the number of trades you make a day. Spreads on the major forex pairs and stock markets are low but they are not insignificant. You should try and make only one or two trades a day if you want to consistently make money.
Another thing successful day traders need is a good appreciation of the fundamentals. To be sure, technical levels are very important for short term traders but fundamentals also need to be understood. Knowing how to react to certain news releases and events is essential. Combing fundamental and technical is the best way.
Day traders need the flexibility to go with trends or to trade against the flow. Short term markets are choppier than long term markets and traders need to be able to switch from long and short easily. They can’t get caught up only playing one side of the market and they should cut losses quickly. Pivot points, moving averages and RSI are good indicators for day traders.
A lot of people get confused with day trading, primarily because of the way it is portrayed in the media. It’s important to understand that 90% of traders at investment banks like Goldman Sachs and Citigroup are not engaged in real, directional trading. What they actually do is make the market for their clients. They quote prices to their customers and take a couple of points profit from the spread.
Let’s look at an example. Say a customer rings up Goldman Sachs and wants to buy Apple stock. The trader at Goldmans simply buys Apple direct from the exchange for $90.50 and sells it to the customer at $90.60, thus making a risk free $0.10 per share.
Bank traders have direct market access and this model is how most investment banks run their books. They also use order flow and volume to further reduce the risk of their trades going wrong but this is essentially a very low risk business model.
So, this is how Goldman Sachs are able to go weeks at a time without having even one losing day. Real, directional trading can never have such a successful win ratio.
Getting into day trading?
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I just finished reading about a study that showed many people would rather inflict pain on themselves than spend 15 minutes alone with their thoughts. It’s obviously an interesting study for a number of reasons and I think it contains some insight for traders too.
Researchers from Virginia and Harvard University took 200 people and ran 11 different experiments to see how people reacted to being put in a room alone, for six to 15 minutes with nothing to do.
The study found that at least half found the time alone unpleasant and that “most people do not enjoy ‘just thinking’ “. Another test found that students preferred hearing the sound of a scraping knife to hearing no noise at all.
But the most interesting part of the experiment came when researchers asked participants to rate various stimuli, from attractive photographs to the experience of feeling an electric shock. Participants then felt the shock, and many said that they would rather pay $5 than feel it again.
Then, when each participant was instructed to go into the room alone, they were told they could give themselves another shock if they desired.
Amazingly, two-thirds of men gave themselves at least one electric shock while alone in the room and one ‘outlier’ shocked himself 190 times!
In comparison, a quarter of women chose to shock themselves rather than sit quietly doing nothing at all.
– All of those who shocked themselves had previously said they would have paid to avoid it.
Co-author of the study Erin Westgate said she is still amazed by the findings. “I think we just vastly underestimated both how hard it is to purposely engage in pleasant thought and how strongly we desire external stimulation from the world around us, even when that stimulation is actively unpleasant.”
I have to say that I found this particular study fascinating as it seems that as humans, we simply have a huge intolerance towards boredom. So much so that we would rather cause ourselves physical pain than do nothing at all. This dilemma can be seen in trading.
How many times have you been in front of a quote screen and had the urge to trade? It’s exactly the same as what happened in the experiment. You don’t want to just sit there doing nothing, so you start thinking of trades and putting orders into the market. But as we all know, money can never be made trading like that.
Successful trading requires a great deal of patience and a lot of time waiting for things to happen. As Jesse Livermore says in Reminiscences of a Stock Operator: “It never was my thinking that made the big money for me. It always was my sitting.”
Good trading therefore is boring. It is disciplined and done with a clear methodology. If it is exciting and risky then it’s gambling.
The solution for traders is pretty simple.
Firstly, recognise that as humans we are no good with boredom. By recognising this fact, you can stop yourself from trading for the sake of it. When staring at a quote screen you can then trade with patience.
(It’s likely that if the participants in the above study knew what was going on then they would more easily have sat through the time alone without needing to buzz).
Second, remove the opportunity for boredom. Take down all the screens. Make trading a part-time activity. Or create a system that does the trading for you.
Don’t be the guy who makes 190 trades a day because he’s bored.