Just 2 NQ Points A Day

Just 2 NQ points a day. That’s all I ask. Instead of trying to get every last tick out of a given move, I am content to consistently pull out a little bit, over and over. This is the intent of the strategy.

The strategy is based on these market attributes:
1. The index futures (NQ Nasdaq emini in my case) tend to back and fill a lot. One way trends are (relatively) rare. Important price levels are revisited over and over again.
2. Market prices tend to move. Price doesn’t hold still for long.

Two points and then quit for the day should be achievable almost all the time. I just want to make chip shots. Just be consistent and do it over and over.

On a 5 min NQ chart, around half of all the bars are wider than 2 points:

The average daily range for NQ lately is near 40:

A two point target is in the noise. But that’s the point: Instead of trying to drink every last drop of a passing river, I want to dip my cup in and just catch a little of what is flowing by. I don’t need to catch an entire wave. Just a little portion of it.

All this time as a loser, I have been trading in hopes of catching a big move. I might have a 5 point target and a 2 point stop. I was constantly setting myself up for failure. I would enter at the market and hope for a big move, ready to take the small loss if need be. That risk:reward might look attractive, but my stop was being hit nearly every time.

So I literally faded my strategy. I looked at the current market, and placed limit orders to fade moves roughly 3 points away from the current price. That put my entry at pretty much exactly where my stop loss would have been if I traded my old way. Once one of them hit and was filled, I set a disaster stop of 5 points (basically an arbitrary number at this point), and a profit limit order just two points away from my entry. Then I sat and waited. My profit target would be hit more than 80% of the time. If the market kept going against me, I waited for it to come back. I honored the disaster stop, but in the first 18 paper trades it was never hit. Most of the time, I could get out for break-even or just a small loss close to 2 points. That exit for a small occasional loss is exactly where my trailing stop for a profit usually was under my old strategy.

To avoid fading a strongly trending market and getting my disaster stop hit, I didn’t use this method near the open or market close. I avoided fading near the highs/lows of the day. I waited for the afternoon doldrums and tried when the market was listless, choppy and noisy, putting conditions in my favor.

Another positive element in this strategy is the very short time that I am exposed to the market. In some of the engineering applications I encounter in my work, a trade-off is made between accepting risk vs. having reduced performance. A probabilistic design method is employed. Instead of designing for the worst case failure mode at the worst possible time in all conditions, we look at the probabilities that these conditions may overlap. If the worst case failure only happens at very extreme conditions, and a vehicle only spends a tiny fraction of a percent of its service life at that condition, designing for this condition puts a large burden of weight and performance reduction for the entire class of vehicle across the whole service life. We can slim down the vehicle by only designing to a probabilistically acceptable failure condition. We still have to avoid a disaster, so we make sure any failure is not catastrophic by keeping enough margin in the system. We just allow a failure to cause an aborted mission or acceptable amounts of damage. Back to my trading: most of these trades last only a few minutes or so. While big adverse moves happen in the market, the odds that one of these moves come during the few short minutes that I am exposed to the market are very small. If I’m always in the market and holding positions, then the odds are high. But the shorter my exposure time, the smaller the probability of a big event becomes. Since the probability is not zero, I still have the disaster stop, just like in the vehicle design. LTCM didn’t have a disaster stop. They KNEW that it was statistically “impossible” that they would see the conditions that would blow them up. I am not naive like that. A non-zero probability is still possible. You have to prepare against it even though you will probably rarely see it.

The biggest weakness I see is if I end up fading a persistent trend. I’ve paper traded this strategy a bit, and on a strong trend day it’s easy to rack up two 10 point losses in a hurry. That wipes out a lot of winning trades. This strategy would be best used during choppy sideways markets. How to rigorously define that is not clear to me. I guess that’s where I often get hung up. I can’t know exactly if a move will turn out to be an adverse trend every time. I have to define a way that works much of the time an accept the few times it when it doesn’t. I want to take discretionary elements out for now. The book “Trading in the Zone” is helping me to think more probabilistically rather than in “right or wrong” terms.

So the idea is literally fading my old self to have a winning strategy. I’ll be doing some back testing with it soon. If you have any comments about this
approach, I’d love to hear them.

Trading System Thoughts: Context and Using Cumulative Tick on ES/NQ

My time is being stretched in many directions–custom projects, donor requests, beginning iPhone app development, and working on my own trading skills. This post is one focused on my recent trading thoughts.

First, an unsolicited testimonial. I’ve been part of Richard Todd’s Move the Markets Team for a while now. I find it to be incredibly valuable. If you are looking for a community of experienced traders that are serious about improvement, both of themselves and of newer members, look no further. I recommend it highly. There are a lot of free areas to start with, and if you want to go deeper, he charges a modest monthly fee for full access.

As part of a conversation I had recently with Richard, I was once again reminded about the importance of market context. As I talked about in my WWJT posts, in a trending market, almost ANY trend-following setup will work. In a choppy environment, almost ANY trend-following setup will die horribly. The specific setup DOES NOT MATTER. There is no “best” set of parameters to filter out the losers on a setup basis. The problem is not with the setup, it’s with the market context. A raincoat is not the best clothing to wear on all days, just on rainy ones. Flip flops are ideal footwear on the beach, but not for climbing Mt. Everest. You pick your clothes based on the weather context you expect to encounter. Don’t agonize over whether a blue raincoat or a yellow raincoat works best, and don’t look for the magic set of sandals that keep you warm even on a snowy day. Metaphor overload, core dump…

The most important thing is to identify when the markets are likely to trend, and then to apply a trend-following setup (buy a pullback in a trend, buy a breakout, etc.) or sit out. Conversely, identify when the markets are choppy and listless, and apply a range-bound setup or sit out. I have demolished myself in the past two Augusts by playing dummy trades (trend continuation) in a seasonally flat and choppy market. I get stuck in the trap of obsessing over the entry, target and stop parameters, so I needed this reminder to get back on track.

I believe your time is best spent practicing contextual skills rather than mining for the Holy Grail setup or magic parameters. Try these steps:

1. Become proficient in identifying chop and trends after the fact. This one should be relatively self evident. Look at the day’s chart after the close, and annotate where the trends were, and where the chop was. Continue to do this on intraday charts until you can do it instantly and effortlessly.

2. Go to live data and practice identifying whether the market is in a trend or in chop RIGHT NOW. Don’t worry about if the market is going to keep trending or keep chopping. Just correctly identify what it is currently doing. Continue until you can do it instantly and effortlessly.

3. The last step is to start to try to predict what is likely to happen next during the day. Will the trend be likely to continue? Will the range probably be broken? Many things can give clues to this including volume, time of day, support/resistance levels, tape speed, pending news announcements, and so forth. Along the way you should also gain the skill of predicting whether a trading day may be trending or choppy before the day begins, and also knowing what events and price levels would imply a change to that prediction. This one can take years of screen time to become proficient. Patience and work are needed! I have started to notice myself having the beginnings of this skill. I can only chalk it up to screen time. Watching what has worked, what has failed and what has generally happened in the past. Feeding years of price data into the most complicated neural network there is: the human brain.

Note that in all of these things, I have mentioned words such as “likely to continue” and “probably”. None of this is an exact, deterministic science! You also have to be able to think, make decisions and accept outcomes probabilistically. That means that the specific outcome of any one event does not determine whether a probabilistic decision was the right one or not! In a deterministic situation, the outcome judges the decision. Gravity always pulls you down to the earth, 100% of the time. Jumping off a cliff is always a bad idea, because you will always plunge to the bottom. In a probabilistic situation, it’s the odds up front and the information you had at decision time that say whether a decision was the right call or not. The odds will play out to a degree of “rightness” in the long run, even though you may be taking a beating in the short run. This way of thinking is very difficult for many to attain, including myself. My Outcome Simulator is one tool that can help. The excellent book Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude by Mark Douglas is another good resource. But unless you are hard-wired this way, and most of us aren’t I would imagine, this takes PRACTICE.

Now, I’ve been watching the cumulative tick on ES 5 minute charts. I’ve noticed a couple of things. Assuming that the context is a trending market, the cumulative tick does well at picking the trend direction and also giving an entry spot. If the cumulative tick changes from bearish to bullish, then buying the first DOWNWARD tick spike across the average of the tick lows gives a great entry point. You are basically buying the first pullback in what you hope turns out to be a new uptrend, but are using the tick to tell you when the pullback is in play instead of choosing it based on price alone. If you continue to get downward tick pressure on the next bars, that clues you in that the uptrend may be failing. Otherwise, buying should pick back up and you have a winner in very short order. This strategy would work great with a partial exit, taking some off after some number of points and trailing the rest. Here’s an example paper-trade I took in the NASDAQ-100 e-minis (NQ) today:

I bought the gap fill on a tick downspike (gray oval). The tick downspike is the entry signal, but the reason for the trade is the context: I didn’t buy the first downspike because we were still in space over the gap. The second tick downspike was the first retrace to yesterday’s high. Also, a strong opening gap = bullish tones for the morning, so that said to fade the downspike, not go short. I expected a bounce, and we got it, all the way to new highs, even! Opening gaps that clear the prior day’s highs and lows are typically strong. Gaps inside the prior day’s range are less so.

Back to the trade: Ended up “buying” 1 tick above the day’s low so far (!) I traded 2 contracts, both with a 2 point initial stop. One I “sold” after a 3 point target (first green oval) and the other I put on a 3 point trailing stop and “sold” much higher (second green oval). Net +12.5 “points”.

I’ll be posting more charts and a modified cumulative tick indicator sometime over the next week. I’ll also be working on my market context skills, because that is the only effective way to minimize your losing trades, and is the foundation to using a setup in the right way. My ultimate goal is to choose a trending setup and a chop fade setup, know when to use them, and then consistently apply them, accepting the outcomes as they happen. That should be my last hurdle to arrive at net profitability. It’s been a long, hard journey, but I think I can see the oasis from here!

Draft Trade Plan

This is a draft of my trading plan. It’s not complete and is more of an outline than a finished document, but it gives you an idea of my thinking to this point. One trade setup is detailed–buying/selling the pivot point. If price does not come within my parameters, I’ll sit on my hands at this time. I would add other setups to the mix after being able to show a profit with this one. This trading strategy is designed to be used during range-bound market days, and the parameters below define the structure that I will operate in. Future setups will be intended to address other market environments.

NOTE: Trade plan may only be changed outside of market hours! Trade plan will be followed when markets are open, or no trade.

Vital Plan Elements
1. What Trading Vehicles:
-ES, NQ

2. Position Timeframes:
-Intraday only. No overnight holds.
-Chart period: trades will be taken on a 5 min chart for ES and NQ.

3. Long Setup Description and Parameters:
PIVOT TRADES
-Above daily pivot level=long only
-No countertrend trades
-Entry setup: Long at pivot point plus 1 tick if volatility based trailing stop is long-biased and lies below the pivot.

4. Short Setup Description and Parameters
PIVOT TRADES
-Below daily pivot level=short only
-No countertrend trades
-Entry setup: Short at pivot point minus 1 tick if volatility based trailing stop is short-biased and lies above the pivot.

5. Stop Loss Parameters
-Use either fixed stop of 5 NQ or 2 ES points
-Or use the volatility based trailing stop
-Whichever is closer to market price.

6. Profit Target/Partial Exit Parameters
-Partial exit at TICK fade extreme (full exit if only 1 contract in position). Tick fade extreme is a bar where the TICK got beyond a threshold value of +/- 1000.
-Target is next pivot level (eg R1, S1)

7. Position Sizing Parameters–initial size, increase/decrease base size, add size parameters
-Base size: 1 contract
-Base size increase/decrease: when account crosses contract margin levels
-Add trade size: None currently. No adding to positions.

8. Overall Risk Parameters
-Two losses in a row = quit for day
-Down 2R for the day = quit for day

9. Valid trade entry days/times
-No entries between 12:00-1:00 ET (11:00-12:00 CT)
-No entries after 3:30 ET (2:30 CT)
-Flat before Fed/other big news announcements

There it is, a line in the sand. It’s imperfect and not optimal, but it’s something, which is better than the trading plan vapor-ware I have had up to now. Feel free to make suggestions or criticize it. If I can’t think of a good reason for why I wrote something, I probably wouldn’t want it in there anyway.

Testing a New Trading Strategy

I’m starting to look at some different things for my trading plan. I have the beginnings of a strategy starting to come together. With my emotional makeup and out-of-phase intuition, a mechanical system, even if I am manually executing it, is absolutely essential to me at this time.

I have a simple mechanical entry indicator, a mechanical trailing stop, and a situationally-based pre-emptive profit target exit. I ran a study on NQ 5 minute charts over the last 20 days, long side only so far. Here’s the intital results for one contract:

Strategy Report
Symbol: /NQ
Work Time: 2009-01-08 – 2009-02-06

Max trade P/L: 684.00
Total P/L 2,751.00
Total 142 order(s)

Win rate was around 50%.

On 142 orders, that would be $497 in commissions, so net $2,254.00 on one contract. This tells me that my strategy has merit, at least for the market environment that we have had. I’ll report more on the exact strategy, along with Think or Swim strategy files, later on as things get more concrete. Plus, I’ll have more detailed reports after I get something that automatically parses the ToS strategy output.