Posts Tagged ‘S&P500’

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

June 21, 2010

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!

Watching The Market Open

September 17, 2009

Just a quick follow-on to yesterday’s post on bid / ask spreads. Here’s the chart of the market opening as the spreads of all stocks on the S&P500 come closer together and liquidity comes in:

open-baspreads

S&P E-mini Futures (ES) Trades: 7-28-09

July 28, 2009

I took two trades today off the open in ES. Here’s the chart:

2009-07-28_ES_trades

I used a 133 tick chart of ES. You can see my Shaded Opening Range Indicator on there (set from 0930 to 0931), as well as my Volatility-Based Trailing Stop. I’ve also got two exponential moving averages: one is a 5 period and the other a 20 period. But instead of using the close in the EMA calculations, I’m using the pivot point of each bar, or (H + L + C) / 3. I got the idea from John Person’s book, Candlestick and Pivot Point Trading Triggers + CD-ROM: Setups for Stock, Forex, and Futures Markets. Finally, you see a study I called PACD (Pivot-based Average Convergence Divergence). Nothing too exciting–just the MACD using hlc3 to compute the EMA’s instead of close, but I changed the inputs to match the EMA’s (5, 20, and an arbitrarily chosen 5 signal line). This is showing if the 5 EMA is above the 20 EMA or vice versa, and could be used in place of the EMA’s eventually. None of this is set in stone, and it is a bit discretionary, but it’s working for me.

The first trade was a short on a pullback inside the 1min OR. The Volatility Stop was pointing short, and the NYSE A-D ratio and Tick were down and going lower. The market was fading the A-D line, but I expected the futures to fall, and 969 was the overnight low, 2 points below my target. Soon after entry, everything switched directions, but I still waited to see if it would go my way. I was within one tick of being stopped out for a bit, and then got a push back lower. I stayed with it, but in hindsight, the Volatility Stop switched directions and the 5/20 hlc3 EMA’s had crossed over (or equivalently, the PACD went above zero). I should have bailed out there for a smaller 1 or 2 tick loss, but I stayed with the original stop and it was hit, -5 ticks. Then I went long on a bounce off the OR high, stop under the OR low. This time the internals were with me, and the PACD and Volatility Stop were as well. I set a profit target for 8 ticks, and was filled. If I had margin for multiple contracts, I could have traded two, sold one at this first target and let the other go with a trailing stop, and I could have had a point or two more, but I’m happy to stop with a net positive day at +3 ticks or 0.75 points. For my personality and where I’m at as a trader, I’d rather be net positive by a fraction every day than be up big some days and down big some others. That will change down the road as I pursue net profit over time as the primary goal, but consistency and confidence is what I want to gain right now, not bags of money. Consistency first, moneybags afterwards.

My strategy lately has been to play for smaller profits, and keep wider stop losses–the exact opposite of the 1:5 Risk:Reward home run trades I have historically tried. I never would hit my targets, and I often got stopped out. So I’m bringing the two closer together, and it’s working. I intend on watching the tape and getting out in a controlled manner (like I should have on the first trade) if things aren’t shaping up as planned. The stop loss is just in case of disaster. I also don’t get greedy and take the money when it’s there at a closer target, which is different than in my past. So far so good!