In my three years of day trading markets in Chicago, not one person who opened an account strictly for

Transcription

1 Article Text Copyright (c) Technical Analysis Inc. 1 Day trading and short-term trading techniques Part 2 by Kent Calhoun In my three years of day trading markets in Chicago, not one person who opened an account strictly for day trading purposes lasted more than six months. Yet, the most successful traders held positions for a short-term period. Many people were good day traders but commissions and market slippage eventually took their toll. Consider the type of trading you will pursue to achieve commodity profits. The day trader and short-term trader, especially, must contend with significant physical and psychological adjustments. To me, the market is always in the process of achieving new highs/lows on five distinct levels (Figure 1). These levels are defined by the length of time during which the high or low occurs: Major - 26 calendar weeks with lower/higher prices for at least 10 calendar weeks before and after the highest/lowest price. Intermediate - 6 calendar weeks with lower/higher prices for at least 12 trading days before and after the highest/lowest price. Minor - 12 trading days with lower/higher prices for at least 5 trading days before and after the highest/lowest price. Short-term - 5 trading days with lower/higher prices for at least 2 trading days before and after the highest/lowest price. Intraday - The high and low for each single trading day. For example, an intermediate top represents the highest price in a six-week period after it has not been exceeded for 12 or more subsequent trading days. A major low is confirmed as the lowest price during the previous 26 weeks, after it has not been broken during the next 10 or more calendar weeks. My experience developing trading systems suggested the above values. Feel free to select your own, but be

2 FIGURE 1:

3 Article Text Copyright (c) Technical Analysis Inc. 2 consistent. On a historical price level, I also recognize the all-time highs and lows recorded for a stock or commodity as being very significant levels of support and resistance. Poor fills = rich brokers Fills are a constant problem for a day trader. A trader who traded nothing but the S&P 500 related to me that he lost one tick on entering and one tick on exiting the market per contract. His commission cost was $20 per contract. This meant he was a $350 loser before the trade began on his five contracts! The only solution to this problem would be to use limit orders, but these do not guarantee a fill. When day trading in a volatile market like the S&P 500, you must have your order filled regardless of price. The worst fill I ever received was from a Heinhold broker who filled my gold five-contract sell order 3.00 below t he low of the day! The broker then sent me the exchange regulation from the International Monetary Market that allowed him to do this. Eventually, the public no longer traded gold in Chicago and the pit closed due to poor fills from rich brokers. Trading the cocoa market through Stotler, I once had a sell stop hit, making my order a market order. Market orders are to be filled as soon as possible at the best price available. Five minutes and 12 trades later, my two-contract position was filled $800 worse than the stop loss order. Mr. Richard Pombanyo of the Coffee, Cocoa and Sugar Exchange, suggested I file for arbitration. To file arbitration, a trader sends more money to the Coffee, Cocoa, and Sugar Exchange for filing. The case is decided by a committee of your broker's friends and fellow traders, who often work side-by-side him in the pit. Eventually, the members of the committee may find themselves in the same position as the broker who executed my trade. My broker might later serve on the arbitration committee to decide their financial fate. I saved my money and did not file. The punishment for a bad fill is that the broker will be required to return the money he should not have taken in the first place. I believe customers should receive twice the amount they lost for a bad fill. This might slow down a few brokers in their poor execution of trades. Commission houses are powerless when bad fills hit the customer. Bary Lind, President of Lind-Waldock, was the only person who took a stand for his firm's clients. Mr. Lind did this twice for me when bad fills or non-fills cost my clients more than $1,000 per instance. Once, when a fill was a couple of ticks away from my price, I complained to the broker face-to-face in an elevator. He responded, "Do you think I paid $200,000 for a seat on this exchange to give you a good fill?" I asked him to let someone else's accounts make his exchange payments. His answer did provide a unique insight. These brokers work on the principle of social Darwinism: "survival of the fittest." Floor brokers trade contracts for less than $2 in most cases, and sometimes for free. Is it little wonder they can show a profit by merely scalping one tick from each side of a trade, when commission house day traders must make three ticks just to break even? Reward-risk ratios Designing a day trading system with a good reward-risk ratio is tough. A good trading system will be 50% accurate with a 3:l reward-risk ratio. The maximum equity drawdown should not exceed 40% of the

4 Article Text Copyright (c) Technical Analysis Inc. 3 starting balance. These parameters are not too difficult for intermediate and long-term trading systems but become more difficult when you have less time. I have developed nine intermediate systems and two short-term systems, but only one day-trading system that meets these reward-risk requirements. The systems I am going to present have been tested less than one year, but do meet the requirements. The minimum testing period for an intermediate system should be six years, but anything used for day trading should be tested for one to three years on historical data. Psychological factors Besides increased commission costs and market slippage, the third reason why day traders lose is mental fatigue. The psychological stress of day trading is horrendous. A trader never gets used to poor trade executions, whipsaw markets or the "should've-would've-could've" mentality gnawing at the edge of a trader's sanity. Intellect should control the emotion, but the psychological effect of day trading creates a gradual mental attrition that dulls the senses to the point of mental and physical fatigue. Daily exercise is mandatory for all day traders to keep the, mind alert and the body in good condition. A good health insurance plan and a psychiatrist's phone number also may be needed. If you need some help get it! Rules for day traders If all of this has not dissuaded you from day trading, here is some general knowledge I acquired during my day trading years: Always trade with the direction of the trends all of them. This old bromide is still true. A confirmed major, intermediate, minor or short-term bottom will offer buying opportunities as soon as it is they are confirmed and when previous major, intermediate, minor and short-term tops are exceeded. Look for natural support and resistance points which include today's and the previous day's, week's and month's high, low, close or open; a confirmed prior top or bottom within a limit move of today's price action, or contract high or low. Always use a stop. When large opening gaps occur above or below the previous day's high or low (Figure 2), look to trade in the opposite direction of the open. Specifically: For a $6 upward gap in gold, at least $9 from the previous close, sell the opening and use a $6 trailing stop. For a 20-tick gap in currencies, enter using a 14-point trailing stop. On sharp downward/upward opening gaps when the market closes upward/downward from the opening and mid-range, trade that market the next day short/long (i.e., in the direction from the open to the close.) If a 50% retracement of the gap occurs, expect a reaction backward toward the opening price. Record all gaps in a book for each market you trade and analyze them for patterns of behavior. You may find exploitable peculiarities.

5 FIGURE 2:

6 Figures Copyright (c) Technical Analysis Inc. 4 Do not trade any of these if the recommended stops are beyond the day's limit move, particularly if the trade is a countertrend trade. Computing day-trading stops Stops for day traders are either two or three ticks below/above the natural support or resistance points (Figure 2) or a trailing stop based on a percentage value of a three-day average price range or stops found in the opening price system described in the August issue of S&C. Remember, 85% of the time, a $2 drop from the opening price in gold means the open was closer to the high than the low of the day. Upon retracement, a sell order would be a good idea. Conversely, a $2 rise in gold after the open means the open was closer to the low 88% of the time. To use the percentage stop, first compute the three-day average range (3 DAR) as follows: Add the daily range figures from the previous three days and divide by three. Compute a profit exit point by using a 50% multiplier of the 3 DAR. For example, if the 3 DAR is 10 cents, a 50% profit exit point would be 5 cents. I used 57% of 3 DAR for a trailing stop or for short-term overnight positions. After a profit has been taken, re-enter the original position if the market corrects back to your original price and if at least one hour of trading remains. Suppose a trader expects an up day in soybeans and buys on the opening price. Using his opening price data set described in the August issue of Stocks & Commodities, he could use 6 cents for his initial stop. After the market begins to trend in the desired direction, 57% of the 3 DAR could be used as a trailing stop. A profit exit point would be 50% of the 3 DAR. Short-term trading techniques In volatile markets, profits will increase with the range, but so will the risk. In strongly trending markets, traders will be more profitable not using the profit exit points but, instead, either exiting day trades market on close, or holding an overnight position using the trailing stop as stop-loss protection. This is particularly true when going into the close of a day that either has wide range, heavy volume, a strong close above the open and mid-range or a close above the previous day's high. When the previous conditions are met, the next day's opening price should be higher in more than 70% of the cases. Next month, I'll cover short-term trading techniques, critical day-trading time periods and the half-day trading system. Kent Calhoun began his investing career in 1962 at the age of 15 A former money manager, he is now writing two books: Eight $10,000 Trading Systems and Gold Trading: A Technical Analysis Manual.