Reading Gary Smiths book “How I trade for a living”, I came across a reference to an interview with Donald Sliter, a top S&P floor trader. When asked about his trading strategy he had replied that it is a matter of understanding strength and weakness. When asked to expand on that, he said, “I scalp to the short side if we are trading weak to the Dow. I scalp to the long side if we’re trading strong to the Dow.” The interviewers were amazed that one of the biggest traders in the S&P pit had such a simple strategy.

For me, this reinforces the idea that as an active day trader of the futures market, it is not about developing complex, high probability strategies; it is about having simple, logical, high frequency strategies that give an edge. There are different approaches to creating an edge in trading. One that I like is to have a technique for determining the trend of the market and then looking for opportunities in line with the trend. One of the problems of trading trend following strategies is that they generate frequent losses in non-trending markets. One way to mitigate this problem is to not trade the signals from your trend following strategy, but use them as a filter for your trades.

Lets say you use a moving average (or any other trend identification approach) to measure trends; instead of buying the market when it crosses the moving average, see it as a signal to look for buying opportunities. So your strategy is to be a buyer when the market is above the moving average and a seller when the market is below the moving average. You can then use any number of techniques for generating entry signals in line with the identified trend. If, for example, you are a fan of RSI or any other oscillator, use that as your entry signal, but only take signals in line with the trend as you see it.

When the market is trending, your trend following technique may keep you on the right side of the market and your entry signal may produce multiple successful trades. When the market is range bound, you won’t be trading every breakout, but you may be naturally drawn to buying dips and selling rallies (in line with your trend strategy signals).

Why Day Trade the Futures Market?

Which would you rather have, a strategy that is right 70% of the time and has an average profit of £110, or a strategy that is right 45% of the time and has an average profit of £26…?

          ...Of course there is one vital bit of information missing…the frequency of trading.

If the first system (A) only trades once a day and the second system (B) trades 10 times a day, there is going to be a big difference in the outcome.

Is it going to be easier to develop System A or System B? When I explore trading ideas it is ideas that have the profile of system B that I am looking for. It is frequency of trading that is one of the most important criteria to me. To appreciate frequency, consider a casino.

The odds of the casino showing a profit on the spin of the roulette wheel are 51.35% (19/36). Now if the casino could only spin the wheel once a day, it wouldn’t be a great business, they would show a loss on nearly every other day and would make a very modest profit. On the other hand, if they can (as they do) spin the wheel once a minute, 10 hours a day, the casino will make a fortune and the odds of a losing day are negligible.

I think that we need to bring a similar mentality to trading. We do not need a system that has big average gains, we do not need a system that has a high percentage of profitable trades, we need a system that trades frequently and has an edge. (Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts) Of course to implement such a strategy we need to be available to day trade and we need a market with very low costs.

Trading the Opening Gap

I have always considered the opening price of the FTSE100 futures to be a useful indication of the overall direction of the market for the day. When the market opens significantly up or down from the previous days’ close it is either for good reason, or for no good reason. If it is for no good reason it is to be expected that the market will reverse the opening move. If there is good cause for this opening price, then the market is likely to find support (either buying for an up open or selling for a down open) and will continue to move in line with the opening move.

So when I see an opening move then I expect it to reverse, but if it finds support at these prices I expect the market to move in the direction of the open. Before I first started trading on the floor, I traded from home through a discount broker. After the usual and inevitable losing experiences trading an absurdly optimistic, over optimised, 3-period moving average system, I settled down to studying the market. I came up with a system that was based almost entirely on the opening price in the FTSE. It did not trade very frequently (which is good for an off-floor trader), but it had a high probability of success and required only a few minutes of my day. This approach worked well enough for me to recoup my previous losses and put together a big enough stake to become a floor trader 

The FTSE often opens up or down from the previous close and it seems natural that this would be the case as after the FTSE closes the US markets are still trading. So if the S&P moves up after the close of the FTSE we can expect the FTSE to open up and vice versa. I have never examined US futures in the same depth that I have the FTSE, but I was interested to read a book by George Angell called “Inside the Day Trading Game”. He discusses the concept of the “paradoxical event”, which is really about distinguishing when to fade a move and when to go with it. A paradoxical event is one when an up move is the precursor to a bigger down move and a down move is a precursor to a bigger up move. An opening gap is often an example of a paradoxical event.

Looking at the E-Mini S&P, only between the open and close of the big S&P futures, I have explored the value of the opening gap. Below is a chart that shows the overnight gap in the E-Mini S&P, the days’ gain and the results if you took a position against the opening move. So if the market gaps up, you sell the open and if it gaps down you buy the open. Hence on March 8^th, the gap is up and the market went down 5 points in the day, so by fading the opening gap, the strategy would have made a profit of 5 points.

The results for the 8 day show a profit of 12.5 points, whereas from the open of March 8^th to the close of March 19^th the E-Mini S&P only moved 3.25 points. So it would seem that the direction of the opening gap is also a useful indicator for the days’ direction, although of course a more detailed study needs to be performed to verify this.

Lost in Loss

An email in response to my last article prompted me to consider the significance of taking responsibility in trading. There is a natural tendency for most people, in any area of life, to not take responsibility for results and behaviours that appear negative. We want to see ourselves in a good light and it is tempting to try to avoid responsibility for acts that we consider bad.

I have noticed for example, that liars (I mean here people who habitually lie) do not see themselves as liars. For every lie that they are conscious of, they have their justifications. In their mind the lie would have been to save someone else’s embarrassment or disappointment; something that allows the liar to feel that not only they are not acting deceitfully, but they are actually doing a good and kind act.

I remember once a teacher at my junior school crudely picking some bit of stuck food out of his teeth. After he had finished he justified himself by saying to us (8 year olds) that he only did it because he knew that we had no table manners. We weren’t judging him; he was judging himself and using us as his scapegoat.

What we resist persists
We all lie to some degree and I don’t have a problem with that; what I do consider important is how we explain the lie to ourselves. When you lie are you honest with yourself about it, or do you make up a story to yourself so you don’t feel guilty? It is a difficult question to answer, but one that will say a lot about your trading.

The most important, the most difficult, and the first skill that a trader must learn is to cut their losses quickly. It is essential (as we all have read many, many times); we only lose significant money by holding onto losing positions. So why do so many (perhaps all) of us find it so difficult? What is it about cutting a loss that is so hard? The answer, I believe, is in what we say to ourselves about what a loss means.

It is the meaning we attach to a loss that determines whether we can accept it and let it go; or whether we refuse to accept it and in so doing hold on to it. What we resist persists. If a loss means something bad about you; if it means you’re a loser, or a failure or just no good, or doomed to financial subsistence or whatever; then you won’t be willing to accept it.

Too big
Take it to an extreme, if it was a life or death matter, if you were going to be beheaded if you have a losing trade; you would never, ever, accept the loss, you would hold on for ever and as soon as the position was 1 point in profit, you would grab it immediately! Isn’t that how many of us trade now? If so, ask yourself what does a losing trade mean about you?

If a loss means something negative about us we won’t want to accept it, this is human nature. We would rather hold on as long as we can and then, when we inevitably have to take the loss because it is now too big; too big to hide, too big to ignore, too big to refuse to accept; we look for our scapegoat.

The ‘they’ of the market: the controllers, the insiders, the manipulators, or even the market itself; anything but to take the judgement that the loss implies. The objective of our self-deceit is to avoid the judgement that the loss imposes. In the same way that the teacher condemned the school children in order to avoid the judgement about his manners, so do we look to shift the blame to some third party.

Significance of loss
The problem here lies, not with our self-deceit, but with the meaning that we attach to having a loss. If a loss means something negative, of course we don’t want to accept it; but if a loss had no significance to us, accepting it would be easy.

Day Trader Skills

I received an email from a prospective buyer of my online trading course. His question (below) caused me to think about the wisdom of pursuing trading as a worthy venture. I know that a lot of readers are investors rather than traders, but regardless of your trading horizons, the skills and concerns of active short-term trading are relevant to us all.

Question: “There are a lot of people who say that day trading is for ‘fools’ and that it is very difficult to make a living from Day Trading. What are your opinions?”

Trading is like most business: it requires commitment and perseverance. It is never easy to make money, but people who have mastered a skill make it appear easy. The really successful pit traders that I have known made trading look very easy, tantalisingly easy; but they all had many years of experience behind them. For every successful trader there has probably been a few hundred who have tried and failed.

Two core skills
I think people fail at any business if they approach it without an appreciation and understanding of what is required for success. The majority of traders fail, because they have no such appreciation and they have unrealistic expectations of themselves. Any trader who starts with the expectation of becoming an instant success is setting himself up for failure.

No one would decide to become a golf pro and assume that they could just pick up a bag of clubs and start winning tournaments. Yet novice traders do this all the time. Just to start with the understanding that trading is a skill that is developed over time, through experience, puts a novice trader way ahead of the competition.

There are two core skills in trading: first the ability to anticipate the market (read the market) and second, having the discipline to execute your plan. To learn to read the market you may as well use a trading simulator and only start to trade when you have demonstrated to yourself that you can anticipate the market. Discipline, though, has to be developed and tested in the real world.

Stick to your own rules
Discipline is really the crux of the matter and it is here that most traders fall down. Their failure is mainly due to the fact that they are not really aware of its importance. Just starting out as a trader with the intention of developing your discipline puts you way ahead of the average trader. If you can trade with discipline (i.e. stick to your own rules and limits) you are 95% there!

So I would say that for the average aspiring trader, trading is a fool’s game; but for those of us who approach the business as a business, with a clear understanding of the unique challenges that trading offers, it can be a rewarding and fulfilling career.

Malcolm Robinson

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

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