Getting In the market is easy; HowDay In the market is getting out is hard. Making money in the market is even harder, especially for day trades. The majority of futures trades use some type of technical or mechanical trading system. For the day trader it is a must. This article does not purport to tell trader how to get into a trade; only how to best come out of one. Day trading systems always stress entry points. After all, getting in the market right accounts for more than ﬁfty percent of a trader’s chance to make money. As real estate people say: location is everything. And so it is with commodity trading. Long or short, entry is all.
Trading system then emphasize the proper stop out points. This is essential for it deﬁnes risk, the only thing a trader can actually control. No disciplined day trader wants to be exposed to the vagaries of the market beyond prudent money management levels. Left for last is the exiting of the trade. This is because no system can tell if there will be a proﬁt or how much it will be. Systems use one of two ways to cash in a winning trade: either a predetermined exit price or a market-onclose order (MOC). Both methods have serious ﬂaws. If a trader is going for a predetermined priceobjective, he either gets it or he doesn’t. If he gets it he will be happy, but only for a few minutes as they may go farther than expected and proﬁts are lost. On the other hand, if the objective price isn’t reached, a nice winning trade may actually turn into just a minor gain or a stopout loss.
No trader can afford to have a winning trade turn into a loser. Besides being psychologically damaging, the trader must overcome the loss with even greater profits on subsequent trades just to get even. The market-on-close order leaves everything to the commodity futures trading gods. And every trader knows how ﬁckle they can be. Many a handsome proﬁt can go down the drain in a matter of minutes using MOC orders. But trading systems use this type of order because computes cannot judge intraday activity. The only kind of day an MOC order is effective on is a so called Trend Day, when the market opens on one end of that day’s activity and closes on the other. And that only happens about ﬁfteen percent of each trading month. The rest of the time the trader is at the market’s mercy. And that is not a happy prospect.
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This article is directed to day trades. Especially day trades who have realtime five minute bar charts on their computes. By deﬁnition, a day trader needs an active, wide daily spread market in order to have a chance at proﬁts. Only a mere handful of commodities qualify; ie, the stock index futures (S&P, NYFE), TBonds, Soybeans (in season) and crude oil (recently in vogue.) The essence of this trading methodology is to alert the trader to within the daily activity of a given futures contract. In other words: spotting reversals! Five minute bar charts are perfect for this purpose. Anything longer, say ﬁfteen minute or hour charts can be an eternity in fast-paced markets. Charts of less than ﬁve minutes are too close to the action and trades have a tendency to overreact to price chances.
After several yeas of personal observation, the writer came to the conclusion that whenever the price of a futures contract had closed more than three lower low bars back from any intraday high, it was usually time to go to cash. Conversely, if a trader were short and the market retraced back up and closed above three distinctively higher highs from an intraday low, then it was prudent to cover shorts. Because of volatility, four bars are used in the count for stock index futures. Counting the bars, however, is the tricky part. Say a trader has a proﬁtable short position in the NYFE, for example, and is watching for a possible reversal. Beginning with the lowest priced bar in the session, the trader counts backward for four higher highs. (See NYFE (NCZ) chart). As seen, an intermediate low was made early in the day at the 164.70 level and a ten minute rally ensued only to fall to 164.00 where another feeble rally attempt failed. The low for the day at 163.90 ﬁnally caught; and note that the market struggles for just over one hour (stopping at the high of the fourth bar back) before signaling a reversal.
It is not uncommon for the contract to come back and test the lows as occurred in this instance. An aggressive trader, therefore, suspecting that the low for the day is probably in for that particular session, could take a long position in the 164.50 area for a chance at new highs at the end of the trading day. Once new highs for the day are being made, the trader must be on guard for another four bar reversal from that high. The market did trade back exactly four bars, never lower, and closed near the highs of the day. (Dots denote the higher/lower bars which are valid.) There can be any number of bars which will not ﬁgure in the count. Bars that are equal to adjacent bars are ignored and not counted. Multiple ﬁve minute bars with a common high price but unequal lows are counted thus: each lower low bar back is valid. Bars with equal highs and lows are all counted as one bar. (Again, refer to the chart at the 166.85 level.)
Only the most current high bar starts the count. In other words, fresh information takes precedence. Every new ﬁve minute higher high has the potential to be the top for that session, so the trader must continually evaluate and count back from the high the appropriate number of bars for the market he is day trading. A trader must not make the mistake of just counting four previous bars as signaling a reversal. because the usual pattern of a market is to have unequal ﬁve minute trading lengths. It is important to only count those bars which have lower lows (or highs, if short). Another caution: It is permissible for the market price to retrace lower than three low bars back and still retain bullish day characteristics, provided it does not close below the third bar back.
Needless to say, there are many scenarios that will challenge the trader in making an accurate count. The nuances of this methodology require a certain expertise, but are achievable with practice. The main point is that trades are given an early warning signal that a market has run its course and is ready to reverse. All the market is really saying is: the high or low for that session is most likely in should now be expected. There can be several reversals during any particular trading session. Excessive choppy trading will keep any day trader on his toes. Yet an alert trader can quickly identify a reversal and either get ﬂat the market or switch trading sides.
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Intermediate day highs or lows can be counted but are not as reliable as fresh highs or fresh lows intraday. A day trader, by choice, must be on guard to count ﬁve minute trading bars in much proﬁt as he can. The only trader who could do better would be one who could successfully sell the highs and buy the bottoms. Every trader armed with the knowledge of knowing when a market is ready to reverse directions knows immediately what to do, take the money and run. Or change positions and try for proﬁts in the opposite direction. Not many traders are nimble enough to make two successful, but opposite, trades in one market in one trading session. Using this reversal method will allow a day trader to capture more overall trading proﬁts, once he becomes adept handling the bar count. (In other words, what to count and what to ignore.) Knowing, as someone once said, reduces stress on both the trader and his pocketbook.