SmartDayTrader
Basic
Trading 101
If you are new to trading this will be
very helpful. If you are an old pro, this should be helpful as a review. To
become a successful trader takes a long time. This is not something that can be
learned quickly. I hope if you have found yourself arriving at SmartDayTrader
that you have not been badly burned, that you have not lost a lot of money
buying overpriced programs that were supposed to make you money quickly. If you
already have been ‘burned", just toss your old programs and let’s start
fresh. I am an optimist about trading. Today is the first day of the rest of
our lives.
First of all it’s important to understand
who you are and what you hope to achieve. The type of trading we discuss here
is geared to fast action, quick profits and a lot of short term anxiety. If you
are unable or unwilling to devote a lot of time and energy, quit now. You
cannot "day trade" by calling your broker and then heading out for a
run, or a round of golf. Not only will you have to stay up late if you’re a
night person, or get up very early if you’re a day person to do your
"homework", but you will then have to stay glued to the markets ALL
DAY LONG. You may find yourself in a position and not even be able to answer
the phone or attend to the "call of nature".
Please read our document about timing and
trading to make sure you are very clear about this. Some people think they can
take some hard earned money and once in awhile turn on the computer and make a
quick trade. Forget it. The smarter people make their money at their chosen
profession and hand over a little to their financial advisors for life-time
investments. THIS IS NOT DAY TRADING.
Okay, let’s assume you understand this.
Let’s get on with the basics of what we do here.
The "stock market" can be traded
by buying and selling stocks or "derivatives". Common derivatives
include options, futures and stock indices. The reasons for using derivatives
instead of stocks are many. First, you can focus on a particular derivative and
hone in, whereas it takes a lot of energy to sift through the thousands of
stocks. Second, you can use "leverage". This means you can use less
capital to get started. Third, the stock market derivatives are widely traded,
allowing for liquidity, so you will always have a buyer or seller and almost
always have a narrow spread. The exception here is the stock index options
where the spread can be large, but we will discuss how to use this to your
advantage later. Finally, there is a lot of stock market intraday data that is
available for us to use as clues throughout the trading day. No other markets
offer all of this.
Let’s start with our favorite trading
vehicle, the S&P 500 FUTURES contract. This commodity has been around only
since the early 1980s. It is traded by the open outcry method in
Since our trading vehicle is a commodity
"future" it is not "exactly" the same price as the
underlying index. In essence, if the "crowd" believes that stocks are
heading higher, the futures contract might be higher than the underlying index.
If the crowd believes that stocks were headed lower, the futures contract would
be lower. These fluctuations around the actual price are known as the
"premium" (higher) or "discount" (lower) to the index.
Several free, live Web services and Cable
TV channels update the price of the S&P as well as the "PREM" or
premium and you can calculate the actual futures price. Say the current quote
on the S&P 500 index is 870 and the premium is 1.40, then at that moment
the current futures contract is trading for 871.40.
I won’t go into detail here, but there are
methods for calculating what is assumed to be the "fair value" of the
S&P to which specialized traders known as arbitrageurs or hedgers refer.
They then try to capitalize on any movement in price away from fair value. Not
always important to us on an intraday trading basis.
When you decide to trade, you have to set
up an account at a commodity trading firm. Today, most firms allow you to trade
using discounted commissions, especially if you trade using the computer. You
will be required to place money in your account which is essentially "good
faith" money. The brokers set the "margin" amount using exchange
guidelines. It is your responsibility to keep up to date regarding the exchange
"margins", as they are subject to change. The amount of money you
need in your account to trade during the day differs from the amount you need
in your account if you are planning to hold the trade overnight. Often, if you
are planning to make and close your trade the same day, the amount you need is
much less.
Let’s say the amount you need to trade one
S&P futures contract is $20,000. This would be the "margin"
required. Let’s assume you make a “long” trade, the S&P drops 3 points and
you close out the trade. You will have lost $750.00 (3 points times 250.00 per
point) plus the commissions. If your account drops below the minimum margin required,
you will be asked to add more money into your account. More on money management
later.
Several years ago with the onset of fast
computers and connections the E-MINI contracts were developed. These contracts
(referring now to the S&P 500), are smaller, electronically traded
contracts. In the case of the S&P, the big contract was divided into
fifths, so each point move in the S&P 500 here, is equal to $50.00. The
contracts are ONLY traded electronically; require a smaller commission and less
margin to trade. Also, they trade almost continuously around the clock,
although the volume (liquidity) is not always there after hours. MOST of what
we do as day traders consists of trading this contract, the S&P Emini
contract. IF you are new to trading, you must start with this, start small and
develop your skill and confidence here.
One final difference. The BIG contract
trades in nickels or 0.05 increments. The mini only trades in .25 increments.
On a good electronic trading platform you will see the bid and asked, and for
the mini contract the difference will always be .25, so if the S&P is
trading at 870, you might see that it is currently 870 bid and 870.25 asked.
So now you understand what we are doing “most
of the time”. Right?
So how to trade?
There are many books on trading, many
ideas, and styles. It is imperative that you take yourself for a long walk and
figure out “who you are” BEFORE you start trading. If you like the idea of
grabbing a trade and hanging on for a few minutes or so and can handle the
anxiety, then the type of trading we do here is for you. If not, you are in the
wrong place. Don’t get me wrong. We do some other trades that might last a few
days to weeks, but these are much less frequent and will be discussed in
another article.
One thing you will notice if you read
literature by honest traders is that after trying years of unsuccessful methods
using intraday charts, moving averages and “technical indicators” they finally
began to make money as they STOPPED USING these common techniques. Most will
tell you that the money started to flow when they paid attention during the day
to well thought out support and resistance areas and intraday PRICE and
sentiment information.
The bottom line is that each of us is able
to “see” what we can “see” in the charts or price. If you can make money “seeing”
something in some intraday squiggly lines – GREAT! Go for it.
Here at SMARTDAYTRADER we use an approach
that combines AFTER HOURS market analysis, which takes extensive advantage of
technical analysis, and intraday tactics using the information from our “homework”.
The key to this system is first assessing if we are in a trending or trading
environment. Then determining the predominant trend. Then honing down to the
PIVOTS.
We use the PIVOTS as follows: IF we think
that the trend is up, but the market is more likely to be in a “trading”
environment, we might look to buy the “next low” pivot and hold to “next high”,
or we may look to sell “next high” and hold to “next low”. In a more volatile
environment, we’ll look to High or Low pivot. The market will tell us.
We combine the PIVOTS with intraday
indicators. We utilize the TICK, the TRIN and BREADTH mostly. We add intraday
OEX Put Call sentiment. Finally, each of us adds to that our own favorite “spice”.
What this means is that some of you simply “like” to have a 1 minute chart up,
with oscillators, as this helps you to “see”. Others have 5 or 15 minute charts
up, with Moving Average indicators because that helps YOU to see. This is up to
you. I’ve spoken to many traders over the years and it never ceases to amaze me
how “personal” these individual indicators are. I understand how each of us
needs them. They are like security blankets. AS LONG AS THEY ARE HELPING YOU
MAKE MONEY KEEP THEM, but KNOW IF THEY ARE HOLDING YOU BACK.
My personal favorites intraday are the 15
MINUTE chart of the S&P 500 INDEX (not futures) with the “standard” MACD
HISTOGRAM. I’ve looked at it for so long I “SEE IT”. I also use a 1 minute
chart of the EMINIS with a 1 min and 55 min EMA surrounded by a 3% trading band
of the 10 period moving average. Why? I’ve looked at it for years and it makes
me comfortable.
BUT, my trades are based on the pivot
points. I set ALARMS in the morning which alert me to the pivot points and to
high and low TICK readings. I keep a printout of the PIVOT POINTS and KEY
numbers from the NIGHTLY REPORT in front of me, along with other important
numbers from the Nightly Report, such as the EMA 10, 55, SMA 20 and relevant
QUAD and/or Fib Fan support and resistance lines.
IF we move to one of the upper pivots on
HIGH PLUS TICK, I go short. I allow an 8 point stop loss if we hit this target
with “all things right”. Then I move the stop down and look to take AT LEAST 4
points, but preferably I look to exit at the next low pivot. The opposite
works, too.
On very choppy days, I’ll settle for fewer
points. This is known as “scalping” which is easy to do with the “mini”
contracts. If we hit one of the upper pivots on high tick I’ll short and
immediately put in an order to buy back for 2 points and finesse from there.
But ALWAYS with a stop loss in place.
I do the same for the BONDS, but with less
frequency. I usually wait until bonds have hit high or low Bollinger Bands on
high or low RSI (or Ultimate, etc.) basis CLOSING DATA. Then I look to short or
go long off the posted pivots. If we are really extended in one direction or
the other, I’ll look to hang on and take profit at the opposite pivot point
(i.e. if I’ve shorted HIGH pivot, I’ll take profit at LOW pivot).
This is just an introduction. There is
obviously more to this. For instance, if the market seems bullish, and is
moving up, but the TRIN is high, I’ll have more confidence shorting the Pivot
on a “run” (i.e. high plus tick), than I would if the TRIN were low. I use the
same logic when looking at the breadth. From time to time it’s important to see
what’s happening with OEX sentiment.
Finally, I will “peek” at my 15 min MACD
chart as this often tells me that the trend is weakening or strengthening. Keep
an eye on this for awhile and you’ll see what I mean. For instance, say the
market is moving down all day, but the MACD HIST is moving UP. Then I would
look for a reason to go LONG off of one of our pivots, usually NEXT LOW or MID
pivot, to catch the “surprise” move. That reason would be a dropping TRIN or a
sudden negative TICK that evaporates.
Remember, this is just an introduction to
trading. IF you are new, try trading with 1 EMINI contract and a minimum
$10,000.00 account, using the principles outlined here. After you’ve actually
done this a few times (NOT PAPER TRADED – PLEASE), you should have a diary and
plenty of questions for me. At that point this should all start to gel, and we
can move on to some more advanced topics.
PLEASE email me at jim@smartdaytrader.com if you have
questions at anytime.
Your Friend and Fellow Trader, Jim Raker.