<s> The CompleatDay Trader
Trading Systems, Strategies, Timing Indicators,and Analytical Methods
Jake Bernstein
McGraw-Hill, Inc.
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Sydney Tokyo TorontoLibrary of Congress Cataloging-in-Publication Data
Bernstein, Jacob, (date)The compleat day trader : trading systems, strategies, timingindicators, and analytical methods. / Jake Bernstein.po cm.Includes index.ISBN 0-07-009251-6 .1. Futures. 2. Futures market. I. Title. II. Title: Daytrader.HG6024.A3B478 1995332.64’'5—dc20 94-41343CIP
Copyright © 1995 by Jake Bernstein. All rights reserved. Printed in the UnitedStates of America. Except as permitted under the United States Copyright Act of1976, no part of this publication may be reproduced or distributed in any form orby any means, or stored in a data base or retrieval system, without the prior writtenpermission of the publisher.
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ISBN 0-07-009251-6
The sponsoring editor for this book was David Conti, the editing supervisor was Caroline R.Levine, and the production supervisor was Pamela A. Pelton. This book was set in Palatinoby Donald A. Feldman of McGraw-Hill’s Professional Book Group composition unit.
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McGraw-Hill books are available at special quantity discounts to use as premiumsand sales promotions, or for use in corporate training programs. For more infor-mation, please write to the Director of Special Sales, McGraw-Hill, Inc., 11 West19th Street, New York, NY 10011. Or contact your local bookstore.Contents
Preface ixAcknowledgments xi
Introduction
2.
The Forces Behind Increased Volatility 1
The Computer Revolution and Trading 2
Advances in Market Quotation Systems 3
The International and Domestic Political Backdrop 3Responsibilities and Goals of the Day Trader 3About This Book 4
Beware of Tall Tales 5
Who Succeeds and Who Fails—Qualities for Success 5What This Book Cannot and Will Not Do for You 9No Exaggerated Claims 10
Historical Results 10
Do Your Own Research 10
Practice 11
Getting Started 11
Risk and Loss in Futures Trading 12
The BasicsDefinition of Terms 13
What a Day Trader Is and What a Day Trader Does
What Does a Day Trader Trade? 19Why Day Trade? 19
13
18vi
Contents
3. The Ilusion of System Testing
System Development 23
What Is a Trading System? 24
What's Left? 25
Markets Change—Market Participants Change 26Striving for Solutions 27
The Role of Artificial Intelligence 27
Implications for the Future 29
4. Day Trading with Moving Averages
Moving Average Basics 30
Traditional Moving Average Systems: Assets and LiabilitiesMoving Average Crossovers—Price versus MA 34Moving Averages as Support and Resistance 39
5. Intraday Application of Stochastics
Explaining Stochastics Quickly and Simply 43The Basic Stochastic Indicator 44
Basic Approaches to SI Timing 45
Intraday Stochastic POP: Definition 47
SP Parameters 48
Markets in Which SP Works Well 52
Hit and Run Trading Using the SP 52Variation on the Theme of SP 53
What You Can Expect 54
Preferred Markets for SP Application 55
6. Gaps, Gaps, Gaps
Gap Trading Rules and Definitions 58
Some Observations about the Gap Technique 66Get Some Experience 70
Gap Size and Penetration Size 71
What You Can Realistically Expect 71
A Few Last Words about Stop Orders 72
7. Support and Resistance: the “MAC”
The Moving Average Channel 74
How Support and Resistance Develop during the Day 76Determining Trend, Support, and Resistance 78
Trading within an Established Trend 80
Exiting Positions—Right or Wrong 80
Sideways Trend Trading—Trading within the Channel 82A Few Precautions and Suggestions 83
Using the Channel Technique with Other Methods 84Evaluation of the MAC 86
8. Using Wilder’s RSI for Day Trading
Defining the First Derivative 88Rules for Day Trading with the RSI 89
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Contents
Using Intraday MomentumRate of Change in Day Trading
Intraday Channel BreakoutHow the Channel Breakout System Works 108
Traditional Methods of Technical Analysis and Day Trading
Trend Line Analysis 112Trend Line Applications—Chart Formations 115
A Unique Oscillator for Day Trading
Opens versus Closes 123Construction of the O/C for Intraday Trading 125Examining Some Signals 126
Scalping the Markets
What Is Scalping? 131
Rules for Scalping 132
Suggested Methods of Scalping 132
Buying into Large Declines or Selling into Large Rallies 139
Importance of Orders
What You Should Know about Market Orders 141Market-If-Touched (MIT) Orders 142
Fill-or-Kill (FOK) Orders 143
Stop Orders 143
Stop Limit Orders 144
Good-Til-Canceled (GTC) Orders 144
One Cancels the Other (OCO) 144
Using Orders to Your Advantage 144
How Seasonality Affects Markets
Defining Key Seasonal Dates 148How to Use the Key Seasonal Date Tendencies 149Daily Season Tendencies 153
Intraday Spread Trading
Preselection: The Key to Profitable Spread Day Trading 163Methods of Spread Day Trading 164What You Can Realistically Expect 169
The Consecutive Closes System
Definitions and Signals 170How the CC System Operates 171
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170viii
Contents
19. Sentiment Reigns Supreme
Defining Sentiment 176
A Daily Sentiment Index—Ideal for Short-Term Trading 177A Brief Historical Overview 177
A DSI Day-Trading Application 178
Visualizing Market Sentiment Relationships 178
The Importance of Market Sentiment 178
DSI Historical Data 185
20. Critical Time of Day (CTOD)Basic CTOD Signals and Parameters 186Tips and Suggestions for Using CTOD 188
21. Putting It All Together
22. The Psychology of Day TradingA Successful Day Trader Needs Discipline 198
23. The Impact of 24-Hour Trading on Day Trading
24, Twenty Keys to Success as a Day Trader
Appendix. Formulae
Index 223
175
186
191
197
207
211
220Preface
For many years, futures traders have been fascinated with the idea ofday trading. Increased market volatility has created large intraday priceswings which, in turn, have provided numerous opportunities for theday trader.
In addition to the increase in opportunities, the wide availability ofrelatively low-priced computers and software has helped narrow thegap between the professional day trader and the novice.
The book you are about to read contains many different methods ofday trading. Take the time to learn, study, and track the methods. Then,after you have learned the techniques you want to use, begin trading. Butdon’t plunge in before you have spent some time learning the methods.
One last point before you begin your reading. Do not believe for evenone second that day trading is easy. Day trading may, in fact, be moredifficult than position trading. In the final analysis day trading is not theproverbial “piece of cake” that so many traders seek. If anyone tells youthat you can day trade your way to riches with little effort they'rewrong. Day trading takes work, work, and more work. If you do thework, you'll reap the rewards. It’s that simple and it’s that complicated.
I wish you success in your venture. If I can be of assistance, please callor write me.
Jake BernsteinAcknowledgments
I wish to extend a special word of thanks to Commodity Quote Graphicsof Glenwood Springs, Colorado, for permission to reprint charts fromtheir outstanding quotation/graphics hardware and software program,SYSTEM ONE. I have been a CQG customer for many years and findtheir services outstanding as well as especially useful for the purpose ofday trading.
I am also indebted to Mr. Bill Cruz of Omega Research in Miami,Florida, for his assistance and permission to use reports generated byhis excellent analytical and testing software programs, TradeStation andSystemWriter. Both programs make the job of historical testing and sys-tem development enjoyable and efficient.
Naturally, I owe considerable thanks to the many traders I’ve knownthrough the years who have contributed to my knowledge of the mar-kets. You all know who you are. I’ve learned from each and every one ofyou. My list is far too lengthy to include here; however, I am thankful toall who have touched my life with their opinions, suggestions, systems,methods, and timing indicators.
My hard-working office staff must also be commended for theirefforts in the production of this book. I am not easy to work with. Ichange my mind too easily and too quickly although all turns out wellin the long run. Special thanks to Linda, Denise, and Rob. Patrick getsan extra note of thanks for editing and pasting up the manuscript. And,of course, thanks to Chris for his programming work.xii = Acknowledgments
Special thanks go to Marilyn my office manager and right-hand per-son whose efforts to keep me organized and clear-thinking help keepme on track.
My partner in Bernstein/Silber Futures, Mark Silber, is always a greatsounding board for new ideas. Fortunately, he rejects many ideas andaccepts only the most promising.
My family, Linda, Elliott, Gitelle, and Sara deserve great thanks fortheir forbearance and willingness to share their time with my charts,systems, computers, and manuscripts.
Finally, my acknowledgments would not be complete without a nodto my dear pet pug dogs, Buddy, Puggly, Hercules, Cassie, Roxy, andInky for the play time I stole from them.Introduction
The world of futures trading has become increasingly dominated byshort-term speculation. In the good old days, markets moved slowlyand steadily toward their goals, or they continued in sideways trendsfor extended periods. This is not the case today. In fact, since the early1970s, virtually all futures markets have become increasingly volatile,and the time window of market moves has steadily narrowed.
This is not to say that the old adage “the big money is made in the bigpull” is no longer true. It’s just as true today as it has always been.There will always be large, long-term market moves. What has changed,however, is that short-term volatility has become so significant as tonecessitate the use of extremely large stop losses, thereby forcing tradersto risk substantially larger amounts of capital than ever before. The bigpull still provides outstanding opportunities, but it also entails largerrisks than ever before.
Increased volatility is both a sinner and a saint. Although it has madetrading with limited risk less possible, it has also brought with it aplethora of short-term trading opportunities. Significant profit potentialnow exists in virtually all markets. Prior to the aforementioned increasein volatility, the potential for profit from short-term and day trading didnot exist other than for the floor trader. Now such opportunities areavailable to all traders. But with opportunity also comes risk—they areboth sides of the same coin. Without risk there cannot be reward—with-out volatility there cannot be intraday opportunity.
The Forces Behind Increased Volatility
In addition to increased volatility, several fundamental factors havebecome powerful driving forces in the futures markets, forces which2
Introduction
were not significant to any meaningful degree prior to the 1970s.Specifically, I refer to relatively low commissions and significantadvances in personal computer technology.
Furthermore, the advent of negotiated brokerage commissions and dis-count brokerage services has opened a vast new area of opportunity forall futures and futures options traders. It is now possible for traders whodo not seek the advice, input, and “full service” of a broker to pay great-ly reduced commissions, thereby allowing for more active trading aswell as trading for smaller price moves. Commission cost is the singlelargest overhead factor in futures trading. Commission has always been,and will always be a severely limiting bottom-line factor for the futurestrader. Unfortunately most traders fail to realize this vital fact. Combinedwith losses due to system limitations, trader error, and slippage, commis-sion costs add up quickly. At the end of the year traders are often takenaback with what they have paid out in commissions and fees.
With greatly reduced commissions, however, the short-term and daytrader can now trade more actively, more profitably, and more aggres-sively. Discount commission costs must, therefore, be considered as oneof the most important factors contributing to the growth of short-termand day trading since the 1980s.
The Computer Revolution and Trading
In addition to the radical restructuring of commission costs to retail (i.e.,nonprofessional) traders, there has also been a revolution in computersoftware and hardware technology. Since the mid-1980s, home comput-ers have become increasingly powerful, efficient, and affordable. Thecost of owning a state-of-the-art personal computer system has steadilydeclined while quality and processing speeds have steadily risen. Forseveral thousand dollars, one can acquire a computer so sophisticatedthat by 1983 standards, its cost would easily have approached the$100,000 mark if not more.
Computers, however, are only as good as the software that makesthem productive. They are limited by the limitations of software pro-grams. Computer software specifically designed for personal computers(PCs and Macintoshes) has also made tremendous gains, particularlysince the late 1980s. Virtually no area of science, literature, mathematics,or investments has been left untouched by the quantum advances insophisticated software. The combination of advanced computer hard-ware, high-level computer software, and low-cost computer memoryhave ushered in a new era of futures trading, which, to borrow a con-cept from J. Peter Steidlmayer, I call “the Age of Instantism.”Introduction 3
Advances in Market Quotation Systems
Those who seek to venture into the new realm of instantism have at theirdisposal a multiplicity of market quotation services which provide every-thing from tick-by-tick data to delayed and after-market-closing data.Accurate price quotations at affordable prices are now available through-out the day for access by computer. The availability of live tick-by-tickdata throughout the trading day has enhanced public participation in anarea which for many years was the exclusive domain of professional off-the-floor traders as well as on-the-floor pit brokers. And this has addedto the pool of short-term and day-trading participants. This, in turn, hasincreased liquidity which has facilitated short-term and day trading.
The International and DomesticPolitical Backdrop
While the aforementioned technical and fundamental factors havehelped accelerate the tremendous growth of short-term and day tradingin the futures market since the early 1980s, the backdrop of worldwideand domestic political and economic instability has exerted a synergisticforce in markets already stimulated to greater activity. The uncertaintywhich originated during the OPEC oil embargo has spread its effect tovirtually all markets during the last 20 years. Barely a market has beenleft untouched by international political instability and machinations.
Since the economic peak in the United States occurred between 1975and 1981, the stability of once-revered domestic economic institutionshas been seriously threatened, forcing an understandable deteriorationof trader and investor confidence. Insecurities have expressed them-selves in highly emotional markets and in extremely violent pricemoves within relatively circumscribed periods.
The exaggerated price movements which occurred during the stockmarket crashes of 1987 and 1989, as well as the minicrash of 1992 weresymptomatic of underlying trader anxiety motivated by panic. The pan-ics were clearly the result of diminished confidence in existing institu-tions and in the ability of government to regulate economic affairs.
Responsibilities and Goals of theDay Trader
My task is not to analyze or moralize about the multiplicity of factorswhich have stimulated the growth of short-term and day trading, rather4 Introduction
it is to accept the facts as they are and to teach you how you may takeadvantage of them for the purposes of day trading. It is not the job ofthe day trader to understand the whys and/or the wherefores of marketmovement. The day trader’s sole responsibilities are these:
v First to end each day “flat,” that is, without any positions¢ Second, to make a profit, no matter how large or smallv Third, to keep all losses small and manageable
Within the context of these very general responsibilities and guide-lines for the day trader, all market volatility, regardless of cause, mustbe approached as an opportunity for potential profit. We are neitherdefenders of what is right or just in the markets nor pedagogues whomust determine why things are the way they are. We are interested inbeing true to our tripartite credo as expressed above and in attainingthree distinct goals which are the essence of what this book is designedto teach you. These goals are as follows:
1. To profit consistently and significantly from day trading2. To become better day traders with more experience
3. To maintain a disciplined and business-oriented approach to helpattain day-trading objectives
About This Book
The purpose of this book is to acquaint all day traders, aspiring daytraders, and other interested parties with the basics of successful daytrading. My goal is to expand considerably on the basic day-tradingbuilding blocks, in order to provide concise methods, indicators, andguidelines, which, it is hoped, will prove beneficial on the road to prof-its. Please note that this book is not designed to serve as a cookbook or “nobrain” approach to day trading. 1 am absolutely convinced, after my manyyears of experience as a trader, that effective trading can be learned andmoreover that many traders are quite capable of learning to be effective. One ofthe prerequisites, however, is to learn from a teacher who is organized,experienced, lucid, and, above all, specific.
My experiences as a trader have led me to the conclusion that success-ful day trading is built upon a unique foundation combining art and science. Ifpressed to “guesstimate” as to the proper mix of both qualities, I'd saythat approximately 70 percent of successful day trading consists of tech-nique or science and 30 percent of skill and/or art. This, however, wouldbe a misleading statement inasmuch as both elements are symbiotic;Introduction 5.
without one, the other would be ineffective. The successful day trader combinesboth elements synergistically to produce profits, consistency, and longevity.
Beware of Tall Tales
Even if you’re a newcomer to the futures markets, you have likely beenexposed to the numerous tall tales of great successes by novice tradersor by those who have discovered hot new systems. This is all old stuff.Such tales have existed since the first trader traded the first futures con-tract. And they will exist as long as there are markets to trade andtraders to trade them. Don’t bother chasing these dead ends—they willlead you astray. Also, don’t compete with any of them, they will leadyou, more often than not, to frustration and losses.
My best advice is to compete only with yourself. If you attempt to playothers’ games by their rules, you will frequently be a loser. The quintes-sential element of successful day trading is to find something that you cando well and do it consistently day in and day out. 1 don’t mean to imply byany means that day trading is an effortless proposition or that it issomething as simple as finding a good bread recipe and following it.
Who Succeeds and Who Fails—Qualitiesfor Success
Clearly, day trading is not for everyone. Certain qualities predispose aday trader to success or failure. Before we go on with a concise discus-sion of the techniques, systems, and methods of day trading which I’veacquired by long and hard experience through the years, I’d like tofamiliarize you with the qualities which either facilitate or limit one’ssuccess as a day trader. Many of the things I am about to say apply tosuccess not only in the markets but in every walk of life as well.
To be successful in virtually any human endeavor requires a numberof skills which are not easily acquired. Although the struggle to achievethese skills may indeed be an arduous one, the effort is worthwhile bothin the long run and in the short run. I say this because there is a greatdeal of transference in skills across many different professions andundertakings. This does not necessarily mean, however, that a goodengineer will become a good trader. Nor does it mean that a bad engi-neer will become a bad trader. It’s been my observation that choice ofprofession is not closely correlated with probability of success in thefutures markets. Here is a list of qualities I feel are essential to success asa trader.6 IntroductionFlexibility
I have observed that extremely rigid personality types tend to perform poorly asfutures traders inasmuch as they have not mastered the ability to think beyondthe rules, a skill which is extremely important for the day trader. You will findmost often that market entry is very specific and not subject to a greatdeal of interpretation, if any. Market exit however, is frequently moreintuitive, although it can be subjected to more definitive and operationalprocedures. Consequently, when I refer to such qualities as discipline,persistence, organization, and the ability to follow through, I am notreferring to any of these in rigid terms.
Perhaps the greatest single quality a day trader should possess is flex-ibility or adaptability. Such flexibility, however, must be maintainedwithin the context of specific understandings, trading signals, and/orguidelines which are the subject matter of this book. A trader must beflexible not only to new ideas about the markets, but also to situations whichdevelop in markets during the day. Hence, flexibility is an important quali-ty which, unfortunately, cannot be taught. I can, however, give yousome specific ideas about flexibility so that you may make the necessaryadjustments to your own trading style.
Perhaps a better way to express this is by saying that in order to be asuccessful day trader, you must be “flexible but firm.” In other words, youmust understand the rules, the signals, and the timing indicators.However, you must apply them in a manner which is mediated by otherunderstandings about yourself and about the markets. I will attempt toclarify this for you in the chapters which follow.
Consistency
Another important quality which the successful day trader must eitherpossess or develop is consistency. By consistency, I mean the ability andwillingness to follow a particular program or trading methodology day in andday out as long as the technique continues to achieve the desired results. Inother words, if something you learn in this book or elsewhere is work-ing for you, then continue to use it until it no longer works or until yoususpect that it is slowly but surely becoming ineffective. Too many daytraders spend too much of their time attempting to improve on methods whichcannot be improved. The fact is, not too many methods work consistentlywell in the markets, and, furthermore, those which do work well cannotbe improved beyond a certain point. “If it ain’t broke...don’t fix it.”Consistency is a very important quality which must be cultivated if daytrading is to become a successful proposition.Patience
Introduction 7
Patience is yet another important virtue. Day traders must be willing andable to tolerate a series of losses, as they patiently await a turn in their fortune.However, too much patience is not a virtue for the day trader. Too muchpatience can be a fatal flaw. The day trader who is too patient in hangingon to a losing position will be violating one of the cardinal rules of suc-cessful day trading, which is, of course, not to carry losing positions (orfor that matter any positions) overnight. Losses must, in all cases, betaken as quickly and as expeditiously as possible. The idea is, of course,to ride profits to their maximum while eliminating losses quickly and atthe smallest dollar amount.
Self-Control
Another important quality which successful day traders must eitherpossess or develop is self-control. During any given day, literally hun-dreds of day-trading opportunities will present themselves. Whereasmany of these may turn out to be profitable opportunities, the day trad-er does not know in advance which will or will not produce the desiredresults. The vast majority of opportunities are specious.
Furthermore, the day trader is limited in how many of these opportu-nities may be taken. It behooves the day trader, therefore, to begin eachday’s trading with a general plan of action within which the day’sevents may be interpreted and the proper actions taken. The plan, how-ever, must not be so restrictive as to blind the trader to other unexpectedopportunities. In so doing, some of the worthless or losing opportuni-ties will be eliminated ahead of time, and the trader will stay focused onthose which seem to offer the best potential.
Hopefully, the information contained in this book will be valuable toyou in making these decisions. I liken the job of the day trader to thatof a hunter. The day trader and the hunter are both provided with afinite amount of ammunition. For the hunter, the ammunition consistsof bullets, arrows, or weapons. The day trader’s ammunition is capital.Trading capital and ammunition may both be easily squandered in pur-suit of worthless targets, and the trader and hunter who engage in thistype of useless activity will eventually find themselves without theammunition to pursue larger, more profitable game. The day tradermust be patient, methodically awaiting only the more promisingopportunities upon which to take aim and fire. And then, when theopportunity presents itself, the trader must follow through accordingto plan.8 Introduction
Willingness to Exit Trades at End
of Day
Still another important quality which the day trader must develop is thewillingness to exit positions by the end of the day. Veteran futurestraders jokingly define long-term positions as “day trades which endedthe day at a loss.” The lesson here is that all too many traders enter posi-tions originally as day trades; however, if these trades show losses at theend of the day, they are inclined to hold them overnight or longer giventheir refusal to take the loss. The justification or excuse is that the tradeprobably has more than mere day-trade value. Holding a positionovernight, particularly a losing position, is perhaps the single greatest offensethat a day trader can commit. Frequently, it is also the single most costlyviolation of the rules.
Accepting Losses
The successful day trader must learn how to accept a loss and when torecognize that this rule is being violated. There are some very specificand simple procedures for doing this which will be discussed later on.The day trader must be willing to accept what he or she has achieved bythe end of each day without undue frustration and/or wishful think-ing—win, lose, or draw. As human beings we always look back on whatwe have done, often with regrets, thinking that we should have donethings differently. Although in many cases it is certainly true that thingsshould have been done differently, lamenting that fact is not construc-tive. Learning from it, however, is the appropriate response. Each loss, iftaken at the right time, is a lesson. Each loss will teach you somethingimportant. If the amount of the loss is approximately what it shouldhave been in terms of your system or method, then you have learnedthat you can follow your system. If, however, your loss is not taken ontime and therefore becomes larger than it might have been, then youhave learned that to go against your system will cost you money.
Daily Analysis of Results
Day traders should have a formal procedure for analyzing their resultsat the end of each day in order that the maximum amount of learning beextracted from each trade, whether that trade was a profit or a loss.This, of course, requires some degree of organization and consistency. Iwill discuss the importance of your trading diary in considerable detaillater on. At this time I urge you to begin keeping a diary if you are notalready doing so. You'll be absolutely amazed how much you can learnIntroduction 9
by jotting down your comments at the end of each trading day (orpreferably during the day). It only takes a few minutes, and the rewardis literally hundreds of times the cost.
What This Book Cannot and Will Not Do
for You
Some authors are quite accomplished at telling you what their book willdo for you. I would prefer to tell you not only what this book can do foryou, but moreover what it cannot and will not do for you. I do this at theoutset so that you will not revel in any unrealistic expectations orunwarranted fantasies about what you will read within these pages.This book, in and of itself, is not a treasure map to riches untold or a handylittle instruction book to the secrets of trading success. While it does containmany of my secrets as well as extremely valuable information, secretswithout action, or valuable information without direction and consisten-cy are nothing more than lifeless exhibits at a museum.
Within these pages you will find no claims that this book alone will be avehicle for your attainment of great wealth as a day trader. If you are lookingfor guarantees, you'll need to look elsewhere because you won't findthem in this book. I will only guarantee you that the ideas, systems,methods, indicators, and suggestions in this book will give you thepotential to achieve success, but you, and you alone are the instrumentwhich will transform potential energy into actual energy.
If you seek to acquire the substantial knowledge which I have accruedduring my more than 22 years as a futures and stock trader, then you'vecertainly come to the right place. This book will educate you, guide you,assist you, explain things to you, and illuminate the way for you. But itwill not trade for you, put money in your pocket or in your bankaccount, nor will it fill your head with misleading guarantees. I canteach you how to ride the bicycle, but I cannot ride it for you.
Any individual who has had experience as a trader, albeit limited,learns very early in the game that to achieve consistent success infutures trading is possibly one of the most difficult undertakings ahuman being can attempt. Success comes only to a few. The reasons forthis will be explained clearly and carefully in the chapters which follow.I will demonstrate that the difficulty in attaining success as a trader isprimarily one of the trader as opposed to the system or method. It is mygoal to facilitate success for you by teaching you techniques as well as meth-ods