16
Day Trading
 
day trade is a position entered and liquidated during a single trading day. The tech-Ate of time of day and daily patterns, discussed in such rigid form in Chapter 15,
are put to use by the day trader. Day trading requires extreme discipline, excellentplanning, anticipation, and concentration. The need for a fast response to changing situa-tions tends to exaggerate any bad trading habits; as in other fields, the shorter the responsetime, the greater the chance for error. In this chapter, we will extend the idea of day trad-ing to systems and methods that may also be held overnight, but expect to limit the tradeto about 24 hours. .
To keep mistakes to a minimum, each day's strategy must be planned in advance. Itshould focus on the most likely situations that might occur based on the nature of the cur-rent price movement. There should also be a contingency plan for the extreme unexpectedmoves in either direction. Making spot decisions during market hours will cause more fre-quent errors.
Computers have caused the number of day traders who rely on systems to increase,and have created an entire class of screen traders. The steady increase in automatedexchanges, led by Germany's DTB and followed by France’s conversion of Matif, is sendinga strong message that electronic trading will dominate the future. The availability of intra-day price feeds and system development platforms, such as Omega’s TradeStation, havegreatly increased the number of day-trading participants. Only 10 years ago the best onecould expect was to display standard indicators and moving averages on a real-time pricechart. Now you can fully program complex trading strategies that combine more than onemarket and more than one time frame into a single package and display buy and sell sig-nals on the screen as well as record a historic log of trades. All of these tools have greatlyincreased competition among individual and commercial traders.
For the arbitrageur, computers have had an even stronger impact. Sophisticated sys-tems at banks and large financial institutions consolidate data feeds that bring currenttransactions on every type of interest rate vehicle in every maturity and major currency.Analytic programs can find issues that are outliers and show which combinations (calledstrips) can produce a riskless profit. For the individual trader, few of these opportunitiesare available, although they add liquidity to the market. Individuals, however, find it mucheasier to create spreads of different deliveries within the same market as well as spreadbetween two related products. Stock traders can create sector baskets or look for perfor-mance differences within a sector. Spread trading and formulated values, such as theenergy crack or soybean crush, can be improved using similar displays. Many of the oppor-tunities that now seem so easy to see would previously have been missed. This faster, moresystematic response to the market allows traders to improve profits and reduce risk in anyday-trading method.
IMPACT OF TRANSACTION COSTS
~ Transaction costs are the greatest deterrent to day-trading profits. The failure to execute
near the intended price, plus the commission costs, can remove a large part of potential 
 
DAY TRADING420
o losses. An aspiring day trader has two waysprofitability ands em nce: DY. oon To commissions and by careful selection of opper-oa wees, Tabl oer presents the percentage relationship of moderate transaction onetunities. Table 191 Pisiee move. The average dollar volatility for the years 1990 throvet195 6 is shown t to the percentage represented by a $100 transaction cost. I n eneral$00 isa raodest value for the combination of. commissions and ere ane es etic
werage profit of one- abe very pleased fo ofr ge race the percentage effect of $100 cost shown here.ae esltial a day trader would choose the index markets, more vo at le cu rer cies:and longterm interest rates as their best opportunity for profits. orn epresents the leastdesirable market because ery Tor ore ths market, 820 commission and slippage equal$100 am move othe, or $12.50, totaling $45, would be the smallest possible costs.
ca re ore ic news, or largean secasional fast move in the market, based on unexpected economic ntoccasi
i the average.i i sult in a larger number, raisingOF ent oy ofa furares contract co a level acceptable By most tradersmiges i ifically stock index ts, ;forced to resize contracts, speci as overallexchanges eave climbed. During 1997, the S&P was reduced from 500 pet bas is point‘ $250, and the FTSE-100 from £25 to $10. In 1998, the Frenclto
i i saction costs.to 25% of its previous size. This increases the relative size of tran:
Liquidity — ce‘the importance of liquidity is magnified in day trading. Execution slippage of $ 200, mea
3 ifference between the system price, or Market Order p e, and the actualfica oi ee ‘i ih re little impact on a month-long trade netting $2,000; 10" “ oene veark ea di. ytsade with a profit objective of under $300. The selection 0} says adingbe erica fora day 1 ge markets of greater volume, Whether one contract oF 1,000,cal
    
TABLE 6- Volatility and Li Markets,- 19961990-| .Market $Volatiity %$100Market SEYce 540 18.5,cern 163 8 13‘ose 35 263Australian dollar aaa 1B _British pound _ we usCanadian dollar 231 a4Deutschemark 703 42Japanese yen os _ 103‘Swiss franc 02Gold 3 n2High-grade copper 2 BOCrude oil 458 2.0Heating oil ao 23S&P 500 . 46NYSE Composite es - asTreasury bills 160 2s‘Treasury notes ae I
Treasury bonds
 
IMPACT OF TRANSAL r1ON COSTS 424
thinly traded market produces slippage that will cut sharply into profits. In choosingamong index markets that usually offer the greatest volatility and profit potential, you arealways safest with the markets that combine the highest volume and highest volatility.
Occasionally, markets with light volume show larger price moves than similar marketstraded on other exchanges. Traders will be tempted to profit from these moves but willconsistently find that the execution of an order at the posted price is elusive. The reality oftrading these markets is that a Market Order is not advisable due to the thinness of the trad-ing, a Limit Order may not get filled, and a spread is not quoted at anything resembling theapparent price relationships that you see on a quote screen; there is no real way to takeadvantage of these perceived profits. If an execution succeeds, exiting the position still hasthe same problems plus some added urgency.
Missed Orders
Because the profit objective, projected daily range, holding time, and end-of-day con-straints all put limits on a day trade, there are situations in which the market jumps after anews release and you cannot get filled anywhere close to your intended price. With mostof the potential profit gone before you enter the order, it would not be surprising to sim-ply skip that trade. These missed orders, called unables, can add up to a large part of yourprofits; at the same time they never reduce your losses.
Some markets are prone to more unables. For the energy complex, heated military orpolitical activity in the Mid-East can cause a prolonged period of very erratic price move-ment, resulting in as much as 20% unexecuted trades during a 1-month period. If we con-sider the normal profile of a short-term trading system as having an average net profit of$250, an average loss of $150, and a 50% frequency of profits, we expect a profit of $5,000for every 100 trades and a reasonable profit-to-loss ratio of 1.66. If, however, there are 10%unables, that missed opportunity must come from the profits; if the market was moving inthe opposite way, you would get all of your positions filled. Then 10% of the profitabletrades means 5 trades out of every 100 for a total of $1,250 missed. This reduces the totalprofits to $4,750 and the profit factor to 1.50. it may turn a marginal trading strategy, orone with small profits per trade, from a profit to a loss.
Price Ranges
The average daily range (not the true range) shows the maximum potential for a single
day-trading profit. Some markets, such as gold and corn, combine a lack of liquidity with anarrow daily range and are easily disqualified from a day trade opportunity. Eurodollarshave extremely high volume but very little movement; therefore, they are also not a goodcandidate for day trading. When volume is combined with volatility, the world index mar-kets, followed by the currencies and long-term interest rates, are shown to be the bestchoices. Energy markets represent the next tier, grains remain active, and other marketshave far lower volume.
Day traders may find that those markets with traditional daily trading limits present aproblem during high-volatility periods. Day trading does best in markets "that have wideswings not deterred by exchange limits; a single locked-limit move can generate a loss thatoffsets many profitable day trades. High volatility and locked-limit moves present a contra-diction for day trading, Rules that provide for expanding limits have greatly helped reduce thefrequency of locked-limit days; however, traders must always be on guard for this situation.
Estimating Slippage Costs
If you know the cost of slippage, you can do a much beiter job selecting the markets totrade and have a realistic appraisal of your trading expectations. The factors that make up 
 
15 ah i nner
a actal
DAY TRADING422
 
f thee ket activity, and the size o!
i sity, overall market volume, current marke the sie of theslippage are se Ore these items, current market activity 1S the mos Oe ameorder being placed. Of nese ets of volume ast accumulates throughout the day: WHEpects evo available for most markets, a reasonable approx millon Ct)actual volume is noe number of price changes during a fixed interval. 19 genet CetUsing § directly proportional to actual trading volumes during periods of seater aeboth ‘Mi along with the 1 ¢
Il increase along e num ic oyowt ou have ¢ snarsiy eecorded the order price, execution price, volainy tat bigh ~ty ol ane, time of day, and tick volume, you can find he impoi 7 ry " oi :tod estimate the slippage for any trade by applying the
ili i me +Actual slippage at time T= do + 41 x volatility + a2 x daily volu
ivi i x size of ordera; x current activity at time T+ as
dan solve for Go, 41, 42; 43 and as, ant
i dsheet of values for all trades, you c a and ay andDe eestimat a eeare slippage at any time T during the day, given the cures volume andthen estima approach was taken in 1992" for large Stop onders Wein A Casorder size. wi for large Stop ord
,, The results, sho 6 age wae
SIZE (0 CUTE ae es The far right column gives the slippage ely atthe 5% evelVery modest or oer 5% chance of having slippage greater than $135 Por Onnthat is, thee Ming both entry and exit, Commissions were not included
combini :ae “worst” owe in Treasury bills was confirmed as correct
Price Level / sec tevelsi abnormally high pricommon in markets that are ata Se eseke filowed by bear markets, and the combination creates sustained civ ipa aovac are volatile at low levels are most likely to be at the ane een ae cyoverrewwrning to previous, less yolatile patterns. The agricul arkets, -arry(
Continuing volatility is
‘Thomas V, Greer, B. Wade Brorsen, and Shi-Miin Liv ‘slippage Costs of a Large Technical Trader,” Technicalippage ct.
if 1992). .“Analysis of Stocks & Commodities January 1992) .
eee
i i Contract)*TABLE 16-2 Slippage (Loss) for Stop Orders (Slippage 1" Dollars per 5
 
 
5% Chanceof Worse thanTrad‘Averoge Best Worst St Dev on Entire TradeMarket a oe Me13.63 ~1120 200.20 a7 135ee 48. 13 —22.50 — 168.75 So 3Cet elles 38.49 12.00 pres a eooy 0.00 : :1434 eeee 37.35 17.50 10939 3358 134‘teats ot 18.53 12.50 112.50 . ear IheSeschrae aes 300 7e000 139.51 358feutschern: ’ 009 : : s62.86Teyels 25.70 11.36 62.50 ae 3BPoteen 7792 17.86 280.00 f 3God : 0.00 410.00 72 -
= — Technical Trader.” Technical Analysis of Stocks & Com
” 305 of eTeTpoocn Thomas’. Greer, 8. Wade Brorsen, and Shin Liu."Sippage Costs fa Largemodes (January 1992)
 
APPLICABILITY OF TRADING TECHNIQUES 423
stocks are increasing, show reduced volatility. Many experts have theorized that the highinterest rate yields seen in the 1980s, as well as the high precious metals prices, are a veryunusual event not to be repeated often.
Some markets do not have a high or low price in the normal sense of a physical com-modity; therefore, they do not contain volatility patterns directly proportional to pricelevel. For example, foreign exchange markets have low volatility when they are at levelsperceived as the fair value or equilibrium. Prices increase in volatility when they moveeither up or down from this level, because any change away from the norm is consideredunstable. .
Crude oil represents a different phenomenon because it is a controlled market. Whilecurrencies may become volatile as they move away from equilibrium, they will becomequiet at a new price if that is perceived as reasonable by the market. This is not the casewith oil, because the producing countries continue to drive prices back to their target lev-els by controlling the supply. Therefore, the farther prices decline from the producers’desired price, the more of a struggle exists between fair value and controlled price, result-ing in higher volatility. The dynamics of higher oil prices are similar to other physical com-modities. The day trader must always seek opportunities in potential volatility.
APPLICABILITY OF TRADING TECHNIQUES
Most traditional methods of technical analysis, in particular trend-following systems, arenot used for trading intervals of less than 3 days; however, the price fluctuations duringthese shorter periods are nearly all echnical. An economic analysis of supply and demandcannot be relevant over such a short time span; that approach can only be used for estab-lishing longer-term trading policy. Other than the immediate reactions to overnight cashmarket movement, anticipated daily price changes based on political events and weatherhave not been successfully measured; however, techniques used for day trading can beapplied to slightly longer periods of a few days. The principles used in these time framesare very different, and the number of data points used in the calculations reflect on thefinal reliability. For example, a 3-day daily moving average relies on only three data pointsfor its decision of the direction of the trend; therefore, it will be very erratic.
Both day trading and short-term trading are concerned with timing to improve entryand exit points. The most common way to accomplish this is by a simple form of patternrecognition based on values relevant to the short time frame. From the floor trader’s view-point, only the most obvious recent key levels are important. Today's price movements arecompared with today’s opening price, high and low, yesterday’s closing price, yesterday'shigh and low, last week’s high and low, very memorable older support and resistancepoints, and finally, life-ofcontract high and low. When the same price satisfies more thanone condition, there is greater confidence in the importance of that point.
The importance of noise is also very different for the day trader and the trend follower.Noise, the underlying erratic movement of prices, is not a significant issue for the positiontrader looking to follow interest rates to high levels over the next year. But it is very impor-tant for the day trader, because the trend component of price movement is very small overa 24-hour period compared with the noise. This makes it impossible, using the ordinarytrend-following tools, to decide whether a move up over 15 minutes will begin a trend or
whether it is simply part of the more common market noise.
Time-of-Day PatternsTime-of-day and short-term patterns are combined in the most popular forms of day trad-
ing; the types of patterns have been discussed in Chapter 15. There are natural occur-rences during the trading day that make certain times more important than others. The 
seein FIRE
APPLICABILITY OF) RADING TECHNIQUES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
424 DAY TRADING topening gap and the continuation of that direction usually take the first 15 to 20 minutesof the trading day, as does the reaction to the U. economic reports that are released at3:30 am. in Chicago. After that, a price reversal occurs and a trading range is established, ay aa] ea] aehich lasts until the middle of the session. The midmorning period, which may marginally cS Sep ue} ue} it a? e°expand the initial trading range, tends to include low volume because many of the orders 4 wi ar | sor} itr} ae | teoriginating off the floor (called paper) are exhausted near the open; floor traders take this 33 2 eole *[ eof aol?opportunity for a break, further reducing liquidity. gs es 3 dei} AA) be) |Following midday, activity steadily increases and the existing daily range is tested. It is eens Ze B tgie ele 72 4 oScommon for most day traders to buy the bortom of the rans and sell the top. A break of SEF 2 = l858 BS) ut! | to] | een?either support or resistance after midday is considered a major directional change; traders Sseegeys 3 eR ee eequickly shift to the direction of the breakout with the expectation of holding that position ges SEES 8+ a [at —|—+ i?for the balance of the day. A more thorough analysis of time is shown in Figure 16-1. This 223 Bas eee pp jf et at] = jE]chart, created by Walt Bressert, uses the important recent highs and lows and is very spe- 32 3 222/83 egal 77) 27 mo fea laoco ere eslationships berween the developing range, the Prevers day's range, and the £5825 523 82° HP) et BP ae RYtime of day. Readers may want to compare Bressert’s relationship with those found in EEEE g2le8 . a ape o aChapter 15. Intraday highs and lows that correspond to key levels found on charts—such SPzzt2 ssa £3 Het} ie ee je oe iP ¢as channel support and resistance, and hhead.and-shoulders objectives—are also likely to 2tseglesy + tee fet poet [tedhave increased importance. EEEEEeEsS S£ol | ele 9 e ols |= «: SSSR slest 8 Ge me bE KLos ss leez ajIntraday versus Overnight Price Ranges Eeeacslege &Seere3i5's S| |= e 92 4Holding a position overnight involves margin and, above all else, greater risk. It also rir a 1 IB3 - me fe tuincreases the opportunity for larger profits. In moderately active markets, the opening gap, FFo0 T3223 2tolzZtolz J olz Fofz Fol FFinerSifference between the prior close and the next Oper» can be one-third to one-half the VAAVVAIS SPOT TRIE TSI RRA A IAA Asize of the normal trading range. Markets that are traded in one time zone but reflect the Pfeac tt bt els Pals Pelt tele talbusiness of a completely different geographic region, have larger systematic gap openings. L_ ~loloal2iz= "os =For example, the Nikkei 225 is traded at the ‘Chicago Mercantile Exchange, but the Nikkei > : aeae Value of the Japanese stock market. While the ay Session in Chicago is open . 6 [ da? teresfrom about 7:00 At. to 3:00 em. local time, the time in Japan.is 10 hours earlier, 9:00 Fx. aa = 3 seer] ie | bE} i+] & aeto 5:00 AM., a period when there is nO business activity in Asia. When Chicago opens, it a, % § sB o> amust immediately reflect the price ‘of the previous closing session in Japan; therefore, it £ 835 53gaps to that level. This same siquation happens to a lesser degree for Buropeen currencies, Z Zz22 +which are actively traded on Chicago's IMM. When those markets open at 7:20 A.M., Europe z 2 seo 8ve coming back from hunch and all local economic news has already been absorbed into the 2 = 5 5 3 68market. =3 Zz8Z osKet ble 16-3 and Figure 16-2 we see that the currencies and metals, representing mar- : eres 535 &Kets actively traded 24 hours, have the largest ‘overnight gaps. Viewing world markets only el irett Bs ceduring the U.S. business hours can put Co fer at a disadvantage and force him to deal £| zac a (82 €8all Ww far oo low la* a - : . 3 Slol W 1" owith unpredictable, ‘uncontrollable risks. This has prompted many traders to watch the £ zp 8 goy) te qe hott | aymarkets through both day and night. Most computerized systems have no trouble contin- 3 £23 ..j/°¢][2° = — —uing their calculation through various sessions. be Seg Zsolt 1 ft ta 4 9 |P?~ _ - = Se te (| = el fae |ePoint-and-Figure for Short-Term Trading . 3 4823 self _7/"_ 7 =a ole aleePoi i i é i 3 222 és( bri {bet tet foe He]int-and-figure charting has been a primary tool of day traders for many years. Using the z ago °° te! jarreinimum price movernent as the box size and 3-box reversal, many traders will keep 2 z ees al.) — le_9%continuous, although lengthy, chart of day-to-day price movement. Buy and sellsignals can ~ 289 OL) i = | mm)be taken in the standard manner, but day traders are most likely to use these charts for z 23 Pocletolerolezcl2 -identifying countertrend,support and resistance Tevels. Intraday point-and-figure, as well rr a vaclyvalyv viv aala JojtFosore am averages, often show frequent changes of direction before a new buy or sell sig- -{8 - WAYS EMIS SSG Etnal occurs, even when the minimum box size is used, Trend methods are best applied to 3 L —-|n |e = =~. italc ieshoreterm overnight positions in which the size of the move is much larger. = [1 |
 
Source: Walt Bresserc, 
ns DAY TRADING APPLICABILITY OF TRADING TECHNIQUES
 
 
 
- iTABLE 16-3 Percentage of Overnight Price Gap Com- \ FIGURE 16-' pared with Subsequent ‘Trading Range, for Selected ' 16-2 Opening gap as a percentage of daily move.j U.S. Markets -US.Markets 0 Opening Gap as a Percent i% Change Overnight of Daily MoveMarket 1985-1989 1990-1995 Pork bellies| Cotton 29.6 275 SoybeansCorn 263 265 Crude oilSoybeans 25.5 238Australian dollar SLO 435 SilverBritish pound 39.1 28.1 GoldCanadian dollar 39.0 319Deutschemark 37.9 30.9 BritishpoundJapanese yen 43.0 358 Deutsch: :‘Swiss franc 384 255 jemark (in 9%)Gold 28.7 315High grade copper na 30.9 Japanese bondCrude oi! 324 26.6 German bundHeating oil 33.8 29.0 . EuroyenS&P 500 19.3 16.3 U.S. Treasury billsNYSE Composite 22.0 199 U.S. Treasury bondsTreasury bills 272 25.6 °Treasury notes 26.6 13.6 0 20 40 60 to
26 116 ~ :
Treasury bonds
Percent represented by opening gap
ene
Price reversals that occur during the day can be plotted using a smaller point-and-figure box size than is common for daily charting: ‘The more frequent reversals due to thecombination of more data and smaller box size ‘will define the trend sooner or bring theprotective Stop closer. Remember, stop-loss levels advance only when there are reversals.Yn this way, day traders’ improvements are transparent to the point-and-figure users whowork only with the daily high, low, and closing prices. In general, when there is a choice ofplotting a point-and-figure trend continuation or reversal, the reversal should be plotted.eipis allows the chart to reflect the reversal sooner and bring the stop-loss closer—both are
few seconds
few see acuity ep thoush volume may vary. For practical purposes, prices might be con-
sidered equally spac 4, But consider an extreme example. The price of a less liquid mar-
ket changes every 1 is during more active times, then quiets to 5-minute in 3., there is a lull of 15 minutes followed by a jump in price. Is there a aittorence
in the way we would inte!, rpret the following two patterns? i ia moving average would calculate the wen? Is there a difference in he way
 
 
an improvement over the standard rules. Time A Price TeimeMoving Averages eee $005 10:00‘The intrinsic dependency on time makes a moving aver38° less adaptable to day trading. . 10:02 5005 lobej fo be used properly, a moving average ‘must be recalculated at fixed intervals. Two philo- 10:03 soi 1016i sophic questions must pe answered with regard to intraday moving averages. Do trends 10:04 5025 10.264 - exist in this short time interval, ‘and does it make sense to apply 2 moving average.to all 10:05 . 5020 10.28 -. intraday prices unevenly spaced with respect to time? In a previous section of this chapter, 10:06 501s 10:29 -the conflict between noise and trends was discussed. Markets with a large noise compo” 10:07 5025 10.44
 
nent require more time to identify a trend, ora larger price move; therefore, it may not bepossible to enter a trend trade and still have enough profit potential before the end of thetrading session. It is likely that there ‘will not be more than 25% of the daily range remain-ing after the trend has been identified, making the profit opportunity too small.
The versatility of computers allows all intraday prices to be used in a moving averagerather than the traditional 5-minute bar, furthermore, you can create a price bar based onevery 5 or 10 prices, regardless of time. In a liquid market, prices might be posted every
Pattern A sI
note A shows gradual voward movement over equal time intervals; pattern B
shows slow rallies and 6 rops. When interpreted by a trader, pattem B is often consid-
cred soppy i mad struggling to go higher with anxious sellers. Moving averages ofnA, "shown, and pattern B, interpolated to equal intervals, will have the
same trend direction at each t. There enou formation to know which is best,int, is n c
poi ot gh inf
but it is clear that the patterns can be interpreted differently.
    
 
 
 
 
Ha
‘iiiI
428 DAY TRADING
‘More on Choosing the Length of the Intraday Bar
While there is no right bar length, traders most often choose 5-, 10-, 15-, 30-minute, andL-hour periods to chart, Most of the commercial software packages require that the inter-val be evenly divided into 1 hour; therefore, a 6%minute interval is not allowed. WhenUsing longer bars, such as 1 hour, it is important to consider the length of the last bar ofthe day. A L-hour bar will post its first price at the end of the first actual hour, rather thanwrote after the open; the last bar will be the interval from the last whole hour to the close-da tne case of oil, this may only be 10 minutes. When bars are uneven in this way, the priceranges and corresponding volume are no longer comparable with one another.
se a sis a difference in opinion between analysts over the choice of intraday intervals.
_ One group prefers to pick a standard number because it conforms to the way others trade;
for example, you can expect orders to flow more actively every hour. ‘This approach may beparticularly valuable if you plan to take the opposite position. The other group of traderskre constantly seeking their own time interval, avoiding uneven order flow and price dis-tortion caused by most other traders. If you are part of this group, you may choose yourinterval by dividing the total number of minutes in the trading session by a value that givesyou equal-length bars. You may also want to find a bar length, such as 21 minutes, that rep-vesents a Fibonacci number and comes close to dividing the day equally.
MARKET PATTERNS
‘Atrade that lasts from 1 to 3 days can be improved if short-term patterns oF cycles can befound. For example, in a trending market there are outstanding