STRATEGY AND TACTICS
The 6 Steps to Turning a Strategy Into a Daily Trade Plan
• Once you have a strategy for making money from the markets based on sound principles, you need a way to transform that strategy into a practical plan customized for each specific day you trade. Through our years of trading, we’ve developed a 6-step system for developing this daily trading plan. The 6 steps prepare you to take advantage of market opportunity each day before the market opens.
• Step 1: Perform a top-down multiple time-frame analysis to determine the market context.
• Step 2: Pinpoint and draw in the key reference areas that will likely provide support or resistance.
• Step 3: Check the economic calendar and know when the important economic releases are due.
• Step 4: Know the 10 day ATR (or any multi-day period) and be aware of the general volume environment.
• Step 5: Identify the pre-market conditions that increase the likelihood of having a trend day. • Step 6: Develop different market scenarios based on if / then analysis.
• These 6 steps need to become your daily pre-market routine. Having a routine not only gets you more prepared, but it also keeps you more disciplined and consistent. The pros are very systematic in how they approach the markets, while the losing traders are random and inconsistent. Make this your daily system and your trading will take a leap forward.
The 9 Principles of Effective Intraday Tactics
• If over 90% of the time we don’t get trend days, and our strategy during such times is to fade key reference areas, the question becomes: how do you know which key reference areas to fade and when?
• We’ve distilled all of our knowledge into 9 principles that, if followed, will act as guidelines that will give you effective intraday tactics. The 9 principles are listed below, and in the next section we’ll put them into action and give you detailed notes on each one.
• Principle #1: Some support / resistance zones are automatic fade zones (unless it’s a trend day coming into the zone).
• Principle #2: Most support / resistance zones should only be faded if the bias is not strong against them, and we’re seeing an exhaustion or divergence setup there.
• Principle #3: The first test of a support / resistance zone offers the best odds of a reaction.
• Principle #4: The larger the time-frame of a support / resistance zone, the higher the odds of it holding on an intraday test.
• Principle #5: The more confluence we have in a support / resistance zone, the higher the odds of it holding on an intraday test.
• Principle #6: The more important and significant the previous move that started from a support / resistance zone, the higher the odds of it holding on an intraday test.
• Principle #7: The more the larger time-frames are aligned with a support / resistance zone, the higher the odds of it holding on an intraday test.
• Principle #8: How the price approaches a support / resistance zone influences the odds of it holding or breaking.
• Principle #9: The more factors that align to increase the odds of a support / resistance zone holding, the greater the profit potential from that zone.
Daily Trade Plan Development in Action (Step 1)
• Even though we’re day traders, we begin our top-down analysis with a daily chart to see the big picture.
• Once we have the big picture context, we zoom into the shorter-term picture. Quite often, a 60 minute chart can give us a good view of this, followed by a 15 minute and then a 5 minute chart.
• When looking at all of these different time-frames we’re simply looking at whether the market is balancing or trending. And if it’s trending, we’re gauging the direction and maturity of the trend (i.e. is it just beginning, is it likely ending etc.).
• Once you gain experience in reading charts, you’ll realize that you can quickly gauge the multiple time-frames just by looking at a daily chart. You’ll see the big picture, and then zoom in mentally on the intermediate term and short-term action. Going to the different time-frame charts simply shows you a close-up of what you can mentally visualize just by looking at a longer-term chart.
• This top-down, multiple time-frame approach is what will give us the context as we head into the current trading day. Knowing the context is of utmost importance, as it will directly influence the trade plan for the day by influencing the scenarios that we build.
Daily Trade Plan Development in Action (Step 2)
• The first thing you start with when you’re drawing in key reference areas that will likely act as support or resistance is the big picture view. You take a look at the daily time-frame and see if there are any:
o Major buying or selling tails that cause multi-day or multi-week reversals. o Range extremes where multiple significant highs or lows can be found.
o High volume nodes from previous major balance areas.
o Launching points of high directional conviction.
o Previous major support or resistance areas that have now flipped roles after being broken through.
• Even though we are day traders, we have to be aware of the bigger picture key reference areas, because as we’ve seen they will come into play on our time-frame. Those traders who don’t understand the bigger picture will often not realize when the current trading day is trading inside major support or resistance zones from the past, and this will cause them to make wrong trading decisions.
• After you’re done drawing in the major key reference areas (the good thing is that these don’t change very often so you won’t have to redo this part day after day), you need to step down to a lower time-frame, say the 60 minute chart, and look for all the same types of key reference areas mentioned in the first point above, but now on this smaller time-frame.
• Then you look closer with a 15-minute chart (the actual number doesn’t matter; it can be 20 or 10 minute, just as long as it gives you the view of the market you want), and look for the same types of areas developing in smaller form. Remember that the markets are fractal and the same type of behavior takes place at all timeframes. In this particular one, it’ll be easy to see important gaps (if you’ve set your chart to a day only session), and the important ones are those that were the launching points of directional conviction or breakout moves.
• Then you zoom in to a 5 minute (or so) chart to see the most immediate preceding action. You draw in the previous day’s low and high, as those are always important reference points that often provide support and resistance. You also draw the previous day’s close, as that’s a good reference area for today and will often provide good support or resistance if we open far away from it today and then retest it. You draw in any important buying or selling tails from. preceding several days. And you also look on the horizontal scale and see where the high volume nodes of the last several days were, starting most importantly with yesterday. If they all overlap, you combine them into one profile. Otherwise, you draw in the ones that are still relevant (i.e. price hasn’t traded through them to both sides yet).
• If you are currently trading within yesterday’s or the previous several days’ high volume node (also known as the value area, with its upper extreme being the value area high, and lower extreme being the value area low), you use this as a reference to see who can gain control of the market. If we go above it and hold, the buyers are in control and we want to favor longs, and if we go below it and hold, the sellers are in control and we want to favor shorts. If we’re already opening above or below it however, it will provide support or resistance as we test it.
• Finally, as a last step, you switch to a 24 hour chart to see what has happened in the overnight Globex session and to gauge where you’re about to open up on the current day. The overnight action shows what has happened in Asia and Europe. Remember that the market never sleeps. And it’s important to note the high and low of the overnight session’s trading. These will often provide support or resistance during the current day, especially in the early hours of the day. Also, on some occasions the overnight extreme from several days back can still act as a key reference area that provides support or resistance, so it makes sense to keep those drawn in on your chart until they are violated in a subsequent day.
• A key principle you need to understand when identifying and drawing in key reference areas is that of confluence. Confluence means an overlapping of more than one key reference area. The more key references we have overlapping, the more we get a compounding of probability, i.e. the odds become higher that we’ll see a significant market reaction when the area is tested.
• If you have a wide key reference area that is too broad to be used as a specific support or resistance zone for intraday trading purposes, looking for confluence with other smaller reference areas allows you to narrow it down and have a tighter zone to use for your trading.
• Another important principle is that the bigger time-frame key reference areas will act as more important support / resistance and they’ll cause larger market reactions. Also, the more recent a key reference area is, the more importance it will have on the current trading day.
• Remember that you need to make this a daily routine. Every day before the market opens you need to draw in the latest key reference areas and have your support and resistance zones ready. Never start a trading day without doing this crucial prep work ahead of time, because you’ll be flying blind like most traders in that instance.
Daily Trade Plan Development in Action (Step 3)
• Most traders make one of two mistakes when it comes to news and economic releases:
o Mistake #1: They try to trade the news and economic releases in a straightforward manner. They buy on good news and sell on bad news. This is a losing strategy because most often (except for completely surprise news), the expectations regarding the news are already factored into current prices, and the price move we get is a reflection of how the news compares to the existing expectations and not so much the news itself. Also, when we do have surprise news, the market moves so quickly that trying to take advantage of it is often a loser’s game because you’ll end up with bad trade location and can get easily shaken out with a loss due to the elevated volatility.
o Mistake #2: They completely ignore the news and economic releases. They realize that trading the news outright is not working for them, or they read in technical analysis books that the market discounts everything instantly and so it’s useless to look at the news. The problem with this is that it looks only at direction and ignores volatility. It’s unwise to ignore economic releases because they will have a great affect on market volatility, and this will have a direct effect on every aspect of your trading.
• Instead of making these mistakes, you should be aware of all the economic releases that are coming out in the day and week ahead, without trying to outright trade them. You should know when each is scheduled to come out. A great tool that gives you a clear calendar and highlights the important releases is the Econoday Economic Calendar. You can access it for free
• You don’t need to know the meaning or actual numbers of the reports. Once you’re very advanced you can start looking at them, but until you’re consistently profitable you just need to note when they’re going to take place. Then what you need to do is make sure that you’re on the sidelines and not entering a trade in the 10 or 15 minutes preceding and following the news. The reason is that the increased volatility around the news will likely stop you out of your trade and give you a needless loss. If you’re already in a trade from before and the market is still close to your entry point, it may be a good idea to exit ahead of the news. And you’ll likely want to exit even when at a profit unless market context and structure strongly point to continuation.
• Another very important point is that knowing when the major economic releases are due gives you an indication of when volatility will likely enter the market. Often, in the hours leading up to the news announcement, the market is quiet and directional conviction is not easily sustained (the exception to this is when other factors are lining up to cause a large move,. which we’ll cover in the session on Step 5). The last thing you want to be doing in a quiet sideways market is looking for breakout directional moves, and knowing that an important release lies ahead will help you avoid doing that.
• The above point applies not only on an intraday level, but also on the week as a whole. If the calendar is light on releases early in the week but is full of important ones later in the week, the first part of the week may have quiet trading as a whole, and barring any other confluence of factors (which again will be covered in the session on Step 5), you should not be looking for strong directional moves to take place. The reason for this is that the large institutions that move the markets will often stay on the sidelines and not make major trading decisions until they see the major economic data. Without their order flow and volume, the markets lack directional conviction and often trade in smaller ranges.
• A special economic release is the FOMC announcement. The market is typically extra quiet in the hours preceding this release, and you should adjust your trading (entries, stops, and profit exits) accordingly. Often it just makes sense to stay on the sideline before the announcement, and definitely avoid trying to trade it. You can make more than enough money in the markets without ever trading this event.
• As a final note, some markets have their own important announcements that may not be major movers of the stock indices. For instance, Oil has the Petroleum Status Report which is a huge mover in that market. Natural Gas has its own report. The bonds and interest rate instruments have their own reports. So do the grains. So if you trade any of those markets, make sure to research what the most important reports are and be aware when they’re due to be released. If you trade stocks, make sure you know when the company reports earnings.
Daily Trade Plan Development in Action (Step 4)
• The volatility environment is a massive factor in determining your trading. It will affect your entries, your stops, and your profit targets/exits. As volatility rises, your stops need to get correspondingly larger (or you’ll end up getting stopped out too often by random noise), your profit targets/exits need to expand (to keep a good reward-to-risk ratio with your stop), and your entries will change to include more momentum / breakout type entries. As volatility decreases, your stops will naturally need to get tighter, your profit targets/exits should be smaller (because the market won’t even reach expanded targets), and you should be careful of entering with momentum (because you will get chopped up as price moves back and forth and lacks directional conviction). So to take advantage of market movement in a correct and timely manner, it’s not just about analyzing directional context. Volatility analysis (which includes economic calendar analysis we covered in the previous step) is crucial. And especially so in day trading when opportunity is restricted by the market open and close.
• The Average True Range (ATR) indicator shows you the average size of movement that is happening in any particular time-frame for a certain look-back period. If you’re looking at a 10 day ATR overlayed onto a daily bar price chart, you will see what the average range of a day has been over the last 10 days. If you’re looking at it on a 5 minute chart, you’ll see what the average range of a 5-minute period has been for the last ten 5-minute periods.
• The ATR puts an actual number on volatility. It tells you what kind of volatility environment you’re in and how large a current normal day is, versus a volatile day, versus a slow day. If, for instance, the current 10 day ATR is 16 points, then you know this represents an average range for the day. A 25 point day would be quite a volatile day, while a 9 point day would be quite a slow day. And if price has already moved 16 points during the day, and there are no underlying conditions that say that an extraordinary move is likely to happen, then you know that you’re likely hitting an extreme and shouldn’t be expecting much more range extension that day.
• Volume is another way to gauge volatility because volume is the driver of volatility. The thing that makes the market move is order flow, and the more order flow there is the more volume gets transacted, and the more volume that is transacted, the more potential for movement (i.e. higher volatility) that we have.
• Don’t worry about trying to do any exact volume analysis, especially on a larger time-frame. Volume is one of those things that can get you into more trouble than anything else if it’s overanalyzed (like it is by most traders). Simply have an awareness of the general volume environment to tell you if we’re in slow or active markets. Later, when we get into tactics after the market open, we’ll have a more specific way to look at volume.
• Most traders don’t understand how important it is to always be gauging the volatility environment and the likely size of ranges we’ll see. It’s not just about contextual market reading and direction, it’s also about timing. You need to have a good idea of when we’re likely to see the bigger moves play out. Even if your bigger picture analysis is correct, you can still lose a lot of money as a day trader if you’re not gauging the likely volatility correctly because you can get chopped up playing for a big move that is not likely to happen that particular day. And when you’re day trading, it’s all about what is likely to happen that day, which gives you a finite number of hours for things to play out (in the day session when liquidity is good).
Daily Trade Plan Development in Action (Step 5)
• Condition #1: Mature Balance
o This is probably the most powerful factor in determining whether we’re likely to get a trend day or not. ‘Mature’ is a relative term that is based on the time-frame and context. On the smallest level we’re looking at for our purposes here, you need to see at least a tight 2 day balance to have increased odds of a trend day. Three or more days is better. When you’re looking at a larger time-frame, the balance could stretch out for weeks, and what determines whether it’s mature is really just a visual thing that you get better at seeing with experience.
o You can speed up your accumulation of experience by reviewing historical charts and finding balance areas of all sizes and seeing what they looked like when the market broke out of them. But in general, the more time that a balance area develops, the more mature it becomes, and the more mature it becomes, the higher the odds of a trend day forming when we break out of it.
o When you’re in a large (many days, or multi-week) mature balance area, the odds of a trend day become larger the closer we are to one of the extremes, because at the point of testing an extreme, we can readily see a breakout from the balance.
• Condition #2: Volatility Contraction
o If you compress a coil tightly, when you release it the coil will expand quickly. It works the same way in the market. When volatility contracts and we have an extra small range, it’s like compressing a coil. The odds of eventual expansion are higher, and the greater the compression or contraction, the greater the likelihood that the market will snap back with an expansion. And it also makes it more likely that we will see a larger expansion in terms of size.
o From a practical standpoint, the reason we see a big volatility contraction is because the market is usually waiting for some major economic number due out in the next day or two, and the release of the report is usually the catalyst for the volatility expansion.
o In reality, almost any balance area technically represents volatility contraction. But we’ve already covered balance areas in general, so the specific element we’re talking about here is a volatility contraction during the latest market day.
o A man by the name of Toby Crabel coined the terms NR4 and NR7. The ‘NR’ stands for ‘Narrow Range’ and the number represents the number of days. So an NR4 means that the most recent market day had the narrowest range out of the last 4 days, and an NR7 means that the day had the narrowest range out of the last 7 days. In our trading, we look at any NR day that is 4 or greater. The larger the number, the greater the volatility contraction.
o A good free resource for checking if we have an NR4+ day is http://www.mypivots.com/dailynotes . Simply find the market that you trade and in that specific market page you’ll have the Crobel price patterns highlighted. If there is an NR4+ day, it will be highlighted in green.
• Condition #3: Large gap through key reference area(s)
o When the market gaps right through one or more key reference areas, it means something significant has happened during the overnight session and the value perception of either the buyers or the sellers has changed. If this new perception is accepted at the open, we can often get a trending move in the direction of the gap as the momentum carries through. If it’s rejected, we can often get a trending move the other way as the gap is filled and the whole overnight move is emphatically reversed with conviction.
o In the first case of a trend with the gap, many longer-term market participants find themselves caught on the wrong side of the market at the open, and as they scramble to cut their losses, their buying or selling can often accelerate the move in the direction of the gap. In the second case of a trend against the gap, the other side is aggressive in rejecting the higher or lower prices, and as they reject the gap at the open, all the buyers or sellers that moved the market overnight now find themselves in a losing position losing and their exit accelerates the trend. o Of course not every big gap through an important key reference area has to lead to a trend. Like in all of these conditions, the odds for a trend day are simply improved.
o Note that if the gap is abnormally large (you have to study historical charts to know what constitutes an abnormally large gap in your market), then the likelihood of having an outright trend day is lower as compared to a normal large gap. This is because the majority of the move would have come in the overnight session and the market is likely to balance and consolidate the move during the day session. This is especially so if the abnormally large gap is happening into a major key reference area. These days can chop you up if you try to trade them directionally thinking that a trend day is likely
• Condition #4: Market moving economic release
o If there is a major economic release due on this particular day, this increases the odds that the new information could change the perception of value in the market and cause a trending move up or down away from the current value area.
o If there is no economic release and there are some major ones due over the next day or two, the odds of having a trend day on this particular day actually decrease to below average.
• Condition #5: Generally elevated volatility environment
o If we’re seeing much higher than average market volatility, and especially if we’re in the midst of a bigger picture strongly trending environment (particularly to the down side), we’ll have more trend days occurring on average. And if trend days are more common on average during any period, that means the odds of them happening on any particular day you’re trading are higher, all things being equal. If you traded during 2008, you will have experienced this directly, as we saw many more trending days than normal.
Daily Trade Plan Development in Action (Step 6)
• Taking all of the preparation you’ve done in the first 5 steps of our 6 step process, you now use all of that information to create scenarios for the coming day. The scenarios themselves are your trade plan.
• The problem with most trade plans is that they are rigid and too general to fit any specific day. However using this process to create a scenario-based trade plan gives you a highly flexible, adaptable, and custom-made trade plan for each day. This can make all the difference in your trading, and this is the “tactics” part of the equation. By building this customized trading plan, you’re taking a general strategy and turning it into actionable tactics.
• The reason most trade plans are rigid and not based on specific context is because traders hate uncertainty and want the emotional comfort of a simplistic trade plan that has no ambiguity. They want simple if / then statements. The reality of the markets though is that there will always be uncertainty and ambiguity surrounding your market reads and scenarios. It’s never a simple linear thinking process. You have to think in a non-linear manner and be willing to entertain competing arguments. This isn’t a bad thing. In fact, it’s a great thing. Because if it were too simple, then anyone could do it and there wouldn’t be huge reward potential in trading the markets. So appreciate this fact, and use all of the structured training we’re giving you to accelerate your learning curve by practicing diligently.
• When you’re developing scenarios, you’re always asking yourself who will be in control of the market as we move in and through different key reference areas. Based on the overall context of the market that you’ve analyzed, you identify the key reference areas that are the most important and that, if broken, would imply that there was a major transfer of control. In our market example, the most important key reference areas were the bottom and the top of the current 4-day balance. A break and hold below the bottom would put the bears firmly in control in the immediate time-frame, and a break and hold above the top would put the bulls in control. Each day will be different based on the market context, but you should be able to identify at least one “line in the sand”, or what is called a bull/bear zone, above which the bulls have overall control and below which the bears have overall control.
• Of course all of your contextual analysis and reading of the market in the first step of the process will often give you a bias regarding what are the highest odds scenarios that will likely unfold. In our current example, given the fact that we are in a larger term uptrend and now hitting a major long-term support zone, we give more weight and odds to the bullish scenario. This means that even though we’re watching the bottom of the balance area and will be ready for a potential downtrend day out of it, our thinking is that we are more likely to get an uptrend day out of it as the bigger picture takes hold. And correspondingly we will also trust an upside breakout more and be more aggressive in trading it. In this way, our market analysis not only provides us with different scenarios to be ready for, but also tells us what’s most likely to happen. And as you gain experience, one of your biggest advantages will be to sense what’s likely to play out before it has confirmed, giving you the best trade location and accuracy for your trades.
• Now if the pre-market conditions show that there is a better than average chance of a trend day occurring, then you would be watching for a breakout of one of the important key reference areas and would be looking for a potential trend day to get on board. If, however, the pre-market odds of forming a trend day are low (for example the only condition met is that there’s an important economic release, but the rest of the context is not conducive), then you would be looking to ‘fade’ the key reference areas (i.e. buy at support or sell at resistance). And if in this context the market moves through the key reference area, you would be intently watching for signs of failure because you know directional conviction will be lacking as a whole on this day.
• Finally, you’ll be thinking in terms of zones to construct your scenarios. Your thought process will be something like this: If we break and hold above this resistance, the odds are that we will move to the next higher resistance zone (provided that the next zone is close enough given the current 10 day ATR). If, however, we fail at this resistance zone (either reject it instantly or move through it slightly but not be able to hold above it), then we will likely rotate down to the closest support zone.
• Thinking in scenarios based on deep contextual awareness of all the different market dimensions separates you from the majority of traders who are looking for simplistic setups and signals in a vacuum. All professional traders who make consistent money from the markets, no matter how much their styles or strategies differ, ultimately think in scenarios based on contextual understanding. That’s the only way you’ll have a sustainable edge in the markets. So incorporate this 6-step process starting today, and begin practicing it diligently while reviewing your analysis each day after the market close to get better at it.
The Essential Requirements of a Money Making Strategy
• There are three core elements in the trading process, and those are strategy, tactics, and execution. The bottom part of the pyramid, or the foundation, is the strategy. Strategy tells you how you define opportunity in the markets, and it represents your overall source of edge in the markets. The next level in the pyramid is tactics. Tactics are what you use to implement the strategy. When the market is open, you read how the buyers and seller are responding and make judgment calls as to the best trades within your overall philosophy of how to make money in the markets (i.e. within the context of your strategy). Finally, the last level is execution, and this is how you implement the tactics. This is the part where you actually enter and exit at specific times and prices.
• The day trading strategy that we employ, and the one you’ll be learning, can be summed up simply as: Fading key reference areas during non-trend days, and getting on board the trend during trending days.
• The key skill needed to implement this strategy is to use all of your market understanding to determine what type of day we’re most likely to have (trending or non-trending), and which are the most important key reference areas from a contextual standpoint.
• The essential requirements of a money-making strategy that has an edge are good trade location and economically viable exists.
• Good trade location means finding entry points that give you the ability to clearly define a small initial risk. “Small” is a relative term that can only be determined when compared to the potential reward. Just having a tight stop-loss does not mean small risk if the potential reward is very small. Also, the other aspect of being able to clearly define a small initial risk is to be trading at an area in which if your stop is hit, the market has clearly invalidated your trading idea or directional hypothesis. Otherwise, you are trading randomness in the middle of nowhere and do not have good trade location even if your stop is tight in absolute terms.
• The benefits of good trade location are:
o Better Reward-to-Risk trades- Since you’re trading at the ‘edges’ of key reference areas or at the start of trending moves, the potential move the market can make from there is going to be large compared to the small initial risk needed for your trade hypothesis to be invalidated.
o Better accuracy- The odds of market movement one way or the other is 50 / 50 unless you’re at an area that is an inflection point where one side (the buyers or the sellers) are more likely to take control based on market context and dynamics.
o Less chance of being stopped out by noise- If you’re not trading at the right locations, your stop is likely to be hit based on random market movement, or “noise”. Having good trade location means that when your stop is hit, it is usually a significant move that actually means something regarding the context and likely direction of the market going forward.
• Your exits will only be economically viable if commissions and slippage are a small percentage of your initial risk. If you’re trading the S&P 500 Futures with a $5 round turn commission and you have a 1 point stop and a 1 point profit exit, your Reward-to-Risk isn’t actually 1:1 like you may think. Rather, the commission makes your risk 1.1 points and your profit 0.9 points, turning your ratio to 0.82 : 1. This means that you have an 18% erosion of Reward-to-Risk.
• The other erosion will come from normal and hidden slippage. Normal slippage is what happens when the market is moving fast and you get a worse price than you expect when buying at the offer or selling at the bid, whether on entry or exit. Hidden slippage is something most traders don’t think about. It exists even if you always use limit orders, because for you to get filled on your profit exit, most of the time the market has to trade through your price (because there will often be many orders ahead of yours in queue). This means that if you want a 1 point profit exit in the S&P 500, the market most often has to move 1.25 points for you to get the 1 point profit. Therefore, your accuracy is actually going to be lower than you expect, because by definition the larger the profit target, the lower percentage of the time you’ll be able to reach it.
• The drop in accuracy due to hidden slippage, combined with the effect of commissions, can turn a seemingly winning strategy on paper into a losing one. The conclusion, therefore, is that you have to make the combined effect of slippage and commissions a small percent of your initial risk and profit exit. The only way to do this is to make sure to trade on a time-frame that allows for decently wide stops, and to not shoot for very small profit exits just because they feel good psychologically. In the S&P 500 that would generally mean at least 2 point stops and exits. In the Dow, that would mean at least 15 point exits (the % erosion on the Dow is smaller than the S&P because of the smaller TICK increments the Dow moves in, which makes slippage less). Each market will have its own levels where we hit economic viability.
• If you want a rule of thumb, try to keep the sum of the commissions and typical slippage in your market to 15% or so of your stop size (your profit exit size should never really be smaller than your stop size).
Reading The Market Once It’s Open
• To simplify your read of the market once it’s open, think in terms of two broad categories of day types once again. Is the market at the open showing signs of confirmation of a potential trend day, or is it saying that the day will lack consistent directional conviction overall?
• Even though trend days happen less than 10% of the time, their importance stems from the fact that persistent directional movement can offer very large profit potential if you can get on board of it, and can cause numerous and huge losses if you try to trade against it. So it becomes imperative to identify these types of days. And by definition, if your market read shows you that you’re not likely to get a trend day, then you know that you have the other types of days that happen 90% of the time.
• When you don’t have any conditions of trending potential in place before the open, you still benefit from knowing how to read the early market action because it often tells you which side is stronger, what the bias is, and which zones (support or resistance) to weigh more heavily.
• In terms of reading the market at the open to determine whether it’s confirming a potential trend day or not, we have three main ways of gauging that:
o Open-Drive behavior: To open and drive means that within a few minutes of the open, the market pushes strongly in one direction and doesn’t retrace that initial push. This shows directional conviction from the institutions who move the markets, as they are most active early in the day. And this means that their perception of value has changed, and they’re committing to a new direction early on in the day. This increases the odds of a trend day forming, and if the pre-market potential for trend is high, this is a great confirmation sign.
o Tight early balance: Tight is a relative term based on the current volatility environment. This is a subtle concept that is not always easy to pick up on in real time. The reason for this is that while price may sometimes look to have a ‘volatile’ early balance, with the range of the balance possibly being 40% or more of the current daily ATR, we may be about to get a major volatility expansion that gives us a very large range day in which the initial action that looked volatile ends up being a tight balance by comparison by the end of the day. So we only end up seeing that it was ‘tight’ after the fact. This will take experience to notice in real time, but it can help to see if we’re moving quite sideways with no real bias in the early action. Then visualize ahead and see in your mind’s eye how this seemingly volatile sideways action would end up looking like a tight little balance. reserved.
• Supporting market internals: If you trade the equity indices, you can use market internals early on in the session to either confirm or negate the potential of a trend day forming. If there’s a definite early tilt to the TICK one way or the other and the A/D line is also showing early marked strength or weakness, this could be a great confirming tell that there’s good directional conviction in the market (either up or down), and the odds of the trend day actually playing out if the pre-market conditions support it become much higher.