At the start of trading session, the day trader sees a blank chart!

Most traders review strategies by looking at complete session charts. This may fool them into thinking that entry points are obvious, because subconsciously they are imposing their knowledge of the future on to their hypothetical decision. In reality, the trader can never see past the right edge of the chart! He or she has to make decisions based on imperfect, limited knowledge. That is a great deal more difficult than saying “Of Course! I would have entered there!” afterwards, when you can see the entire chart.

So where are those key points – the highs which will trigger a breakout long trade and the lows which would trigger a breakout short trade?

Some traders answer this question by looking back over previous sessions, probably using a greater timeframe than the one they intend to trade in. For example, a trader using 2 min charts might look back through the last couple of weeks using hourly charts to pick out significant highs and lows.

In doing so, of course, the trader is simply identifying market “resistance” and “support” levels. The plan is to Buy when resistance is broken and Sell when support breaks.

I by no means denigrate this approach, which can be very successful. However, I have never found that it increased my success percentage, so I prefer to work entirely with the information provided to me within the session I am trading.

The traditional way of identifying an upward trend is when successive bars on the price chart have higher highs and higher lows than previous bars. Similarly, a downward trend can be detected when successive bars have lower lows and lower highs than preceding bars. So, as a day trader, you can watch the market unfolding using, say, 1 or 2 min bars, and use this method to identify which way the market is trending.

Consider a rising market. If you see a series of four or five bars, each with higher highs and higher lows, shortly after the market opens, that is indicative of an upward trend. You know that no market goes straight upwards; you expect a trending market to go up in a series of waves. So when eventually you see a bar with an equal or lower high than the preceding bar, it is taken as a sign that a period of consolidation is beginning at this higher level. I usually refer to this as a “pullback”.

For a breakout trader, the pullback is the signal to go on alert. If the trend is to continue, the pullback will end when price has consolidated at this level, and price will then break out to a new high. The job of the breakout trader is to make the best use of this knowledge, and enter a long trade at an appropriate point.

One problem with waiting for a series of bars with higher highs and higher lows (or vice versa for down trends) is that the trader may well miss an early opportunity to enter the market. The reason for this is that markets will often be very volatile when they open. This applies particularly to markets like many of the traditional commodities, because they are actually closed prior to the open. Therefore, a lot of orders build up as people take positions based on the latest news and analysis, and all these orders hit the market in the first few minutes of trading.

Even the more sophisticated electronic markets which have 24-hour trading can be very volatile at the traditional opening time. After all, it is when many professionals in finance companies and banks have arrived at work, got their morning coffee and switch on their screens to start their trading day. There is an inevitable spike in volume.

But how can a day trader, faced with a blank chart, take advantage of this early volatility when there are insufficient bars on the chart to indicate a rising or falling price trend?

One way would be to focus down to even finer time periods. For example, although you intend to trade with one-minute bars during the main session, you look at 15 second bars during the open.

Other traders use tick bars. In this approach, bars on the chart appear when a certain number of transactions take place. For example, every 1000 trades. In the opening minutes, several bars might appear on the chart because volumes are high. Later in the session, as volumes ebb, it may take several minutes for a single bar to form.

Both of these approaches are valid, but being a simple soul, I prefer a simpler solution. I just take the direction of the first bar in my chosen timeframe as my initial estimate of the trend. So if I am trading 2 minute bars, and the first bar closes higher than it opens, I am biased towards an upward trend. If the second bar does not make as high a high as the first bar, but its low is still higher than the low of the first bar, it is an “inside bar”. I usually treat this as if it were the beginning of a pullback after the move upwards in the first bar. That way, I latch onto a lot more of the early market moves.

Some people consider it naive to take the direction of the first bar as an indication of the session trend, but that is not the point. For a start, we are not interested in the entire session, only the trend for the next several minutes, since our trades are usually quite brief. Also, there is NO guaranteed way of determining the future trend, because the future can never be known. The important point is to form a view based on the best information you have, and to do this consistently in trade after trade. Sometimes you will be right and sometimes you will be wrong, but at least you have a framework upon which to make your trading decision.

If your percentage of successes is reasonably high AND you manage your trades well, then overall you will be successful and your account will grow.

As an example of this discussion, look at this chart showing the first 2 minute candles in a recent soybeans session (blue candle is rising price, red candle is falling price):

Is that a set up for a Buy?

Not if we are waiting for a series of higher high / higher low candles before we determine there is a trend. But it is if we take the first bar as indicating the trend direction and the second bar as a pullback.  A little while later we had this:

So you might have got an excellent entry during the 3rd candle as price broke out from the pullback rerpresented by the 2nd candle. What if you were more conservative and wanted to see a series of rising bars before you accepted there was a trend?

Candles 1, 3 and 4 all have higher highs and higher lows, so the standard test for a rising market is met. In that case, candle 5 is the start of a pullback…

A little while later we have this:

You can see that, after a brief pullback in candles 5 & 6, there was a breakout in candle 7. If a trade were taken there, without too tight a stop, it would have gone on to being a good trade (but not as good as the more aggressive entry in candle 3).

Sometimes the earlier entry gets you in to a bad trade because the trend never develops. Sometimes the cautious entry gets you into a bad trade because the trend is spent by the time you get into it. In this case, the trend continued for the whole session and both entries gave good results.

Note that you can configure TradeOnAUTO software to trigger on either approach.

Wheat continues its poor run. It is tempting to use the new facilities in Version 2 to set up some kind of reverse trade which could do well in periods of low volatility like this!

A little clarification on the returns shown. TradeOnAUTO enables the trader to allocate a percentage of his or her capital to each strategy traded. So, for example, if my account has $100,000, and I allocate 15% to the wheat trade which then loses $300, that represents a $300 loss on $15,000 – reported as -2%. I do it this way because I am experimenting with different strategies, some of which require more capital than others. So it would not be accurate to simply record dollar profit/loss amounts without taking into account the amount of capital invested.

We are a little way into a S&P 500 Emini trading session, and the cloudy future is lurking beyond the mysterious right edge of the chart…

What to do? What’s the plan?

The breakout trade is one of the most important techniques for the new day trader to master. In many ways it is a counter-intuitive trade, because it requires a trader to BUY at the top of the market, or SELL at the bottom of the market.

People new to trading can be confused by this. They feel that when the market reaches the highest level it has ever been at, then that must be the time to sell. When it is at its lowest point for a long time, surely it will not go lower? Surely it is time to buy!

However, a little clear thinking helps to understand the situation better. For simplicity, I will only discuss a long trade (when the market is rising), but all my comments apply equally in the opposite situation for short trades (when the market is falling).

When the market is trending up, we typically see it moving up in a series of waves. What tends to happen is that price moves to a new high and then pulls back a bit while some consolidation takes place. After a while, there is another break through the previous high point and the market sets a new high. It then consolidates again before repeating the process. In a strong trend, this will happen time and time again.

This explains why, in a market which is trending up, it is a good time to buy when price breaks through the previous high point. The logic is that the breakout confirms the continuation of the trend, that the market will now move to a new high, consolidate for a while, and then continue to move up – hopefully for a whole series of subsequent waves.

By taking this trade, the trader is following the old precept of “the trend is my friend” which has been a trading mantra for us long as I can remember (too long!).

Of course, no matter how strong the trend, a time will come when it will break down. At this time, the breakout trader will be on the wrong side of the market and the trade will lose. (That is why a stop loss order must always be in place!) However, in a strong trend, the breakout trade may succeed several times before the trend peters out.

Markets are not always trending. Sometimes they move sideways, forming a price band where price varies between some upper and lower levels. You see various statistics bandied around, but the most common one is that the market trends for about 30% of the time and is moving sideways 70% of the time.

Timeframe considerations can enter into this. A market may look as though it is moving sideways when viewed on a daily price chart. However, the daily chart may mask strong trends in finer timeframes. For example, somebody looking at the same market using a two-minute price chart might detect strong trends as price moves towards the upper and lower levels of the horizontal price band observed in the daily charts.

A breakout trade is unlikely to be successful if the market is moving sideways in the timeframe being traded.

When you see a chart showing a rising trend, it seems obvious that you should buy an early breakout, but when you are in the midst of the action, it is not so obvious.  Here’s how the day panned out beyond the right edge for the chart at the top of this article.

Did you pick it as a possible setup for a Buy trade?

The first three strategies (Wheat Trader, Beans Trader & S&P Surfer) are the LITE strategies.

The Corn Trader strategy is based on the settings first published in this blog a year ago, and which was outstandingly successful in 2011. (It doesn’t win often, but the wins are often very large.)

EUR_1 and  EUR_2 are strategies I have been experimenting with in Euro futures. They are meant to be run as a pair, with EUR_2  being the “reverse” trade. It runs in a different time frame to capture movement around the time markets open in Europe.

SPI_1 and SPI_2 are the same strategies running at the open of the Australian stock index futures in Sydney. I have only just started trying these, so may need to “tune” the parameters to the market as time goes on. Also, it may turn out that the SPI just doesn’t have the volatility we need for day trading.

(The %returns shown are based on the capital I applied to the specific market in this account. People with different account balances will have varying results because the software may trade different numbers of contracts to stay within their risk management guidelines.)

Another poor month for wheat – not particularly bad, but it’s a while now since we had one of those explosive months that make the wheat market so exciting.

In fact, it was a poor month for our LITE strategies all round, with even the S&P surfer having a negative result.

The simulations for the TradeOnAUTO Lite strategies for January were as follows:

Wheat Trader (4% Risk):     -10.6%

Beans Trader (4% Risk):     -5.6%

S&P Surfer (3% Risk):         -2.4%

S&P Surfer (5% Risk):         -4.5%

(Note that we try to make the simulator as realistic (and conservative) as possible, but simulated results will never precisely reflect real trading results.)

Why were the simulator results for wheat worse than those we achieved in live trading ( -10.6% v -2.1% actual)?

The simulator is not wrong, but for consistency it is based on the results you would achieve if you had 20K capital invested in each trade each day. If your capital is different (especially lower), your actiual results will differ. On some occasions the simulator may just be able to take a trade with 3 contracts, whereas you may just be short of the capital requirement for 3 contracts, and just take 2. Money management certainlly has an impact, but ifs effects tend to balance out over time. Sometimes real trading will be worse than simulated, sometimes better as they were this month.

This is the last post presented in this format – look out for the new style, following more strategies (including this one), starting tomorrow!

No trade, but some adverse currency movement.

Interested in Version 2?  See more details here.

Version 2 is coming!  We are on schedule for the release of the new, more powerful version of TradeOnAUTO Professional software at the end of January. From now on, all new clients will be receiving Version 2. We plan to send the software to existing clients over the coming weekend.

We will also be updating the blog format at the end of the month. Rather than simply reporting on one contract, we shall be running all the LITE strategies, together with some experimental strategies, each day. They will be run in an IB paper trading account which gives a very accurate approximation to live trading, including slippage and brokerage fees. (In fact, the fills in the paper trade account are often worse than fills in the live account.) The statements for the paper trading account will be published in a monthly summary.

There will also be a series of articles describing the TradeOnAUTO trading approach. We hope you will enjoy the new format!

TradeOnAUTO Lite Upgrades Policy

If a TradeOnAUTO Lite client upgrades to TradeOnAUTO Professional, the initial license fee will be discounted by the fees paid for Lite during the preceding 3 months. So if you are a Lite subscriber paying, for example, $200/month, you will receive a $600 discount on your initial license fee for TradeOnAUTO Professional.