Day trading requires precision in the technical analysis of intraday charts. Today’s day traders require tools that help them make fast decisions with accurate analysis of price and volume, as well as assess the current condition of the overall market. To help traders make split-second decisions, day trading charts need to be crisp, colorful and easy to read. Additionally, day traders need unique tools that help them react to high probability setups as soon as they occur. For day traders who are entering or exiting a trade, a quick reaction time means money.
Most day traders rely on top-of the- line computers and charting software to get fast, reliable data feeds and to customize their chart setups and various indicators. These charting programs have a host of technical tools including multiple chart styles, indicators, drawing tools, such as trend lines and Fibonacci retracements, and the ability to program or add custom indicators.
LIGHT UP MY PRICE
Candlestick charts are popular among day traders because they are very easy to read, even at a glance. Candlesticks can print in different colors depending on price movement within the bar.
The most popular colors are green bodies for up candle bars (bars that have a higher close than open) and red for down bars (bars that close lower than the open). Another popular setup uses just an outline of the body for up candles and filled-in bodies for down candles. In either case, the candles should be big enough to identify quickly and have a sharp contrast from the chart’s background.
Chart background colors should be fairly neutral to allow good distinction from the candlesticks. White, gray or black backgrounds are most commonly used.
TIME, TICK AND VOLUME
Charting periods are another factor that weighs in the setup process. Each day trader develops his own style of trading that, in many cases, relies on a specific chart interval. While many traders use time-based price charts (such as 60-, 10- or 5-minute charts), tick and volume charts are becoming popular.
Unlike time-based bars that close after a specific amount of time, tick and volume bars close at the end of a specified data interval, regardless of the time that has elapsed. Tick charts plot prices for a specific number of transactions, while volume charts record the prices for a specified number of contracts or shares traded.
Tick and volume charts can paint a more accurate picture of market action by showing the effect that the amount of transactions or volume has on price. More price bars within a set amount of time equals more volatility. So without having to use a separate volume indicator, traders can quickly determine the amount of trading taking place just by glancing at their chart and noting the time it takes for each bar to print.
Additionally, tick and volume charts can point out areas of support and resistance that time-based charts might miss. Traders must find the correct tick or volume interval, however, for their market and style of trading. Sometimes, these are based on Fibonacci numbers such as 55, 89, 144, 233, 377, 610, etc. Similar to time-based charts, the smaller tick or volume charts are used for shorter term trading or scalping, while the larger tick or volume intervals are used for longer day trades.
Day traders often add a countdown meter, sometimes referred to as a timer, to their tick or volume charts. This tool displays the number of ticks or how much volume has elapsed during the current price bar. As the countdown meter progresses faster, a trader can easily gauge the increase in volatility without having to wait for several bars to print. Alternately, when the numbers on the countdown meter advance slowly or are not moving at all, it can tip you off to a sluggish market.
This is also helpful for traders who use the bar close to make trading decisions as the meter can alert the trader when the close of the bar is getting near. Because tick and volume charts are not time-based and a bar could take just a few seconds or several hours to print, having an intrabar reference tool can be an essential companion.
MULTIPLE INTERVAL CHARTS
Many experienced day traders use multiple time, tick or volume charts in their market analysis. While monthly, weekly or daily charts provide insight into the big picture of the market, traders may use a variety of minute, tick or volume charts for intraday charting (see “On the level,” page 41). This allows traders to get a view of the overall intraday market trend. This is important because what may look like a good short trade on a 144-tick chart may only be a pullback from a strong uptrend on a 610-tick chart. The more confirmation signals multiple charts show for a price move, the better the chance for a successful trade. Many day traders identify favorable trade conditions on longer-term charts, and look to the short term to pinpoint their entry. Using multiple interval charts can also help to manage trades. Monitoring a longer-term chart can help a trader stay in a trend and not get pushed out by short-term price fluctuations.
Indicators are another area where day traders use specialized tools. Although many indicators work great on historical price data, day traders need to make decisions in real time while the current price bar is still forming. Day trading indicators must react quickly to tick-by-tick market conditions and have very little lag.
The majority of commonly used technical indicators are based on calculations using a set amount of historical price bars throughout a defined look-back period. These indicators are slow to react to current price action and, thus, lag too far behind the market itself to be much good. Given that most common indicators were originally developed for use on daily price charts, day traders must look for indicators that are faster and react with less look back or with adaptive (variable) look-back periods.
One familiar indicator among day traders is the adaptive moving average. A moving average simply provides a reference for where price has been and whether price is moving up or down. However, basic moving averages use a static look-back input, say nine or 20 price bars.
An adaptive moving average (AMA) uses statistical calculations to determine a more appropriate look-back period. A properly designed AMA will have significantly less lag time than a traditional moving average (see “Writing your AMA,” page 39). AMAs can react very quickly to price action and can be a great tool when used alone or applied to different indicators.
Pivot points are another popular indicator used by day traders. Traditionally popular with floor traders and market makers, pivots can identify significant support and resistance levels. Pivot points are calculated using the high, low and closing prices from the previous day of trading and are charted as horizontal lines overlaid on an intraday price chart. The formulas for the pivot point and the surrounding areas of support and resistance are:
Resistance Level 3 = R3 = R2 +
YestHigh - YestLow
Resistance Level 2 = R2 = PP +
YestHigh - YestLow
Resistance Level 1 = R1 = PP * 2 -
PivotPoint = PP = ( YestHigh +
YestLow + YestClose ) / 3
Support Level 1 = S1 = PP * 2 -
Support Level 2 = S2 = PP - YestHigh
Support Level 3 = S3 = S2 - YestHigh
There are many variations of pivot point calculations available, but the concept behind interpreting these points is similar. Pivot points can be used to determine the overall market trend by tracking price movements above or below the central pivot point. As price crosses above this central pivot, it indicates a bullish market and vice versa for crosses below the pivot. Additionally, prices may hover between the first support and resistance levels (S1 and R1), but breakouts from these levels often lead to a move that reaches the next subsequent level of support or resistance. Pivot points can be a helpful tool for creating profit targets and stop points.
While some traders rely completely on price action for their trade entries and exits, other common indicators among day traders include stochastics, CCI, TRIX and ADX, to name a few. Day traders tend to make up their own rules on how to use indicators successfully, but all must react very quickly, with look-back periods rarely exceeding the previous 14 bars — adaptive or not. Successful day traders are careful not to use too many indicators because waiting for too much confirmation will only slow down reaction time, potentially missing out on profitable trading opportunities.
Another day trading method of determining the direction and strength of the overall market is using internal market data. Traders often have a quote screen above their charts with information on the indexes relevant to the markets that they are trading.
Knowing the current level and net change in the Dow Jones Industrial Average, Nasdaq and S&P 500 can help identify strong market moves. E-mini traders also may want to have quotes (including last sale, bid and ask sizes) for all of the major electronic stock index contracts as a reference because these markets often move together.
Along with the many tools already mentioned, day traders often rely on audio or visual alerts to let them know of certain market conditions. These alerts can be configured to trigger during virtually any type of market activity including price level, indicator threshold or the time of day.
The practical importance of this shouldn’t be overlooked. Watching the markets can be tedious, so even if a trader “zones out” during a slow period in the market, alerts will sound and let them know that it is time to get back in action. Alerts can be configured to make a beeping or horn sound followed by a verbal description of the actual condition that has taken place. These alerts can help traders focus their attention on what they consider ideal market conditions.
In fast-paced electronic markets, getting behind a trading desk may feel like climbing into the cockpit of a fighter jet. Day trading has evolved into a profession that relies on a high level of situational awareness. Price charts are the critical link between what is happening in the market and a trader’s intentions. Developing an easy-to understand, high-performance charting desktop allows day traders to process information faster, providing them the reaction times necessary to do battle in today’s markets.
Lee Leibfarth is an independent futures trader. He develops custom indicators and provides educational services for traders. He can be reached at firstname.lastname@example.org.