There is a great sense of accomplishment in dueling successfully with the sharp knife that is the electronic futures market. When analytical techniques are combined with the inherent thrill of trading, then day-trading the E-mini stock index futures market becomes a fascinating and compelling endeavor.
To be successful, the E-mini futures day-trader must be armed with top-notch tools and plenty of experience. Without these, the trading day may feel more like a trip to a casino rather than a professional activity based on intelligent risk-taking. The day-trading practitioner eventually realizes there is no Holy Grail indicator or technique that ensures success. If it were easy, and profitability could be achieved automatically, we wouldn’t be trading an actual market.
The road to profitability will consist of applying a variety of methods that create high probability trades. When high probability trades are combined with proper trade management, a complete day-trading system is realized.
The best way to illustrate a well-defined, high-probability trade is to look at an example of how multiple techniques can be combined. We’ll use the E-mini S&P 500 futures (ES) from July 16, 2009. The strategy will incorporate four key techniques, all of which exist in the public domain: Market Profile theory, day-type determination, price-level determination and scaled trade management. The example illustrates how an eclectic mix of trading techniques are put to use by the experienced day-trader.
MARKET PROFILE
Market Profile was first described in 1984 by the highly regarded commodity trader J. Peter Steidlmayer. It was disseminated and popularized at the Chicago Board of Trade over the next 15 years. An authoritative text on the subject is “Mind Over Markets,” by James Dalton, Eric Jones and Robert Dalton (Traders Press, Inc., 1993). There has been a resurgence of interest in the technique in the last several years, especially in the active electronic day-trading community.
There is significant substance to the Market Profile theory, but it often is unclear how to specifically trade with it. For the purposes of this example, we will apply one of its key definitions, the price distribution value area.
Market Profile makes use of a unique presentation of price charts. Every 30 minutes of the trading session a new time-price opportunity (TPO) is printed. The TPO is drawn into a price distribution curve that, like typical price charts, has price on the vertical (right-hand) axis of the chart, but with the entire day drawn in one vertical distribution. This price distribution shows how many times the market traded at a given price level and shows certain characteristics of price movement to new levels. As always, a picture is worth a thousand words.
In “Different view” we see the Market Profile price distribution chart from the middle of July 2009. (This chart was captured from TradeStation using the ActivityBar indicator.) Each day’s price distribution is shown in the vertical format specified by the Market Profile. From the daily price distributions, it’s possible to discern where the market spent much of the trading day, as well as extensions to the high and low ends of the trading day’s price range.
One key Market Profile concept is that of value area (VA). A price distribution VA defines a one-standard deviation movement in price. It is the price range that covers approximately 70% of the trading day. The VA identifies where the bulk of the market is currently positioned and from where it will initiate new price discovery. The terms value area high (VAH) and value area low (VAL) are used to identify the VA range.
On the Market Profile chart, two dark lines have been drawn by software. These lines identify the VA for the July 15, 2009, trading day. During that day, the VA was between 920.75 and 930.00. We will be interested in how the market performs, relative to this VA during the next trading session. In particular, we note that the market opened the July 16 session at 925.50, well within the previous day’s VA. Using this information, a trade setup can be developed. Specifically, if the market opens within the previous VA, it may remain constrained there. Taking a position regarding this assessment — the likelihood of the market remaining within the previous day’s VA — sets the stage for a possible trade.
DAY TYPE
We now add the second component to our trade setup: day type. Our goal is to make a call as to whether the day is a trend day or a rotational day. If a trend day, we will want to trade in the direction of the trend, perhaps entering using a local price retracement. If a rotational day, we will want to fade the market from a predetermined price extreme. To make a day type determination, we use exchange-wide tick data, referred to as ticks.
Ticks are not the up- and down-tick values of individual stocks, but a periodic count of the number of stocks that have traded up (the bid price moved up to the ask price to complete the last trade) minus the number of stocks that have traded down (the ask price moved down to the bid price to complete the last trade). For the NYSE, tick counts range between 1,000 and -1,000.
Ticks data are delivered continuously and periodically, up to a frequency of one reading per second. It is possible to estimate day type, even as a session is unfolding, by using ticks, not as an instantaneous value but by its accumulation. The accumulation of ticks is referred to as Cumulative Ticks (CT). Once again, a picture is worth a thousand words.
A CT indicator based on the NYSE ticks is shown from July 16, 2009, in the first chart in “A tick in time.” In the chart, one-minute averaged CTs are shown as a dotted line that overlays the one-minute E-mini S&P 500 price chart. We see a nearly flat line of CTs (enclosed by the rectangle). This indicates that, at least for the near-term, the market is not trending but exhibiting rotational behavior and can be faded. Contrast this with the second CT chart from the previous session, July 15, 2009. In this chart, a dark trendline has been drawn under the dotted CT graph. On July 15, the CTs were giving a clear indication of a trend day (see the second chart in “A tick in time”).
PRICE LEVEL
Because CTs indicate a rotational market, we want to fade it, long or short, from a well-defined price level.
In “Level headed” the E-mini contract is drawn with the typical key price levels: session open, previous day high/low, support level 1 and 2 and resistance level 1 and 2.
We compare these levels with the VAH and VAL and determine that the previous day’s high corresponds with the previous day’s VAH. This is a fortunate result. Because the CT reading indicates a rotational market and because the day’s open was within the VA, we determine that a short position from the previous day’s high makes for a
high-probability trade.
TRADE MANAGEMENT
Once we have identified an entry, the task of how to enter and exit the market becomes the focus. First, we will make use of a resting limit order that is two contract ticks off the reference price level (see “Rested and ready”). In this trade, the limit order price is 930.25 (930.75 - 0.50). The stop-loss can be quite conservative because the trade is based on an expected reversal at what is now a well-defined level, the previous day’s high and the previous day’s value area high. In this case, if we are filled, we automatically have a stop-loss entered for all open contracts at 1.5 points off the 930.25 entry price, or 931.75.
Once in the trade and with our initial stop-loss set, the question of how to exit with profits must be addressed. The technique used is a fast scale-out plus trailing stop strategy. Fast exits at one and one-and-one-half ES points from the entry price are used on the first and second thirds of the position, respectively. To this is added a trailing stop that follows price. This trailing stop is indicated by dots just above the market in the price chart. A final exit price of 925.75 is achieved from the trailing stops. The fast profit-target exits put the trader in a no-lose position quickly. The trailing stop logic helps keep the trader in the market for a relatively long winning runner — in this case, 4.75 points.
ANTICIPATION
Market Profile, day type, price level and trade management work in concert to define and execute a successful E-mini stock index futures day-trade. The market was anticipated with a limit order at a well-defined price level. The market was not chased with a market order. Use of automated stop-loss protects the trader, should the expected reversal not occur. Fast profit taking scale-out, while also retaining winning runner contracts, means the day-trader can participate in relatively long-term moves with little account risk.
There is no single technique that offers success in the difficult task of day-trading the E-mini futures market. But by bringing together a number of market views and strategies, high-probability trades can be identified and the market anticipated. Profitability is possible with this style of day-trading.
For 20 years Michael Gutmann was a software engineer and manager at Intel Corp. He trades his system daily and wrote “The Very Latest E-Mini Trading: Using Market Anticipation to Trade Electronic Futures.” He can be reached at mike@vgxcapital.com.
