INTRODUCTION

Ive often commented that the only real purpose of a college education is to give students a basic set of facts and teach them how to think. Its not a lot different from giving a potential homeowner a saw, a hammer, a sack of nails, and a pile of lumber and teaching the person how to use each item at his or her disposal. The type of home built by 100 such individuals with this opportunity will probably turn out to be 100 houses with 100 separate sizes, shapes, descriptions, and eventual uses. The probability is that each new home will work well for the new homeowner, even though all are different.

In the same respect, the needs and desires of each and every trader will probably differ considerably from others in the same profession. Traders must believe in their strategies if they are to have the confidence necessary to trade the system successfully. This can only happen when the traders themselves have participated fully in the construction and development of their own systems.

While spending several years as a coach of a high school academic team, I had the privilege to work with several talented, competitive, aggressive, and gifted young people. They would have had very little success had I insisted on a structured process to create a solution for the project at hand that made up our competitions. We were much more successful allowing the imaginative, creative energy of the group lead to the resolution of many of the problems encountered on the way to a solution.

So it is with any dedicated group of individuals. Allowing the creative energy to find its own direction and ultimate solution is far superior to any structured method.

It has always been my observation that most successful traders are so not because of their ability to follow blindly the lead of someone else, but because they can draw from many experiences, observations, and interactions gained over years of market research, thereby creating a successful trading strategy.

It is not my purpose to dictate the structure of a definitive trading system and insist that all who are serious about using the materials in the book must use it in a specific manner or be doomed to certain failure as a trader. That is not a practical or reasonable solution, any more than we could expect all new homeowners to live the identical lifestyle of their neighbors in homes that are the exact duplicate of each other in every respect. Humans are extremely different organisms in many ways.

INTRODUCTION

For those desiring a more structured trading environment there is also presented in Chapter 14 basic information on the development of a computerized system that takes advantage of many of the strategies discussed in earlier chapters.

I cannot emphasize enough the necessity of customizing any trading strategy you develop, either from this book or from other sources, to each specific issue or contract you will be trading. As discussed regularly in the upcoming pages, each stock or contract has its own personality with regard to its response to any technical analysis vehicle. The ability to recognize these differences and take advantage of this knowledge is often the one factor that separates the really great traders from the rest of the bunch.

As you read through the remainder of this book, realize that the material presented here can be used to either enhance an existing trading method or actually build an entire system from the ground up. You will find here a different way of looking at trading in general. My hope is that you will find these techniques helpful as you strive to increase your trading accuracy.

There are many chart images presented on the following pages. It was necessary to create these images with a significant amount of detail to adequately explain some of the complex routines being addressed. As a convenience to readers, I have placed several of these detailed images on my web site in a larger format and in color to make it a bit easier to interpret the routines. As you encounter these images in the following chapters, you may want to visit www.clayburg.com to examine them more closely. Please follow the appropriate links.

DAY TRADING METHODS AND PHILOSOPHIES

When one speaks of the relative length of time one is actually in a trade, the terms long-term and short-term are often used. Most would agree that day trading, in general, would be classified as a short-term strategy, while holding positions overnight for one or more days would fit more into the long-term category. However, with the popularity of day trading, multiple market strategies that are used to accomplish this complex task have come of age. Consequently we can further define certain day trading strategies as long-term and others as short-term.

When we refer to day trading in general, about the only parameter we actually define is that an entry and exit must be accomplished during the same day to qualify the trade as a day trade. Therefore, technically, a trade that is entered at the first print of the day (the first price at which the commodity or stock issue trades for any given day) and exited on the close of the trading session qualifies as a day trade. Obviously, dealing with the opposite extreme, a trade that is open for no longer than a few seconds also qualifies as a day trade.

LONG-TERM DAY TRADING

Long-term day trading strategies, since they are usually placed early in the day and exited near the close, are more likely to be used by those who are not able to observe the markets closely throughout the trading day. The amount of actual time and effort required to implement such a strategy successfully on a daily basis is significantly less than that required to trade a shorter-term situation where many trades are entered and exited throughout the day. These longer-term strategies will produce fewer trades than the short-term methods to be discussed later. These trades are therefore impacted to a lesser degree by transaction costs such as commissions and slippage. (Slippage is the difference between the price you specify when placing an order and the actual price at which your order is filled. This parameter can vary significantly with the issue in question and the overall activity of the market. In most cases slippage is negative, reducing the profitability of the trade by the amount of slippage experienced.)

The objective of a long-term day trading strategy is to capture the larger profits that can be generated by the so-called trend days. These are the trading days during which the market opens near the high or low of the day and closes near the opposite extreme, trending more or less in the same direction for the entire day. These days, which occur on a regular but infrequent basis, can be extremely profitable. Lets examine a few strategies that can lead to a successful day trade on these trending type days.

One of the favorite strategies for trading the trend day is to analyze the market activity of the previous day (or days) in an attempt to profit from an extension of similar activity for the next day. These trades are entered either on or shortly after the open of the market, expecting the trend for the day to continue in the same direction as the previous days trend. This technique is also referred to as follow-through trading, as the trader is anticipating that the forces that created previous trends in the market are still present and will continue to provide similar impetus to the market during the majority of the next day. The expectancy of this strategy is, in the case of an uptrending market over the previous day(s), that the market will open in the vicinity of the close of the previous day. Follow-through from yesterdays activity should continue to propel the trend higher through the balance of the trading session. Substantial profits can be gained in this manner.

An equally effective method used to capture the big trend for the day for your trading account is one of several strategies that consider the activity of the market early in the day, These approaches attempt to analyze a relatively small data sample shortly after the opening of the day and develop from this activity a method by which a profitable trade will result. The most widely used strategy for this type of trade involves one of the many variations of trading the breakout or reversal of a market-determined early-morning range. Some strategies involve the placement of buy and sell stops above or below this early range in the expectation that a breakout of this early range will continue for the rest of the day. Others use this early range as a predictor of sorts, attempting to determine how far the market will rally or fall after breaking out of this range. These systems then attempt to capitalize on the reversal of the opening range breakout, assuming that the high or the low of the day has been established by this time and that the remaining activity for the day in question will be in the opposite direction.

There are in existence a great variety of effective methods that can be used to profitably trade the opening range breakout. It can be effectively argued that one variation or another of this technique is the basis for a majority of the most profitable day trading strategies. One of the more effective ways to take advantage of this method, using the Directional Day Filter, is covered in detail in Chapter 10.

A trade generated by any of the aforementioned methods is effective only if, in fact, the trend as predicted for the day actually develops and generates a profitable result. Obviously, this is not always going to be the case in real-time trading. There will be a significant number of days during which this projected trend will not develop. Many days will evolve into a wandering, sideways, trendless affair that, if we are lucky, will result in a modest profit-or perhaps only a breakeven trade. These days can also result in significant trading losses should this wandering trend develop a slight upward or downward bias in the opposite direction of our anticipated trend. The worst-case scenario also exists whereby the trend of the day develops in the direction opposite the one we are anticipating according to the signals generated by our basic strategy. We are depending on a developing trend to be of significant magnitude to generate a fairly large trading profit when our signal is correct. When we are not correct, this same significant market movement can result in unacceptable losses for our trading system.