Day Trading & Forex Forum

Q - What strategy will overcome unfilled orders because there aren't good pullbacks on breakouts?

A - The problem is, as soon as you get more aggressive, that's the exact moment the stock will reverse. You can use continuation patterns like triangles on lower-time-frame charts to enter positions, but even these require assuming more risk. So the real answer most of the time is that you miss the trade and move on to the next one.

Q - Is an intraday move sufficient to enter a breakout, or should I wait for the closing price?

A - There is no right or wrong answer about intraday vs. closing breakouts. You need to work with trading signals that fit your lifestyle. These may be closing or intraday triggers; it depends on your risk tolerance and ability to watch the markets. Short-term traders can't wait for too many end-of-day signals. Alternatively, long-term traders need to apply good intraday filters to avoid whipsaws and protect themselves from sudden losses.

Q - How do you keep from getting shaken out by whipsaws?

A - You're really asking the ultimate Zen trading question: How do I know I'm right? Zen answer: There is no right and no wrong. You manage risk. Do that well, and you're right.

Breakouts and breakdowns either go or they don't go. Most of the time you can't tell the difference. Some patterns are easier than others to interpret, and certain kinds of setups have a gut feel that tells you the coast is clear. Just control risk the rest of the time and take the trade to its logical conclusion.

Remember the input you have on the position's outcome. First, you can choose a small position instead of a large one. This keeps your risk small if you're wrong, but you can still make money if you're right. Second, you can take your best shot and keep a tight stop-loss. You take the loss and move on if you're wrong. You add to your position if you're right.

Q - Do you implement a turnaround strategy? For example, do you reverse your position after stopping out in one direction, or do you simply get out?

A - I operate under the premise that each setup, long or short, needs to stand on its own merits. Hitting a stop loss doesn't automatically make it a good trade in the opposite direction. In fact, getting the direction right is the easy part. The hard part is finding the reward-risk equation that's favorable for the new setup.

Q - How can I trade a breakout and not get stuck in the crowd?

A - Timing is everything with breakouts. You're trading with the crowd when you see a breakout and hit the entry key. You're ahead of the crowd if you're already positioned when the stock breaks out, and you're behind the crowd if you're waiting for a pullback to enter the trade. Both of these methods make more money over time than chasing the breakout.

Q - What should traders think about before committing to a position?

A - Trade setups have trigger prices called execution targets. The trigger points are reached within price levels called execution zones. Traders should stop what they're doing and pay close attention when price approaches one of these levels.

We track a variety of information on our trading screens, including quotes, charts and indicators. But our real job is to watch for ripples on a quiet lake. These are the numbers that are out of place or approaching levels where other traders will take action. The trick is to be aware of these levels and have an action plan before they take notice.

Most traders are programmed to react to breakouts and breakdowns. This is the Pavlov's dog syndrome, no more and no less. Traders see the market move, and they salivate. It's far better to train yourself to recognize price zones where a small wiggle will bring in the crowd. Then you're acting on the situation instead of reacting to it.

Q - Should I scale into and out of positions?

A - You can average up or down as part of position-building as long as you're using it as a strategy rather than an excuse for a bad trade. Keep your initial size down so you don't take too many shares at high-risk levels. You can also add to profitable positions, but keep in mind that the reward/risk equation changes as a position moves in your favor.

Scaling into profitable positions increases risk if you don't pick the right execution levels. The best plan is to wait for the position to clear an obvious barrier before adding to it. Then move in your stop to protect your growing profits.

I rarely scale out of positions, because I like to exit on wide-range bars and pass my shares to someone else. This is just a personal preference. Other folks probably do a better job scaling out and keeping a piece for a follow-up move.

Q - I'm trading 15-20 setups per day. Am I overtrading?

A - Only you can tell if you're overtrading. I don't know if your positions are 100-share scalps or 5,000-share bombs. There's a big difference between the two. Do as much as you can without getting confused about why you're in a particular trade.

Write a note to yourself each morning to sum up the day before it begins. It should say "The chips could break down," "Watch for a Dow selloff," "Keep an eye on banking stocks," or things like that. Use this document to decide on offense vs. defense going into the new trading day.

Q - How do you assess volume before making the trade?

A - I use volume only at certain points of pattern development. These tend to be near breakout or breakdown levels. Then I want to see if there are divergences between price and volume, or anything that will inhibit the expected move. I also examine volume on pullbacks and will pass on trades if I see something I don't like.

A good rule of thumb for volume is to ignore it unless it absolutely, positively captures your attention when you look at it.

Q - If I want to buy or sell 20,000 shares in a flat market, how do I keep from getting noticed?

A - With highly liquid stocks, just hit the button a few tiers away from the inside and get filled. With moderate-volume stocks, do the transaction over 30 minutes by picking an average entry or exit price. If possible, don't trade more than 1,000 to 2,000 shares at a time.

You need to be clever and patient when trading large lots on thin stocks. Pick very quiet periods and stretch the entry or exit out over a long time. And never show your real size to the public, specialists or market makers.

Q - Is it a problem to trade stocks that average below 50,000 shares per day?

A - If you're trading size that makes up 5% or 10% of the total daily volume, you become the market when you put in your order. So you must plan on massive slippage in your pre-entry calculations if you want to trade large size in thin markets. Also keep in mind there's no strategy to get you out of the market without massive slippage if you want out fast.

Q - What role do the futures play in entering trades?

A - There are three correlations between equities and the futures markets. There are stocks that trade with the futures, stocks that trade against the futures, and stocks that go their own way regardless of the futures. You have to determine the correlation for your stock before using the futures as an entry tool.

For example, tech stocks correlate well with Nasdaq 100 futures, and blue chips correlate well with S&P 500 futures. Oil, gas and gold often trade against the short-term futures direction. Biotechs that trade on news releases can go their own way, regardless of the futures markets.

Trade execution always depends on limited information. Entry itself is secondary to effective management in determining whether you make a profit. Having said that, there is more correlation between equities and the futures markets now than at any time in the past.

Article reprinted with kind permission of the author.