TRADING 101 REVISED 12-28-2011
Trading Rules 101 is a co
mbination of patterns and observations we learned on the trading floors of the Chicago Board of Trade and the Chicago Mercantile Exchange over the last 35 years. Much of it was it was made up during the time the desk worked the phone for Marty “The PIT BULL” Schwartz. It was an amazing time back then. Today the ROAR of the S&P pit is gone but long after electronic trading took over the rules continue to be a vital part of our trading “tool box”
MrTopStep NO ONE RULE; is not to trade in a closet. Find a trading buddy, share ideas and most of all be patient. While our trading rule E-book may not cover everything we do think it’s a good beginning of a new way to look at the markets. With algo rhythm and program trading making up over 75% of the trading volume we feel the more tool you have the better off you are.
MUTUAL FUND MONDAY: Over many years of watching, we have concluded that the Mutual Funds use Mondays as a favored day for the portfolio managers to buy stock. Part of the theory is traders look to buy on Friday and hold into Monday/Tuesday’s open.
TURN AROUND TUESDAY: Tuesdays are also part of the early week strength. The thought process is that the markets tend to rally early in the day and early in the week. This especially applies during a bear markets. Following Mutual Fund Monday’s performance there is a tendency for morning strength.
ACTIVE MONTHS: The BEST 6 month performance period for the stock market begins in November and lasts through April.
10 HANDLE RULE: over many years of watching the S&P, we believe that the index often moves in 10 handle increments. For example, the S&P opens unchanged at 1194, trades up and down before trading either 1204 area or 1184 area. That is when the 10 handle rule (market tendency) goes into effect. Often times, the index will reach an inflection point and reverse after trading approximately 10 (maybe 12) handles as a bit of exhaustion takes place on the first test, at least briefly. How many ten handle increments play out depends on the market volatility, but with each 10 handle move there tends to be a short term high or low made. We look for this to work in either upside or downside price action. Also, during midday trade the same 10 handle price action tends to apply. 1215 last trade, up 20 handles on the day and could be the midday high, we would then look for 1205 or 1225 area to trade.
COUNTER TREND FRIDAY: Over the years this trade works best on unemployment Friday when the S&P futures gap way up or gap down on oversized, pre-market GLOBEX volumes of 400k to 600k ES traded before the 8:30 open. This is a fade, the bus too full trade. Example: The S&P is down 6 handles at 6:00CT and then down another 8 or more handles after the jobs number is released. Now, the S&P is down 14 handles or more on the 8:30CT open. With 400k+ minis traded before the “OPEN” this tells us that traders have already voted. Depending on the price action the idea is to buy a sharply lower open or allow for another 2-5 handle drop just after the open. The idea behind this is that with that many minis traded and it being a Friday and knowing most traders can’t hold the futures over the weekend they put in buy stops. With all the selling used up pre- open the ES will start to short cover into the buy stops that lift the offer side of a buy program.
THE THURSDAY/ FRIDAY LOW THE WEEK BEFORE EXPIRATION: This is a PIT BULL trading rule. The S&P tends to make a low on the Thursday or Friday the week before the expiration (more so on the quartiles). The rule is to look to buy weakness on that Thursday or Friday looking for a low to hold into Monday or even into the expiration itself. Generally, the trade is to buy on Friday and hold into Monday.
THE 5-MINUTE RULE: This requires a pivot to be settled / converted above or below on a 5 minute basis to avoid the whipsaw of being stopped out only to have been correct regarding the market direction. It is just a filter to avoid that humbling situation of being out, but right.
BUS TOO FULL: This is a street guy’s term for when the markets are overbought or oversold. When everyone is BEARISH and the markets are going crazy we are looking for buying opportunities. We sometimes use the bus is to full, instead of the term “oversold or overbought” as the bus tends to accelerate to extremes in either direction.
EVERYONE IS TOO LONG or TOO SHORT: We often use these terms when traders in the pit and retail have gone from long into the rally to short into the decline. This generally means we think the markets are nearing a top or bottom or at least in the short term. This would be where we would look to fade the crowd. This leaves the market susceptible to snapping back. Another example of how this works; when the S&P moves at least 8 or more handles and the locals and small paper get long during the rally or short on the decline, the market may be temporarily overextended. Basically, this equals overbought / oversold conditions “thin chowder”
NO STOPS GO UNTOUCHED IN THE S&P: Over the years, both in the open outcry and electronic platforms, there is a tendency to “run the stops” as most traders can certainly attest to! Scalpers tend to use 3-5 handle stops and when the markets are moving they trail the stops up or down based on the direction of the move. Most algo rhythm and program trading systems are set to move in the direction of those stops on a daily basis, so the short term stops are the easiest targets, but eventually, mid and long term stops fall like domino’s. We like those extremes!
THIN CHOWDER: This is from our East Coast traders. It is a term used as the market nears or “tests” highs or lows of the move and instead of creating energy to extend to punch through to new highs or new lows, the trade becomes THIN and lacks conviction. Bostonian’s “don’t like thin chowder” so they are likely to send it back. Hence, the market refusing to “make a NEW LOW or a NEW HIGH” is basically equal to a rejection.
T+3: T+3 is commonly in reference to “window dressing or window smashing” as the calendar nears the three days prior to month, quarter and or year end. The trade date +3 days until settlement. Depending on how the month, quarter or year end is shaping up; many portfolio managers add to winners & sell losers (or vice versa) in this precarious time in the calendar. The “Of Course We Owned That Hot Stock This Quarter” is not that easy of a trade!
TRADING THE 3′s RULE: Briefly as part of trading a rule of 3‘s is generally, the pivot from where the market is trading at that point of the day where we came from & where we may go never stay on a “3? but will always trade a “7? breaking “3? trades “00? breaking “00? leads to a “7? (HENCE THE “3?) & vice versa keep an eye out you’ll see it in the price action.
THE WALKAWAY TRADE: This is an end of the quarter trade. On the last day of the quarter, the portfolio managers have a tendency to run out of money after marking up stocks earlier. So, by 12:00-1:00ishCST this leaves the S&P susceptible to a decline later in the day. Traders look to set up a short position in the early to mid afternoon, as the professional money managers walk away leaving the equities ready for an afternoon fade.
THE UNCHANGED GAME: rule comes from one of Wall Street’s largest OTC desk. Because big bank desks make prices for options and stocks they have what is called a “Long and Short” book.
Example: A large hedge fund calls the banks desk for a price on 500k shares of IBM. The desk makes a price and if the hedge fund like’s the price the banks desk sells the 500 k shares. When the trade is made the customer is long the stock and the bank desk is short the stock. When the S&P futures are up the LONG side of the book doesn’t need adjusting but as the market goes higher the SHORT book needs to buy protection. The desk trader has two choices;
1)Take some profits on the LONG book which actually adds more upside risk or
2)BUY S&P futures, if the S&P sell off to UNCHANGED or lower. This is the main reason that sometimes there are so many big bids around UNCHANGED. If the markets continue to fall or rally they buy or sell the necessary protection for the LONG / SHORT book on the 3:00 CST cash close.
THE FIVE BUY or SELL PROGRAM: Back in the 80s and 90s when we used to do a large part of the program business we noticed how the S&P would get exhausted after three buy or sell programs.
Example: The S&P’s are selling off and the SPH is trading at a big discount.. As the SPH sells off all the program traders would put their bids in. Once the first bids were hit out; the cash would drop until the next set of program bids showed up. The first sell program was easy to get off and the second one would usually go OK too, but into the third or fourth sell program the bids would start to show up all over the place thus causing a low / short covering rally. This would work the other way on the upside; after three or four buy programs the offers would pile up and with no outright buyers the S&P would lose premium and sell off again
THE PLUNGE PROTECTION TEAM: PPT For years people laughed at who the buyers were at the bottom of a crash and the PPT was always front and center. We heard the term used during the 87 Crash and every other steep decline since. The definition below came from INVESTOPEDIA:
A colloquial name given to the Working Group on Financial Markets. The Plunge Protection Team (PPT) was created to make financial and economic recommendations to various sectors of the economy in times of economic turbulence. The team consists of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve, the Chairman of the SEC and the Chairman of the Commodity Futures Trading Commission.
“Plunge Protection Team” was the nickname given to the Working Group by The Washington Post in 1997. The team was initially perceived by some to have been created solely to shore up the markets or even manipulate them. The team was created in response to the 1987 market crash.
S&P 500 FAIR VALUE: Fair value is the equilibrium price for a futures contract. This is equal to the spot price after taking into account for compounded interest (and dividends lost because the investor owns the futures contract rather than the physical stocks) over a certain period of time
The “fair value” quoted on TV refers to the relationship between the futures contract on a market index and the actual value of the index. If the futures are above fair value then traders are betting the market index will go higher, the opposite is true if futures are below fair value.
Read more: http://www.investopedia.com/terms/f/fairvalue.asp#ixzz1hHViwDqD
TRADING RULES
1. Do not over trade
2. Do not take a loss home
3. Never add to a bad trade
4. Once you have a profit in a trade, never let it become a loss.
5. When making a new trade, set loss idea-don’t over stay or start hoping.
6. Don’t be a one-way trader. Be flexible.
7. Concentrate on one pit.
8. You’re trading to make money-not for fun and games.
9. Add to good trades only.
10. Learn quirks of all traders and brokers.
11. Learn runners and brokers houses.
12. Try to avoid trading in the market in middle of session unless real busy.
13. When caring a position in the market don’t leave the floor without leaving a stop loss order.
14. Never buy rallies or sell breaks when initiating a new trade-only do this when liquidating a bad trade.
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