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Selected Tactics For Short-Term Trading
Daryl Guppy © This extract copyright 2002.
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Many years ago the Government gave me the opportunity to drive
M113 armored personnel carriers. These were fast tactical vehicles and we trained in rapid
deployment tactics. These tactics relied on the same speed and agility that had added the
Australian Light Horse cavalry charge at Beersheba to the regimental colors. Successful
short term trading calls for the same speed and agility and in this book we examine the
discipline, routines and some of the procedures necessary for survival in a dangerous
field. We deploy our trades with speed and precision, and extract them at the first sign
of overwhelming danger. These are cavalry trading tactics and should not be confused with
a cavalier approach to risk and reward in this market time frame.
A few traders apply these tactics every day, but most of us belong to
the part time cavalry. We use these tactics in nervous, unstable and volatile markets. In
essence these are defensive strategies designed to limit the time spent in the market.
Speed offers protection and limits risk by reducing the time the trade is open. If we
believe the market is nervous it makes more sense to snatch profits from short term trades
than to buy into a stock near the top of its up trend, hoping it does not sink.
Tactical success in the field relies on an armored personnel carrier, a
platoon or company of troops and enough firepower to overcome the enemy. Success in short
term or day trading rests upon five elements.
·
Reliable real time data supply
·
Effective end of day charting and analysis
·
Straight through order processing
· A
broker that offers effective stop loss and contingent buy order services
·
Your full time attention while every trade is open.
Please do not kid yourself. Dropping troops out of the back door of an
armored personnel carrier while under fire is no less dangerous than day trading the
market. It requires total commitment, constant training practice, and courage borne of
confidence in your skills. Anything less invites, in our case, a financial disaster.
The first day I was introduced to the standard infantry weapon on the
rifle range, I was perplexed at the degree of caution shown by the weapons instructor. He
took a lot of time – an inordinate amount of time it seemed to me – explaining
the dangers of the weapon. Gung ho and pumped up, we just wanted to jump straight in.
After all, the L1A1 SLR worked on much the same principle as the semi-automatic .22
calibre rifles many of us had used at home for shooting rabbits.
His concern was well placed. These were dangerous weapons and in the
hands of this group of inexperienced recruits, they had the power to inflict widespread
carnage and great personal damage. Treated with respect, and used with skill, the weapon
was a tool that ensured a soldier’s survival. The instructor’s method was to
make us fear him more than we feared the weapon in our hands. This would give us time to
survive and learn to use it effectively.
The gullible are easily separated from their money by a promise of
quick and large profits, so in planning the structure of this book, we deliberately saved
the discussion of our profitable and favorite intra-day trading techniques until last.
These have the reputation for glamour, but they are a collection of dangerous weapons-
lethal at short range. They are a disappointment for the aspiring day trader raised on a
diet of media hype. The returns appear to be small change and the work required for
mastery is time consuming. No easy profits here.
Snapshots are not pictures. This is not a photo opportunity. Tourists take pictures, but
our objective as traders is to take money. This means that like a marksman, we wait until
we can take the perfect snapshot at the market.
The approaches included are a personal selection of day trading and
short term tactics we apply to Australian markets. It is not an exhaustive exploration.
There are many different ways to trade this time frame, some more effective or less
effective, than the ones included here. We encourage readers to explore these avenues and
we provide references to other resources in the text.
In some chapters we draw on techniques or approaches first created by traders like Robert
Deel, Tony Oz, Oliver Velez and others. We do not claim these as our own. Our interest is
in the way these are applied, and where necessary, subtly altered, to provide effective
trading solutions in our Australian markets. We provide an overview of the original
technique, and then explain how it has been modified. The results are illustrated with a
case study.
In each section or chapter we start with a general introduction and
overview of the topic. Our intention is to highlight the application in short term and
intra-day time frames, alerting readers to special risks. Where appropriate we include the
data base search formulas used to locate these opportunities. Some apply to end of day
charting packages like Guppy Traders Essentials and Metastock. Others come directly from
real time data suppliers including Marketcast, AOT On Line Trading and Hubb Data who
provide real time data screening.
Many chapters include a detailed example of the technique in action.
Some of these are blow-by-blow, tick-by-tick, narratives of real time trades. This is
unavoidable in this time frame because traders must focus on the detail of price behavior.
At times, literally every trade counts and a tick up or down means the difference between
profit or loss. We have chosen these ‘fishing’ stories carefully to ensure they
fully illustrate the implementation of the tactics under discussion. Success in short term
trading demands attention to detail so we encourage readers to follow the detail in the
trading approaches they are interested in.
TRADING TIME
The first few chapters are a wrecker’s balls designed to demolish
some popular misconceptions which stand in the way of success in these short term time
frames. They include the supposed advantages belonging to inside traders, and their close
relatives, those who know exclusive market moving news. The single most powerful self
defeating excuse for poor trading performance is the idea that success depends on
exclusive news. It is an antiquated hangover from the turn of the nineteenth century. It
pervaded and distorted market analysis throughout the twentieth century. It is the myth of
the insider. There have been some spectacular examples of successful insider trading and
from these the popular press has succeeded in convincing many people that insider trading
is rife in every stock.
There is no room for conspiracy theories in this book. Day trading and
short term trading is built around the idea that every fast ride ends suddenly, but we
control when we get on, and off. The ride is widely advertised. We join an eager crowd who
all have access to the same news and facts we do. Success does not depend on exclusive
access. This is not a private ride. It is a public excursion.
Survival and success depends on skill and not on some secret knowledge
of prearranged events. Traders of all types steered clear of corporate collapses like
Enron, WorldCom and HIH Insurance because one look at the chart of price action showed a
strong and solid downtrend. Many of the general public continued to hold, or buy, this
stock. The same news was available to everybody, but success came to those who assessed it
objectively.
FINDING OPPORTUNITY
Once we move beyond the first section, each chapter is designed to
introduce and explain one or two important concepts underpinning short term trading
success. Each includes a case study trade to highlight the application and impact of the
concepts, be it trading surprise news, increased volatility or a breakout to a new high.
At the end of these chapters we include a summary of the technique. Readers in a rush can
take a shortcut by simply flipping to the end of each chapter to read the summary. This is
useful, but it ignores the subtlety in application involved with short term trading. The
case studies explore the twists, the inferred clues in order volume, and the skill
required to effectively apply the technique. It is detailed reading but the difference
between your golf swing and Tiger Wood’s is also in the detail. Day trading looks
like a quick fix but it takes time to prepare.
This is the media’s idea of day trading and it was helped by the
inefficiencies of the US market. At the turn of the century the US market traded in
fractions – quarters, eights, sixteenths and teenies. The minimum tick size
translated into $0.065 cents. Imagine buying a $0.10 stock knowing the next minimum price
bid could only be at $0.165. Few US stocks traded at this level, although when Enron
traded at $0.41 the minimum tick represented a 16% return. I would be happy to
‘nickel and dime’ the market for these types of returns. Many US day traders
turned this type of scalping into a high frenzy of trading, reputedly making twenty or
more trades a day.
Sorry, this trading style does not cross the Pacific.
PRODUCING PROFIT
The instruments of leverage – derivatives including warrants,
options and futures – supply the very profitable edge of short term trading. Success
looks easy from the outside with warrant prices moving from $0.05 to $0.13 with apparent
ease. This is the magic of price leverage in action and it attracts many new and unskilled
players. But make no mistake. These sophisticated markets call for high levels of skill.
This is not a modern version of haggling over the price of batik with a stall holder in
Bali. The stock market most closely emulates this direct haggling between buyer and
seller, but not the derivative market.
We focus on derivatives. When the public actively trades the warrant,
the market maker may intervene at times to restrain the growth of prices beyond what they
consider to be a fair value range. In most active warrant markets the market maker stands
to one side, and for a while the trading truly reflects the haggling between buyer and
seller, and opens the door to market inefficiency driven by crowd despair and enthusiasm.
This inefficiency makes warrants an appealing short term trading
instrument. We are not interested in working on the market maker’s theoretical terms
when it comes to pricing and volatility. We are interested in observing the activity of
excited crowds. This is where we trade, but to trade effectively requires an understanding
of the order the market maker seeks to impose on the action.
LETHAL WEAPONS
Stocks and trading instruments which offer price leverage open the door
to very useful trades. This is a long section because success depends on the detail.
These chapters are the first of those dealing with specific short term
techniques. These are bread and butter trades. Returns are 5% to 15% in a 24 hour
overnight period. Like most day trading strategies, they look easy at first glance –
and they are when the exact set up conditions are met. The details of pattern recognition
and the evaluation of the order screen structure make the trade possible.
It is the detail of the intra-day price action with tightly placed stop loss conditions
that make the trade profitable. Not all readers have the patience required to micro manage
the detail so the rewards are likely to slip through their fingers.
PROFIT TAKING
These are short term time frames and success depends more heavily on
good trade execution than it does in position trading or investment approaches to the
market. Time and timing is critical. A delayed order can mean the difference between a
successful trade and a failure. Direct access to accurate, real time price and trading
data is not an optional extra.
We take readers on a detailed tour of what is currently available. This
includes the full range of electronic and hybrid stop loss execution systems. Once you
plug in a stop loss order facility to a fully electronic market like the ASX then the next
logical step is to expand the range of contingent orders. This is intelligent use of
computer technology but it appears few brokerages believe their clients could benefit from
this.
Beersheba was the scene of the last great cavalry charge in modern
history and I, like my great uncle, was proud to serve in the same regiment that still
carried those battle honors. Their success rested on monotonous training and the
experience gained in small skirmishes. Officially they were mounted infantry and battle
victory depended on accurate shooting once they were deployed for action.
We are not engaged in the same endeavor, but we draw on the traditional
cavalry tactics of fast action, precision and swift defensive extraction and apply them to
the market. When market conditions are appropriate, we raid the trading screens for profit
and our survival depends on consistent skill.
Train hard and raid well.
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