Oct 292010

In A look back on my journey – Part 6 – Volume Profiling I talked about the volume profile and how that gives me potential areas to put on trades.  The next question is how to confirm & time an entry.  I want to start off by saying that I’m convinced me that the market is a lot more random than we may think.  We can come up with support & resistance levels and either they hold or they don’t.  Can we “confirm” an entry if the output of the trade is random?

Everyone is talking about order flow and it’s the new buzz word.  I have to admit when I created this blog 5 months ago I was caught up by the order flow craze and I was determined to learn what it is and how to use it.  And so I named this blog “Trade with the Flow”, as in “order flow”.

I’m no expert on order flow, I’m just learning it myself.  A lot of people talk about tape reading and how the legendary traders such as Jesse Livermore & Richard Wyckoff could trade by reading the ticker tape.  A lot has changed since then as we now have real time volume for each trade and we have the ability to know if each trade was on the bid or the offer.

I started learning order flow with the volume ladder (also known as volume footprint by Market Delta but I think they trademark that name so I prefer to call it the volume ladder).  To me the ladder is just a way to organize time & sales to make it more readable.  Here’s an example:

One idea for trading with the volume ladder is this:  When there are a bunch of longs at the top of a bar and they can’t take price higher, then if price drops a few ticks lower then these longs must stop out which will push the move down even farther.  And the opposite for the shorts.  And that’s how I use the volume ladder in a nutshell.

The challenge is this pattern occurs all the time and then “disappears” as longs continue buying and push price higher.  Another challenge is you have to be very quick to recognize it.  I think it’s a really cool way to see what’s going on at each price but honestly I have trouble making money with it.  Sometimes a bar will reverse without this pattern.  Sometimes this pattern won’t result in a reversal.  Sometimes the pattern will fail 3-4 times in a row and then catch the top.  In short, it’s a tool that takes lots of practice.  And even after spending most of 2010 using it, my view is that it can help to time entries but context is much more important.  And if you have the right context, entries become a lot less important.

Now I should talk about delta because “delta” is whether the order was on the bid or the offer.  I don’t want to go into detail about all this because Market Delta’s website has lots of free videos and webinars on the subject.  But I will say I find the delta concept can be misleading at times.  Pros can use a combination of limit and market orders and the delta will only show the market orders.  This makes the traders using limit orders invisible.  So in other words, the orange box at the top of the ladder chart shows longs entering on market orders.  But they were selling into someone wanting to go short.  So we can count the volume as “buying” volume but does that tell us what’s really going on?  And sometimes when the bid/ask moves around, the delta can be completely wrong.  I’ve compared delta with different datafeeds and it’s always conflicting.  In any case delta tracks the traders using market orders and the traders using market orders are not always right.  So next the challenge becomes how to know which side is “right”?

Before answering that, if you total up all the shorts on a bar and all the longs, you can then subtract the shorts from the longs and come up with a total, and this is the “delta” that people refer too.  But as I said, it’s not completely accurate.  Sometimes the bar will go up with positive delta and sometimes the bar will go down with positive delta.  So it’s not simple.  Some traders accumulate the delta, others look for divergences, and others apply momentum calculations to it (“delta momentum”).  But as I said, if the concept has issues to begin with, then all these derivatives of delta are going to have issues as well.  Here’s an example of delta shown as candlesticks:

I do have delta on my charts and the main way I use it is this:  If I see a lot of buying yet price doesn’t go higher, then that’s not bullish.  One doesn’t need delta for this, the VSA folks have been doing this for a long time now.  If you have a high volume up bar but it closes well off the high, you can assume that a lot of that volume was selling which pushed it back down off the high.  So it’s the same concept really, just different ways of looking at it.

The other way I use delta is when i enter a position, say long, the only way price will move up is if other longs enter behind me.  So if I see delta increasing then that tells me longs are entering.  But if longs are entering then price will be going up too and it’s easier to just watch price.  For example a bunch of longs could enter giving a positive delta but maybe price doesn’t move?  Which should I believe?  Unfortunately there’s no simple answer to that.

In the chart above I marked a bar with a very high delta.  There was a lot of buying there and the market only went up 3 ticks (it’s a 3 tick renko chart).  Does that mean price is going to reverse?  No.  It means at those current prices there were a lot of sellers.  If those sellers stop out, that could push price up.  If those sellers keep selling and/or if no more longs join the move, then price will reverse.  So one has to be analyzing what’s going on at every price in order to anticipate moves.

Which leads me to my favorite tool for reading order flow – The DOM.  This is more appropriate for scalping and for timing entries with precision, such as when using tight stops.  It takes a long time to learn and I’m just getting started so I’m not qualified to write much about it.  I’ve asked a lot of traders about it, hoping to learn the secret to reading the DOM.  Everyone has said basically the same thing:  There are no secrets.  It’s an art more than it is a science, and it takes a long time to learn.  By long time I mean watching only the DOM for a few months. Very few people have the patience and discipline to do this.  I sure didn’t a year ago, but I do now.

I hope to write more about the DOM in the future but I want to stress that unless you’re scalping I really don’t think it’s necessary.  I know a trader who enters only with limit orders and he’s very profitable.  This shows how context is much more important than an entry.  It can go against him a few points he doesn’t mind because he is right the majority of the time.  He may be able to time the entry better with the DOM, but then he wouldn’t be able to trade multiple markets as easily.  And many times I try to time my entry only to find out that I just made it worse.

My goal for this page, like this series, is not to teach (a task for which I am not qualified) but rather to share a few ideas & experiences, and to tell you what I’m currently doing.  I must admit I haven’t fully worked out how I use order flow, but my current focus is the DOM.

Next I’ll discuss how to put everything I’ve talked about together.

Continued in A look back on my journey – Part 9 – Conclusion

Oct 162010

I’m going to take a break from writing about day trading because October was a milestone for me.  It marked 12 consecutive months of profitable swing trading on ES!

Before I show my account statements, let me say this:  There are a lot of dishonest people out there.  Trading is a profession where everyone wants to believe the dream.  There are a lot of scams, namely people posing as profitable traders in order to sell you something such as training or software.  And there are a lot of  wannabe traders pretending to be profitable traders just to have fun.  In just 3 years I’ve seen a lot and even been taken by a few myself.  I plan to write a few posts on that because I think it’s a serious problem with the trading business.  The summary is you can’t trust anyone.  Including me.

I hope by posting screenshots of my trades and parts of my account statements, you see me for what I really am:  A small retail trader who’s begun to be profitable over the past year.  No more, no less.  When it looks good I take the trade with real money.  When I’m unsure or if I’m experimenting I take it on simulator.  And I don’t hide it.  All posted swing trades are real money.  For daytrades, an account starting with “S” or “T” are simulator and an account starting with “7” is real.  If my DOM is blue it’s sim.  If it’s white it’s real.  My blog is about my trading.  If I pretend to be an expert trader then it’s not going to help me.  I have plenty of other hobbies to bring me happiness, trading is a business.

Now that I got that out in the open, here is the performance summary from October 1, 2009 to September 30, 2010 from my swing trading account at Interactive Brokers.  The stocks take up a huge amount of space, I was averaging a couple trades every day, so here is the futures part:

Prior to that I had many small wins and a few large losses that would wipe out all the winnings.  But in October 2009 I made a few changes:

  1. I started being more selective with my setups
  2. I started scaling out of trades
  3. I focused on ES

The first one was not easy.  My swing trading is discretionary.  I was looking at a lot of different data including the cycle charts, professional activity, the COT report, small option traders, and various other breadth data.  I was not trading specific “setups”. So how can I be more selective?  Intuition was a large part of it.  Sometimes I just knew ES was going to reverse.  I didn’t know when, but I knew it was.  As we’ll see, “when” is actually very important.

The second item I started doing was scaling out.  I noticed that I often let nice winners go to zero and I became determined not to let that happened.  So I scaled out as the trade went in my favor so that when it finally reversed I only gave back a portion of the winnings.  This meant I had to increase my size.  The most I was trading was 8 contracts, which I admit was too risky.  After the flash crash I traded one or two max.

The third item was I started focusing on ES.  You can see above that I lost money on stocks.  I was trading a mechanical swing trading system on and off for a few years.  I ended up pulling the plug on it this year.   You can also see Euro & Crude.  I never made money on those consistently.  The Euro leverage is huge and crude is very volatile, both not good swing trading candidates.  Also the DAX & Stoxx trades were actually day trades that I held thinking  they’d “come back”.  What I found was I could read ES very well but the other markets not as well.  So why bother with them?  Focus on what works and that was ES.

I made a little over $18k in the past year trading ES.  What’s really impressive is, up until August 2010, I only had a few really small losses (less than $500 each) totaling around $1k.  My profit factor at that point was around 20 meaning I won 20 times more than I lost.  Then in August I had a trade that went against me and instead of cutting it I let it go and ended up taking a $2k loss. This is also what caused the Dax & Stoxx losses.  Remember the issues from A look back on my journey – Part 2?  Up until this point, this series has been about day trading but those issues were present in my swing trading too.  It wasn’t a catastrophe but it did bring my profit factor down and it did get me to thinking about it.  And during my vacation I worked on redoing my swing trading to make it more mechanical with less risk.  To make it more mechanical I based it on the sine wave cycles.  I tested that for a few weeks on simulator and it was a disaster.  That’s one of the events that started me doubting the utility of the sine waves, which led to me removing it from my day trading, which I wrote about  in A look back on my journey – Part 4.

After that I put my swing trading on hold.  The great performance record had a hidden cost – excessive risk.  I was always right on my read of the markets, they did ultimately do what I thought they would.  But I was often wrong on my timing.  I was often too early.  And it was a serious problem.   The black swan could wipe me out.   I was actually long the day of the flash crash.  In fact I made money on my long which hit my target at 12:35 NY time while I was out.

Here are the trades:

After dinner a few hours later a trader friend of mine wrote to me on gtalk, saying he couldn’t believe ES.  I had no idea because I was away from the markets and had just gotten back to my desk after getting the kids to bed.  When I saw the market tank I couldn’t believe it.  What if I hadn’t exited my long?  What if I had held it, without a stop?   I’d be flipping burgers right now.

It’s amazing how much more clear you can think when away from the markets.  And that’s what our 3 week summer vacation was to me in August 2010.  Time away to rethink things through.  So when I came back I stopped swing trading until I could come up with a way to do it with very tight risk control (such as 1% of my account).  Actually I just put it aside totally so I could focus on day trading.

In October I’ve taken two trades, one on the Euro (technically in September on the last day of the month) and the other on ES this past week.  Both looked very good to me and I couldn’t refuse.  The Euro got me $497 and the ES trade $1042.  That $1k on ES isn’t included in the totals above because I did October 2009 to Sept 2010 to make it exactly one year.

Here are the trades:

I continue to be very hesitant to place swing trades.  I think it’s too hard to time the entry.  The market is too random in the short term to get a good entry without it going against me.  The only way I can see to safely swing trade is to enter the swing trade as a day trade and if it runs well then keep a portion on as a swing trade.  But in order to do that one has to have the day trading down pretty well and that’s what I’m working on now.

Let’s say I’d normally day trade 2 contracts.  I see a super swing trade setup.  My idea is to enter the day trade and then instead of closing out the second, if it looks like it could run then let it run.  This is much harder than it sounds because there is a high probability that the trade will pull back enough to trigger any “breakeven” stop.  If not on the entry day then overnight and the next day.  It’s quite complicated and I haven’t worked it all out so I’m just focusing on day trading for now.  However, when my intuition tells me there is a very good setup, well I just have to take it. 🙂

So now I’ve covered swing trading and next I’ll be writing about order flow.

Continued in A look back on my jounrney – Part 8 – Order Flow

Oct 142010

In A look back on my journey – Part 5 – Market Profile, I talked about Market Profile and how that can provide context for trading as markets go in and out of balance.   One thing I like to do is adjust my balance areas to make the balance and imbalance areas more visible.  Often balance areas overlap and when that happens I merge them into one bigger balance area.  And sometimes the market will break out and I’ll split the profile into two profiles, one for balanced and one for imbalanced.  I learned to do that from Balance Trader and he has a course on it if you’re interested.  I do not use his setups directly, but the way I trade is similar so I recommend the course.

So back to splitting and merging, here is what the current ES market profile looks:

You can see lots of overlapping activity from 10/8 to 10/12.  If we merge them together then we get a better picture of the balance area:

There are limitations with this.  Currently we have a balance area preceded by lower balance areas.  If the market drops down and starts balancing in a previous balance area, there is no way to merge just the overlapping areas.  If we do a merge then we’d end up with something like this from mid september:

There is some overlap between the lower & upper balance areas, meaning the market went up and came back down and then went up again.  So I can’t isolate those areas.  When that happens I just merge it all and it looks like above. That big area contains several weeks of data.

Now what would happen if we merged all the data into one big profile?  I tried it once and it’s very tedious & time-consuming.  But there is another approach.  I learned this from FuturesTrader71, it’s called a volume profile, and when the volume profile contains a lot of data he calls it a “composite volume profile”.

Here is what my current composite profile looks like for ES.  I’ve overlayed daily bars on the chart:

You can see that some prices have more volume than others.  Those with the most volume are similar to the VPOC of market profile.  This are marked with green lines and are called Composite High Volume Nodes (CHVN).  The prices with the least volume are similar to the “singles” of market profile and they’re marked with red and are called Composite Low Volume Nodes (LVN).  It’s the same concept as market profile except time has been removed from the equation and it’s pure volume.  Note: the daily bars overlaid on the chart do use time and that’s just to get dual use out of this chart, much like the market profile chart has a dual use by providing 30 minute bars.

The theory is that certain prices have been accepted in the past and are more likely to be accepted in the future.  And certain prices have been rejected in the past and are more likely to be rejected in the future.

Remember in Part 5 how I said when the market is balanced, I want to fade moves to the edge of the balance area?  The same idea applies with the volume profile.  I can fade a move to a LVN, expecting it to return to the HVN.  And as in market profile, sometimes the HVN can act as support or resistance.

So now we can understand my main trading chart chart:

When I was trading with cycles, I used 4 tick charts:  13500, 4500, 1500, & 500.  I’ve replaced all 4 of these charts with the chart above.  And removed the sinewaves.  Talk about simplification!

I annotated how yesterday’s high acted as support.  This is to show that basic S/R is still valuable in trading.  Then I annotated how the CLVN acted as resistance and resistance became support.  This is the most basic way to trade and after 3 years of trying to complicate things I’m realizing that simple is best.

Note: The volume profiles and the red & green lines update dynamically so it’s possible the lines were in different places during the day.  For example if a CLVN gets more volume the red line might move up or down a few ticks.  I don’t have an easy way to show how they looked real time so I’m annotating the chart as if they didn’t change.  So if you wonder why I went short there instead of some place else, that might explain it.  This is why I often take screenshots when I enter a trade, so I can see the chart exactly as it looked real time.

The red & green X’s mark my trade entries.  I traded ES poorly yesterday (-8 pts).  I’m still studying what happened but one mistake I made was that the market was imbalanced and I was fading it, anticipating a return into balance.  As I said, it’s not easy to know that realtime.   And when I did trade the long side, I was using very tight stops and got stopped out twice and missed some nice moves up.  I’m still practicing trading with tight stops (this is all on simulator) so this is a learning experience and a work in progress.  And I hate to admit it but I had one relapse where I “gave it more room” and then averaged down (issues from Part 2).  Wow, just admitting it just felt good.

So in summary, whether it be market profile or the volume profile, the same concepts apply:

  1. Lots of volume implies acceptance
  2. Very little volume implies rejection
  3. Price tends to rotate around areas of acceptance when balanced
  4. Price tends to move from one acceptance area to another, and during this move the market is imbalanced
  5. This move from balanced to imbalanced to balanced repeats again and again
  6. When balanced, fade moves to the edge of the balance area
  7. When imbalanced, don’t fade it, go with it
  8. Telling the difference in real time is very challenging

For more information on volume profiling, FuturesTrader71 is the expert and here are some resources:

  1. His blog is Simplicity in Trading
  2. He tweets his observations & sometimes his trades via Twitter
  3. He has a series of webinars, some free and some require a donation to his charity

Speaking of webinars, he is doing a free webinar today (October 14, 2010) on setting up charts for volume profiling.  If you’re reading this at a later date don’t worry it will be recorded and available with the others.  And James Dalton is doing a free webinar on market profile on October 19, 2010.  If you’re reading this at a later date, look for it in the SFO webinar archives.

Wow, this has been a long journey.  Now I can post my charts and we can speak the same language.  Which reminds me, one of my goals in writing this blog is to meet others who share the same beliefs and trade in similar ways.  So if you’re into this, contact me.  I’d love to set up a forum or a chat room or something.  I’m not an expert but I’m willing to share what I’ve learned so far.  We’re almost there, just a few items left on the journey, namely order flow, which I’ll attempt to cover next.

Continued in A look back on my journey – Part 7 – One year of profitability swing trading ES