How does a futures day trader know when to buy and sell? To put it simply, by
following a day trading system. A day trading system outlines a structure for trading that includes the rules or criteria for
getting into a trade, either long or short, and closing a trade, either at a profit or
loss.
A day trading system can be developed from scratch or purchased ready made.
The principal requisite of a day trading system is that it be profitable overall. This does not mean that every trade need be a winner.
Rather, the relative size and frequency of losses and gains must be such that, over time, a net profit results. For example,
assume that only half of the trades of a 10-year Treasury Note day trading system are profitable. If the average profit exceeds the average
loss, then overall trading will be profitable.
A day trading system can be discretionary or model-based. Discretionary day trading systems rely solely on the "gut feeling" of the
trader. For a variety of reasons,
most traders have moved away from relying on discretion or at least, confine their discretion to only a small part of the overall system.
Model-based day trading systems quantify the conditions or criteria for a trade signal to be generated
with the intent of eliminating the discretionary element from the trading decision. In many cases, the day trading system builds upon
the study of technical
analysis with the goal of identifying
a proprietary trade indicator that gives the user an edge over other traders. Many such day trading systems
are programmed via computer to run continuously and automatically notify the trader whenever a buy or sell signal is generated.
In some cases, it may even be possible to interface the day trading system directly with the online trading platform so that trades are executed
without even requiring the trader's intervention.
DAY TRADING SYSTEM: MODIFICATION
Whatever type of day trading system is used and regardless of its origin, it should first be tested under simulated but real-life conditions prior
to risking actual dollars. This will also enable the day trader to develop some skill in implementing the day trading system.
Trade system modification requires that the trader keep accurate and complete records of each trade, including conditions
before and after the trade completion. This is referred to as trading system feedback and ideally, the trading system feedback
should span a variety of market conditions to fairly identify the systemic (persistent) strengths and weaknesses of the system.
For example, a day trader of the E-mini® S&P 500® may determine that the system works best when using a bar chart constructed over a
5-minute time interval instead of one constructed over a 15-minute or 30-minute interval. It may also be that the system
performs best only during certain times of the day, for example, during the first and last two hours of the regular trading day. How the
trading system performs during the volatility that typically accompanies
the release of important financial or economic news can also be determined. Finally, based on the relative size and frequency of gain versus loss,
the trader can determine how much money to risk on any given trade to reduce
the probability of ruin.
An analysis of the trading system feedback can provide clues for later trade system modification.
For example, say that a system often tends to close a profitable trade too soon.
This suggests that the condition for closing a profitable trade needs to be more accommodating. If closing a profitable trade with a trailing stop
order, then the stop order can be trailed farther behind to accommodate more of a price reaction before a profitable trade is closed.
Also, if trading more than one contract, then the trader may consider closing only a portion of the position on the initial signal with the
intent of closing the rest at a later and better price.
As another example, say that the system generates a high number of trades that once established get quickly stopped out. However,
subsequent to this, the market then moves favorably. In other words, the system correctly anticipated the market move but the trade
was closed on a brief market reaction. The solution here may simply be that the protective stop order needs to be more accommodating,
that is, set father away from the entry price to accommodate more of a market reaction and, consequently, risk more on the trade.
After any system modification, the system should then be implemented for a sufficient length of time to collect valuable feedback on the modification.
If performance is superior, then the changes are maintained. If not, then the trader can return to the older system and perhaps try another
trading system modification. The trader can even create several "second-generation" systems, each one distinguished by a particular
modification. These systems can then be implemented simultaneously and, after a period of time, the trader simply selects the one that performs best.
Day trading systems are dynamic, subject to modification in order to better respond to the current market
climate and improve overall performance and profitability.
There are no guarantees of profitability in the world of futures day trading, but the development of a reliable day trading system coupled with the
personal discipline to follow that system go a long way toward making a day trader successful.
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CME E-mini®, CME®, E-mini® and Globex®. The following are trademarks of The McGraw-Hill Companies: S&P®, S&P 500®.