4 keys to successful trading

In my last article, I offered an example of how historical analyses of market patterns, combined with discretionary intraday setups, can offer promising trade ideas. My example, from Wednesday June 6th, relied on a finding that the odds were favorable that we would see an up day for the session, based upon the previous day's high levels of institutional buying and selling.

A second piece of research told me that, given the pattern of early buying during the day, the odds were well over 75% that we would take out the previous day's high of 1273 on the S&P futures. Once again, this called for looking for a second setup in which selling dried up above the day's price lows. Here is how that setup materialized on the Market Delta chart. Recall that the chart segments volume occurring at the bid vs. offer price, displaying blue when volume dominantly occurs at the offer (buyers more aggressive) and red when volume mostly occurs at the bid (sellers more aggressive). As I noted in my previous article, I am not affiliated with Market Delta, but do utilize it as one of my tools for reading intraday market strength and weakness.

Notice that we hit a price low during the 9:50 AM bar and, once again, saw buyers enter the market aggressively, lifting offers all the way up to 1269.25. Subsequent bouts of selling came on reduced volume, with considerably less volume hitting bids at the 10:00 and 10:10 AM bars relative to 9:50 AM. By 10:30, selling can only take us to the 1267.25 print before running out of gas. This emboldens the buyers, who aggressively lift offers. This buying eventually takes us to our target price.

Notice at the 10:50 AM bar, price retraced six ticks before resuming its run up. With large traders able to move the market many ticks at a time, it is important to know when your trade is wrong and when you need to be patient and take heat. Formulating trade ideas with specific targets is one way of developing the confidence to stay in trades. When you have tested historical patterns extensively and seen them work out in a majority of instances, it is easier to stick with them. On an intraday level, the coding of buying vs. selling activity as blue vs. red also offers a nice guideline for staying in trades. Once the trade is profitable, we stay in it as long as the volume at the offer exceeds the volume at the bid for each bar, which is given by the numbers along the horizontal axis of the chart.

Finally, notice how combining the historical patterns with intraday setups reduces risk. The trade idea was based on the notion that selling was drying up after the 9:50 AM bar lows. Had we made new price lows--or if we saw sellers more aggressively hit bids after the 9:50 AM bar--we would have evidence that our idea was not going to pan out and we could exit without a major loss. The combination of historical patterns and intraday setups also sharply reduces the number of trade ideas during the day, focusing us on high percentage ideas and reducing commission overhead.

Ability to take heat. Risk management. Patience and selectivity in trading. These are sometimes viewed purely as psychological characteristics of traders. They also can be characteristics of our trading styles. Trading well--with a demonstrated edge and a superior feel for order flow among buyers and sellers--is the best tool of all for maintaining a positive trading psychology.

Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com and a blog of market analytics at www.traderfeed.blogspot.com. His book, Enhancing Trader Development, is due for publication this fall (Wiley).