Trading and Day-Trading Stocks and ETFs with Dave Steckler, Part 2

In Part 1 of our conversation with Dave Steckler, he shared with us his philosophy of trading and of the markets, introducing us to both his "three-legged" trading approach (what to trade, when to take a position, and when to exit a position), as well as a strategy for swing trading using indicators in ways that are often different from the ways they are commonly used.

Here in Part 2, Dave Steckler shares with us his strategy for day-trading ETFs. Having recently talked about ETF trading before a standing-room only crowd at the L.A. Expo in Pasadena this weekend, I can attest to the interest in day-trading ETFs among many traders. Dave Steckler's ETF day-trading strategy will likely give readers and traders much to think about and experiment with over the coming days, weeks and months.

Dave Steckler is an investment advisor at Global Investment Solutions. In 2002 he developed the Alpha Rotation Program (ARP), a long-short market timing system using no-load mutual funds and exchange-traded funds (ETFs). He also trades a portfolio of stocks and ETFs using methods described in this conversation. He can be reached at dsteckler@aol.com.

David Penn: This is a good place to talk about your ETF day trading strategy. What can you share with us?

Dave Steckler: As I said earlier, with very high volatility, it was becoming more and more difficult buying stocks using the risk controls that fit my trading style. My stock account is an IRA account, so I can't use margin. I was getting tired of trading for nickels and dimes. It becomes emotionally wearing on you.

Sitting in front of the computer all day long, and it's like, great - I did four trades today and I made $64.19. And tomorrow, I lose $72.38. It wears you down.

Penn: Sure.

Steckler: So, I said, all right. Either I've got to stop trading, and then what the heck am I going to do with myself, or I've got to figure out a better way to do this. Well, with the leveraged ETFs, the 2x and the 3x, they trade with high volume and, with the volatility, you can get some nice moves out of them.

One of the things that I learned a long time ago is to swim downstream, not upstream. By that, I mean trade in the direction of the trend. How do you define it – you know I'm going back to Dave Landry here. You know the big blue arrow?

Penn: Yes, like you said before.

Steckler: It's always easier to trade with the trend than against the trend. That's not to say you can't make money contra-trading, but it's a lot easier, particularly when you're day trading equities.

I found the percentage of winners to be much higher trading with the trend than against the trend. So when the Index, it could be the SPX or the NDX, is above its 50-day or 200-day moving average, I will only trade the long side. When it's below both, I'll trade the short side. For other traders it could be just the 200-day moving average. Whatever the trader wants to use to determine the trend of the underlying market, that's the direction you trade in.

Penn: Right.

Steckler: This is what I do because I'm from the school of "no brains, no headaches." I look at the 50- and the 200-day moving averages. If the Index is above the lower of those two, I consider the trend to be up.

If you pull up a daily chart of the SPX and just put on a 50- and a 200-day moving average, you'll see the Index is above the 50 and below the 200. Since the index is above the lower of these two, I consider the trend to be heading higher. In fact, if you look at the S&P 500 since March, we've made higher highs.

Penn: Yes.

Steckler: We're trending higher. Now there are so many different ETFs that can be traded nowadays. It's up to the individual trader. What I did was put together two groups of five leveraged ETFs. They’re pairs. DXD and DDM, ultra short and ultra long for the Dow 30, QID and QLD ultra short and long for the Nasdaq 100. SDS and SSO, ultra short and ultra long S&P 500. SKF and UYG, ultra short and ultra long for the financials. TWM and UWM, the ultra short and ultra long Russell 2000.

The respective index for each pair is above at least the lower of the 50- or 200-day moving average, so I'm only trading the long side right now.

David, please look at the screen captures I sent you.

Steckler: This technique uses both a 5-minute and a 30-minute chart. The 30-minute chart is used for the setup. The 5-minute chart is used for the trigger. Now please look at the 30-minute chart.

On the 30-minute chart, you see below the price bars in the lower half of the chart, the indicator CCI Average. CCI stands for Commodity Channel Index. Below where it says CCI Average, there's a white horizontal line. Below that, there's a light blue line. Then you've got a squiggly yellow line and a squiggly orange line. Further down, you've got another light blue line and below that you've got another white line. The white and light blue lines are the solid, horizontal lines.

Penn: Yes.

Steckler: The upper white line is +200. The upper light blue line line is +100. The squiggly yellow line is the CCI. That's not the same as the CCI Average, which is the orange line. The lower light blue line is -100. The lower white line is -200. If you look in the middle of that screen, David, to the right of "295.22" you’ll also see the numbers 100 and -100 in light blue, then 200 and -200 in white.

Penn: Right.

Steckler: Now, please look at the 5-minute chart. The solid white line here is the 50-bar simple moving average. The dashed yellow line is the 9-bar EMA.

The way this technique works is this: Again, the 30-minute is the setup and the 5-minute is the trigger. Let's say we’re looking to do an entry. When the 30-minute CCI closes below -100, we have a valid entry setup. Remember: "closes," not trades below intrabar. That's important.

Now, look at the 5-minute chart. When the 5-minute bar closes above its 50-bar simple moving average, go long on the opening of the next bar.

If the ETF continues to trade lower, the 5-minute bar will probably never get above the 50-bar SMA, so you won't get a trigger signal. The 30-minute CCI could fall to -200. If the CCI closes at or below -200 on the 30-minute chart, you're looking to enter on a close above the 9-bar EMA on the 5-minute chart.

Basically, what we're looking at, David, are rubber bands. It's stretched at -100. It's stretched even more at -200. It's like standard deviations.

Penn: Right.

Steckler: A one SD move is likely to have a lesser bounce-back reaction than a two SD move. If you never close at or below -200, you wait for a close above the 50-bar SMA on the 5-minute. If you get so oversold that you close at or below -200, you enter on a close above the 9-bar EMA on the 5-minute.

Penn: Okay.

Steckler: Let me give you an example. Please look at the SSO chart. Let me show you when this happened. If you look on the 30-minute chart on May 15th, at 11:00 a.m. Central, the CCI closed at -214.

Because the 30-minute CCI closed below -200, I'm going to enter SSO when the 5-minute bar closes above the 9-bar EMA. If you now look at the 5-minute chart, you can see that’s what happened at 12:20 p.m.

I entered right after that. I don’t have my trading notes in front of me. It opened at 24.35 on the next bar so for argument sake, I'm in at 24.35.

Now, once I’m in it is all about risk management, so where am I going to get out?

Again, coming from the school of "no brains, no headaches," I use a 5 percent loss. As soon as I get my fill, I put in stop limit price at a 5 percent loss. If I'm in at 20, I've got a stop limit price at 19.

Penn: Right.

Steckler: Again, there's so many different ways you can calculate stop losses, but I try to keep it as simple as possible. So, I'm long on Friday at 24.35. Now, after my entry the price dropped further. It went down to 23.96 that afternoon, but it never hit the 5 percent stop loss. In other words, it didn't fall back 5 percent.

Penn: Right.

Steckler: I'm still long. Now a lot of people say, "I will not carry a day trade over the weekend. I won’t even carry it at night. I’m not going to trade it over the weekend." There's something to be said for that.

On the other hand, if you do that you can miss out on some great moves. One way to manage that risk is take a smaller position. Others say, "I don't care. It's a system. It's been tested. It's going to do what it's going to do, and losses are inevitable and you just have to manage your money."

I carried this trade over the weekend. Monday on the 18th, we had the big opening higher. Now, back to "once I’m in, where do I get out?" Remember, even here it's a three-legged stool: what to buy, when to buy, and when to sell. Well, I know my "what to buy". It's going to be from these five ETF pairs.

Penn: Right.

Steckler: When to buy them is the setup technique I've just described using CCI. When to sell is as follows: unless I'm stopped out for a loss, if on the 30-minute chart the CCI closes at +100 or higher, that's my exit setup. I then sell on the first 5-minute close below the 50 bar SMA.

If however, the 30-minute CCI keeps climbing, it can close at or above +200 and if that happens, it's very unlikely the 5-minute bar will immediately drop back as far as the 50-bar MA.

Penn: Right.

Steckler: So if we get above +200, we exit on the 5-minute bar when it closes below the 9 EMA. It's basically the reverse of the entry. The SSO trade was unusual because it lasted three days, until 5/19. By and large, you're in and out in the same day, next day at latest.

If you get in at 2:00 in the afternoon, you're probably in for the rest of the day. Enter a trade in the morning, you'll probably get out later in the day. Typically, these are same day or overnight trades. It's unusual to last three days but it happens. Now, if you look at the 1:30 bar on May 18th, on the 5-minute, it came down and touched the 50-bar MA.

Penn: It did, right.

Steckler: But it didn't close below it so the system stayed long. Now, look back to the 30-minute chart. The CCI got above +100 on 5/18 but never reached +200, so I'm still using the 50-bar MA on the 5-minute as my exit trigger. That occurred on 5/19 at noon, when it closed at 25.71.

I sold on the next bar's open, at 25.70. So on Friday the 15th, I went in at 24.35. I got out on 5/19 at 25.70. That’s a 5.6 percent gain in three days before transaction costs. I did a similar trade with UYG, also getting in on the 15th but getting out the same day.

Penn: Interesting strategy well-explained.

Steckler: Now, there's a couple of things that I learned at the school of hard knocks here. It's not unusual to have a setup signal come late in the afternoon and your buy trigger gets hit 5 minutes before the market closes. I will not take this trade. A lot of times that's just squaring away of open orders, and there are shenanigans being played, and I have no confidence that that trend will continue the next morning. I'm in Central Time, so the market here is open from 8:30 to 3:00.

If I get a setup on the 2:30 bar, I won’t enter. Theoretically, I've got 30 minutes in which to enter, because once my setup is hit, I go to the 5-minute bars for my entry. I won't enter.

I will however, exit if I’m long and at 2:30 the 30-minute CCI gets to, say +125, and on the 5-minute the ETF closes below the 50, I'll get out. I'll honor that sell, even though the next day it might open up a lot higher, I won't take a chance. I'll ignore an entry signal late in the day, but I will not ignore an exit signal late in the day.

Penn: Sure, I can see that.

Steckler: Okay. This is the technique that I use for day trading or overnight trading ETFs.

Penn: Really, interesting.

Steckler: Yeah. It actually – it's worked out pretty well. I can tell you trading in the direction of the prevailing trade, trading in the direction of the prevailing trend, keeps you on the right side of the trade.

And as I say, what ETFs are put in the traders' toolbox is entirely up to him or her. It could be non-correlated ETFs. You could have oil. You could have gold. You could do a commodity ETF, like DBC, or an inverse ETF. Obviously, four of my five ETF pairs are all equity index ETFs which means that they’re all going to be highly correlated. I don’t have a problem with that because it's very unusual to have all five going off on the same day.

Penn: So the correlations matter less because of the short time frame. The UYG trade you mentioned getting stopped out on the 15th, then the SSO trade we just talked about on the 19th.

Steckler: The beauty of this system from a day trading perspective is that you’re buying a pullback. If the trend is strong, this system does not get you in on a breakout. That's fine. A lot of times in a strengthening market, buying on the first pullback is your safest entry. I know both Larry Connors and Dave Landry have written about this.

Penn: Right. Traders say they want to buy pullbacks in strong markets, but when those pullbacks come …

Steckler: You've got to honor your methodology. You’ve got to honor your risk management techniques, because that's what enables you to trade another day. That’s how I day trade/overnight trade ETFs.

Penn: Very interesting. That will give our readers a lot to chew on. Thanks very much for that.

Steckler: My pleasure. I mean it’s actually a lot of fun. The only thing that can drive you crazy is once you're in the trade, and let’s say, it got up to +135 on the 30-minute, now I'm using the 50-bar on the 5-minute exit. Every five minutes you're raising your stops. Never lower your stops, always raise your stops.

Penn: Exactly.

Steckler: Typically, on a successful trade, you'll pick up 3, 4, 5 percent per trade, which may not sound like a lot, but do that 4 or 5 times a week --

Penn: Yes.

Steckler: Just on four trades a week, right. I'm not saying I put 50 percent of my portfolio in each trade. I don't risk more than 1 ½, 2 percent of my portfolio on any trade, on any single trade. It makes the math easy, 2 percent, for a $100,000.00 portfolio means put $2,000.00 in the trade. I've got a 5 percent stop. The most I can lose is $100.00.

Penn: Right.

Steckler: So, on a $100,000 portfolio, I'm risking 1/10th of 1 percent. Okay, you're not going to make a fortune on any one trade, but do it consistently and it adds up.

Be sure to visit TradingMarkets.com next weekend as Dave Steckler talks about the role of money management in his trading in the conclusion of our Big Saturday Interview: Trading and Day Trading Stocks and ETFs with Dave Steckler.