ES Course

The Don Miller Inner Circle Professional E-Mini Trading Program

E-Mini Strategy Coursebook
The Key Strategies, Indicators, And Money Management Techniques Of A Professional E-Mini Trader




Introduction

In this coursebook, I will provide you with details on the strategies, indicators and money management methods that I use in my E-mini trading. This is intended to supplement the learning that you will receive when you watch my three day so live trading recorded in the accompany CD-ROMs.

If you have had no previous exposure to my E-mini trading courses or have attended my live seminars before in the past, then this coursebook is designed to get you up to speed.

For many traders, however, especially those already familiar with my trading style and methodology, the teaching that I provide when you view the CD-ROM presentation should suffice. If this applies to you, then you can probably just skim through this coursebook.

Don Miller




Coursebook Contents

I will take you through four parts. Here they are in the sequence in which you should tackle them:

Part I: Do you have trading experience in stocks, but are new to futures and the E-minis? If so, this section will take you through all the basics so that you can easily incorporate the E-minis into your trading repertoire.
Part II: There are a number of good reasons why many stock traders are switching their main trading activity over to the E-minis. I explain their advantages and how you as an E-mini trader will benefit.
Part III: You will learn all of the key trading concepts that have been essential to my success as a trader. The knowledge contained in this section will give you a solid foundation for successfully applying the strategies that I teach you.
Part IV: In this section, you will gain a full understanding of all the indicators I use, and how I put them together in order to identify the high-probability trading setups. I will show you my main trading patterns, rules for entry, stop placement, and exit.


Introduction To E-minis

One of the most exciting financial vehicles I have seen in my trading career are the index futures and their ability to participate in broad market moves with one trading decision. More specifically, the "E-mini" futures contracts have been a focal point of my trading as well as many other financial professionals and individual investors.

In fact, many stock traders are finding the advantages of trading the E-minis so compelling that they are making the switch, and like me and many others -- they have made the E-minis their main trading vehicle.

Are you one of those traders who are making the switch from trading stocks to trading the E-minis? Or are you perhaps thinking about it?

If so, Parts I and II are aimed specifically at you. In Part I, I will give you a brief overview of what the E-minis are and how they are traded. And in Part II, I will describe to you the specific advantages of trading the E-minis.



What Are The E-Minis?
Most stock traders have heard of the "S&P Futures." But because you need a large amount of money to trade them, the S&Ps are largely the domain of institutions and large market players with deep pockets.

To open up index futures trading to a wider spectrum of traders, the CME created smaller sized contracts called the E-minis. The E-mini S&P 500 contract was designed with the individual investor in mind. The contract value is 50 times the underlying index (as opposed to 250), just 1/5 the size of the “big” contract. For example, if the underlying value of the S&P 500 futures is 900.00, then one e-mini contract has a value of $45,000.
Before I give you the history behind this, together with more details, let me briefly explain what the E-minis are.

The S&P 500 E-minis, which we’ll refer to as ES, reflects the S&P 500 class of assets.
When you look at an S&P E-mini bar chart...

...you're looking at very close representation of the price action in the S&P 500 Index. The S&P E-minis are therefore a great way to trade the action in the S&P 500 Index.

Besides the S&P E-minis, I also trade the Nasdaq-100 E-minis.

The Nasdaq E-minis (which we’ll refer to as NQ because it reflects a common symbol used by many quote providers), like their ETF counterparts the QQQs, are an effective way to trade the Nasdaq 100 class of assets.

Like the S&P E-minis, when you trade the price action of the NQs....

Daily Chart of the December 2002 Nasdaq-100 E-Mini

...you're essentially trading off the price action of the Nasdaq-100 Index.

Nasdaq-100 Index






A Brief But Important History Lesson

When somebody slaps a label of anything that begins with "The History of..." my eyes usually glaze over. However, if you are considering switching from trading stocks to trading the E-minis, this section will probably have some impact on you. Once you understand the motivation behind their creation and why they've exploded in popularity, you will probably be even more motivated to open up your futures trading account!

The Chicago Mercantile Exchange is the largest futures exchange in the United States and the second largest in the world for the trading of futures. The CME offers trading in futures contracts and options on these contracts, primarily in interest rates, stock indexes, currencies and commodities. The CME uses two ways to bring buyers and sellers together: open outcry on their trading floors and GLOBEX around-the-clock electronic trading platform. The E-mini trades through GLOBEX, but has great synergy with the larger pit-traded S&P contract.

In 1997 the Chicago Mercantile Exchange (CME) launched the "E-mini" S&P 500 futures, which has become the fastest growing product in CME history. It was revolutionary in that it made electronic trading open to all investor and trader classes through GLOBEX, the CME's electronic trading platform. What else was visionary was the size of the contract was set at one-fifth of the standard pit-traded S&P, making it available to a broader base of traders.

What I like about the E-mini contract is that every trader is equal. The GLOBEX system is first in/first out, and if you have a better bid/offer, you are executed. In effect, you are in a queue and are price matched.

This contract has met with unprecedented success. The E-mini's opening day volume was about 7500 contracts, and recent average daily volume has seen approximately 500,000 contracts traded.

A recent single-day volume record reached almost a million trades!

While index-based Exchange Traded Funds such the QQQs and SPDRs (both of which I’ve traded in the past) have been catching on in popularity, they do not compare to the substantial growth I have seen with the E-mini futures contract. This contract has substantial liquidity and is an excellent way to trade stock indexes.





The Similarities And Differences Between Trading Stocks And Futures

In Part II, I will go over the most important advantages that E-mini traders have over stock traders. But in this section, I want to cover the mechanical similarities and differences between trading the E-minis and stocks.

Let's take a look at the basics. With both E-minis and stocks, you can go long and then close your position by selling. Also, you can short the E-minis just as you can short a stock. But there is a big difference. Whereas with a stock you have to wait for an uptick, there is no such requirement with the E-minis. In essence, it is just as easy to short an E-mini as it is to go long. More about this later.

What Exactly Are You Trading?

Then there is also the issue of "what" you are trading. With stocks, you are trading "shares." However, with E-mini futures, you are trading "contracts." A futures contract is a legally binding agreement to buy or sell a specific item, at a specific price, and before a specific expiration date.

Many stock traders get hung up on this concept, but from a practical standpoint, you are still trading on the basis of price action.

The main thing you have to keep in mind as an E-mini trader is that there are four contract months: March, June, September and December. Let's say that you are holding a December contract going into expiration month, but you want to hold that position for a longer period of time. You can "roll" the position forward into the June contracts by simultaneously selling your December contract and buying the March contract.

What Happens When The Price Moves?

When you are long or short the S&P E-mini, you should know the following:

The ES is priced in 25-basis-point increments (i.e. 920.00, 920.25) and equate to $50 per contract in profit or loss for every 100-basis-point move (920.00 to 921.00).

So, if you are long one S&P E-mini contract, and the price moves up 500 basis points, your contract value will increase in value $250.

When you are long or short the Nasdaq-100 E-minis, a different point increment is used:

The NQ is priced in 50-basis-point increments (i.e. 980.00, 980.50) and equate to $20.00 per contract in profit or loss for every 100-basis-point movement (i.e., from 980.00 to 981.00).

Therefore, if you are short one Nasdaq-100 E-mini contract, and the price moves down 500 basis points, your contract value will increase in value $100.

What Kinds Of Orders Can You Place When Trading E-Minis?

As with stocks, you can place both limit orders and market orders. However, when placing stops, you must be aware that the Globex only accepts Stop-Limit orders. In this kind of order, you must specify a limit price when placing your stop. Once the stop price is reached, the stop-limit order becomes a limit order to buy or to sell at the specified price.

Most stock traders are familiar with stop-market orders. This means that once the stop price is reached, the order becomes a market order. Globex does not accept these.

There are many other details that I could include in this introduction, but my main purpose is to convey the idea that if you are stock trader, E-mini futures are not as exotic or hard to understand as you may think they are. Please consult your broker in order to gain an in-depth knowledge about the mechanical intricacies of E-mini trading. To give you give a better understanding of why so many stock traders are shifting their focus to the E-minis, let me take you through some of their advantages.





Part II: Why Trade The E-Minis Over Stocks?

Let's move on and look at the many advantages that E-minis have over trading individual stocks.
Leverage

The first advantage the E-minis have over stocks is the fact that the leverage is amongst the best in the business. If you daytrade stocks, you can leverage your money 4:1. If you hold positions overnight, the leverage drops to 2:1.

But with the E-mini futures contract, you are getting a leverage factor of approximately 11:1.

For example, if the E-mini contract is trading at 900.00, you are controlling $45,000 of S&P 500 Index equities.

If your overnight margin (the amount you have to post as bond or the amount held in your account by your broker) is $4000, your leverage is also about 11:1.

When you daytrade the E-mini contract, some brokers will allow a margin of 50% of the overnight. You can see how quickly the leverage can approach over 20:1.

Think about what leverage has done for you with your home. If you buy a home for $250,000 and you put 10% down ($25,000), you will double your money if your home simply goes up 10%. You'll triple your money if it goes up by $50,000. This is the magic of leverage.

But as you know, this same leverage can bite you. If your home depreciates by 10%, you have lost all the capital you have placed in it. This is why protective stops and correct positions are essential, especially when leverage is in place. But when correctly used, the leverage in the E-mini markets allows your capital to rapidly accumulate at a far greater pace than the leverage offered to you in stocks.
24-Hour-A-Day Trading

Stocks officially trade from 9:30 a.m. ET to 4:00 p.m. ET, plus a few more hours in pre-market and after-hours trading. The E-minis trade throughout the day, for a total of approximately 23 hours. This is key. Why?

Let's imagine if you are long stocks and a terrorist attack occurs at 8:30 p.m. ET. What can you do about getting out of your stocks? Nothing! And you have to wait until morning to be able to get yourself out. BUT if you are long E-minis, you simply go to your screen, click a button and voila...you are flat! And in this day and age, my scenario here is unfortunately not farfetched.

You have unlimited overnight exposure with stocks. With the E-minis, your exposure is limited to the time you receive the information to the time you exit your trade.

There Are Few Overnight "Holes" In The E-Minis

We've all seen stocks open at half their previous day's closing price (or worse!) after they have announced negative news. This is a gut-wrenching event when it occurs.

If you were long D & K Healthcare (DKWD) on Monday 9/16/02, you might have thought the stock would soon attempt to break above 25. The next morning, however, you saw your share value plunge nearly 60%. That was on news that the company had forecast lower earnings for the first quarter.

If you held shares of IMClone Systems (IMCL) on 12/31/01, you were kicked in the gut as the stock dropped 16% when the FDA declined to accept its application for a new cancer drug.

This sort of thing has never happened to the E-minis. Yes, they gap higher or lower, sometimes 2% - 3%. But they have never gapped down to the extent that stocks sometimes do (as much as 50% - 80%!). And this lower overnight risk allows you to better plan your position size and potential risk on a trade. Remember, stocks make large overnight "holes" all the time. E-minis rarely do.
No Upticks Needed To Short E-Minis

We've all had the unfortunate experience of wanting to get short a stock at a certain price, only to see it not uptick for quite some time. When this happens, our fill is far worse than we hoped for and our edge was greatly diminished. Just as unpleasant are cases in which we see a huge plunge occurring and we don't even dare to pull the trigger because we know there is no way to avoid getting a horrible entry price.

With the E-minis, no uptick is required. Nor do you need to "borrow" it as you do with stocks. You simply hit the bid and you are immediately short.

As I walk you through the real-world examples later in my coursebook, you will see that when my trend and momentum criteria are met, the ease of being able to short the market provides you and me with a huge edge when we trade the E-minis.
E-Minis Are More Difficult to Manipulate

Call me a cynic, but when you have stocks that plunge shortly after brokerage firms make their recommendations, plus the specialists or market makers involved -- the possibility of manipulation exists.

And I would rather not be short a stock that some analyst just happens to fall in love with and then watch as it moves against me when I wake up in the morning. Also, many stocks trade thinly due to the market makers or specialists being unwilling to take size.

This is less of a problem with the E-minis. When they become more popular, their liquidity will become better and better.
The E-Minis Only Have One Personality

Individual stocks trade differently from each other. This is because their price is controlled by individual specialist firms or market makers. You may see exactly the same trading setup in several stocks, but they can all react differently because of the way the specialists run their book. This can be very frustrating.

This is not a problem with the E-minis. In my opinion, they trade much more cleanly and smoothly than stocks, and this makes their behavior much more predictable and easier to trade.

Stocks are not tightly correlated to the movement of the overall market. Let's say you felt the overall market would rise sharply. Obviously, your E-mini position would rise with the overall market. But there is no guarantee that an individual stock will rise, too. As you know, on good market days up to 50% of the stocks will not rise. This leaves you at a big disadvantage. Now even though I am going to teach you how to identify exact buying and selling opportunities, you may want to add your own market-timing indicators to them. These market timing indicators might include the VIX, put/call ratios, Advance/Decline Indicators, the TRIN, etc. If you do decide to use these indicators, they are keyed off of directly timing the market (E-minis). Individual stocks will move in a less correlated manner to these indicators.

The bottom line is: You can have an opinion about direction of the overall market and then try to trade an individual stock according to your directional bias. But then even though you are 100% correct about the market...you can still lose money because the stock went the opposite direction of the market. With the E-minis, you don't have to worry about it moving in a different direction from the overall market.


In conclusion, I have given you a half dozen strong reasons why you should trade the E-minis over stocks. There are other reasons as well which I won't go into detail about here. But just so you know, they include tax advantages (talk to a qualified accountant) and cost-effective commissions.

Let's now move onto...




Part III: Key Trading Concepts
When I set out to create this trading coursebook, I wanted to provide a complete body of knowledge that would teach and train people to trade successfully.

You might be saying, "duh." But you see, most peoples' conception of such a trading coursebook would probably consist of a section on the indicators I use, another section on my best patterns, and then the strategies that make all of these components work together to form a cohesive methodology.

I will tell you right here that I would be doing you a disservice and I would not be true to my goal of truly helping people if I created such a coursebook.

The reality is that I am here today earning my livelihood as a professional trader not just because of a good methodology. Rather, there are much larger concepts at work, and if you don't master them, you are not very likely to succeed no matter how hard you try and no matter how good my trading methodology is.

So, let me repeat myself. My goal is to teach you to trade successfully. To do that, I must teach you some larger principles that go beyond my trading strategies. That is what this section, "Key Trading Concepts," is all about.

Without fully grasping the concepts explained in the following pages, any method, chart or setup would simply cause you more potential for harm than profit. Let's start by addressing and dispelling a few myths about this often-misunderstood business.




Dispelling The 7 Most Dangerous Trading Myths

As online trading has grown in popularity among brokers, financial publications, cable TV stations, and traders themselves, I believe there are many myths surrounding the industry that are promulgated to serve interests other than those of the trader seeking knowledge and guidance. And as the E-minis are generating strong interest among many newer investors and traders, it's especially important that we dispel these myths. Here are some of the main ones:

 

Reinforcing The "Skill" Concept
Take a look back at Myth #1 vs. what is Reality. I view trading as a business that requires the development of a refined skill over a period of time. I often compare the profession of trading to careers of aircraft pilots and surgeons. Yet perhaps the best way to reinforce the skill concept is to compare the similarities of trading with another skill field, with which many are very familiar:

Golf...

So let's have some fun and incorporate the mindset of an amateur golfer and see if any of this hits home in our pursuit of trading skill. (By the way, my apologies to those unfamiliar with golf and its terminology. I assure you, however, that you'll understand the points I'm making.)

 

Many pursue trading for the income potential, without regard to the time and commitment required to develop and refine the underlying skill.
 

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While profit potential is a necessary component of the trade decision-making process, focusing on profit alone can be like driving the ball as hard as you can for distance with little regard to precision.
 

Simply put, volatility and its inherent risk can be double-edged.
 

Have you ever hit a drive into the woods? It happens. And what do the best golfers do? They chip out into the fairway, take the extra stroke and immediately focus on the next shot. Trying to simply drive the ball harder can turn a 5 into an 8, and adding to losing positions can have a similar negative effect.

Do you ever get the feeling amidst the industry hype and chest-pounding that all of the other traders are making piles of money? Yet you know just because you don't hear screaming or get hit by someone's club toss on the course, that everyone is playing the same course and struggling with the same challenges that you face.

Would you prefer that your caddy hit your shots, or simply provide counsel as to various options which can help you make the ultimate decision, take the shot, and accept appropriate responsibility? It's no different with trading.


Trade & Risk Management

Now let's go over a few trade-management fundamentals, including effective entries, exits, use of protective stops, and incorporating the concept of trade probability.

As every E-mini trade entry is made with the intent of capturing anticipated market movement, let’s review some attributes of high-probability entries:
Align With Probability

I'll give you an in-depth approach to using probability soon. For now, suffice it to say that it's the trader's goal to be positioned in such a way where the market will move in a given direction more times than not.
Ensure Sufficient Profit Potential Exists
Get into the habit of asking yourself questions such as:

· What is the risk/reward ratio?
· Are you risking $1.00 to make $3.00 or $3.00 to make $1.00?
· Where is there likely initial resistance on the trade?
· Is it clear sailing on a three-minute chart, but with a brick wall of resistance on a 13-minute chart waiting to smash your trade?
· Do you have multiple support levels working in your favor?

Being able to answer all of these kinds of questions prior to making a trade entry can help ensure that the profit potential exceeds the initial risk.
Minimize Loss Potential
Knowing the specific premise for your trade and what it will take to break that premise and trigger a protective stop are prerequisites for any successful trader.
Effective Stops
I will show you where I often set my stops in the strategy section of my course. But let's first establish the absolute necessity for using them in the first place. Effective use of trade stops is incredibly important in protecting you against significant capital losses. Nothing will put you out of business more quickly than not using stops or applying them incorrectly.

Stops can be price-based or premise-based:

An example of a price-based stop is exiting when the price movement exceeds a certain amount (e.g., $0.10) from the initial trade entry.
A premise-based stop would be triggered by chart signals such as key support or resistance, rather than a specific price.
Conversely, premise-based stop exits would be triggered upon a change in the original trade premise, regardless of price, with the objective of not allowing a stop based on a specific price increment to trigger a stop, while the premise remains intact and profit potential still exists.
However defined, you must think of stops as a temporary escape to cash to immediately reassess and reevaluate, with re-entry or reversal, should signals dictate. Depending on one's trading style, re-entry or reversal timing can vary from immediately to several time periods later, depending on specific trade conditions. As such, it may help to consider the exit to cash to be more of a "yield," rather than a "stop."

Stop costs should also be considered a natural and managed cost of doing business in a profession that depends strongly on the concept of probability to conquer uncertainty.
Profitable Exits -- Your Loneliest Decision

Have you ever noticed that few people ever assist or encourage you to exit a profitable position? Between analysts with little incentive to issue "sell" ratings, investors and momentum traders who don't want you to do anything to adversely affect their position before they exit in the dark of the night, and a general misconception of "buy and hold" strategies (how long do we hold?), it's no wonder why I refer to trade exits as "the trader's loneliest decision."

Suggested exit strategies include:

Exiting into Supply. Imagine you're running a store. Suppose you were selling merchandise to relieve inventory and a busload of out-of-town customers suddenly appeared waving their folded money because they simply "had" to buy your goods. Would you sell to them while they were physically in the store and willing to fight over your goods and pay a premium, or after the bus left and you have to not only chase them down, but offer to sell your merchandise at a discount? A similar analogy holds true for purchasing inventory from suppliers. Would you rather buy from suppliers able and highly willing to sell you inventory at a discount, or when they have less incentive and you have to pay them a premium? Whether you’re running a store or buying and selling E-mini inventory, the concept is the same.

Resistance Levels. Areas of price resistance can include larger contra-trend supports and statistical targets, such as Fibonacci levels.

Balancing Gain Maximization and Uncertainty. Since the market is an uncertain environment at best, attempting to time perfect exits is a clear exercise in futility and can quickly lead to trader frustration. One way to offset the imprecision inherent in the market is to scale out of positions at appropriate resistance or statistical target levels, thereby ridding one of that "perfectionist" demon that can cause havoc in one's trading psyche and results.

High-Risk Trading Times. Staying away from the marketplace during times when risk or cost exceeds reward is a key to any successful trader's performance. While "when not to trade" periods can vary based on trader style and area of specialization, here are some generic high-risk trading environments where you may want to consider scaling back or not trading at all.

During Periods of Low Volume or Low Liquidity

· 11:00 A.M. - 2:00 P.M. ET
· Before/after general market sessions
· Day(s) before or after holidays
· Prior to the release of key economic or market-moving news (e.g., FOMC, MSFT earnings)

When Time is Not an Ally (For Intraday Scalpers)

· 3:30 P.M. - 4:30 P.M. ET

When There is Insufficient Data

· Opening minutes of general session
· Immediately following key news release

When You Have Less-Than-Peak Trading Focus

· When you are fatigued, stressed or ill
· When important family or business issues are weighing on your mind

Mastering Probability

One indisputable fact in this or any other real business is that no one can predict the future. While this point may seem ridiculously obvious, let me repeat it for emphasis –

No one can predict the future.

As mere mortals, we're all trading on what many have called the "right side of the chart," and neither you, nor I, nor the top traders in the world can tell you what the market will do in the next minute, hour, day or week. And while it might seem unimaginable to think anything less, many emerging traders seem to spend day after day searching for that Holy Grail, crystal ball, analyst, stock caller, or other device that will rid them of the requirement to operate in an environment of continual uncertainty.

Perhaps you've seen traders who take great pride -- perhaps even boast -- of the ability to accurately "predict" a market's movement. Or perhaps you've gotten personally frustrated over a trade entry because the market moved in the other direction leaving you with a feeling that you were "wrong." Yet, since no one can predict the future, how can there ever be a right or wrong?

Chest-pounding or perceived trade "failures" are clear cancers in this business, as uncertainty prevents there from ever being a right or wrong.

So how do we begin to overcome the challenge inherent in an uncertain environment?

The answer is to seek a simple bias that skews probability in one's favor over multiple trades.

How To Find A Simple Bias That You Can Use In Your Trading

Many folks have commented on my rather "simple" view of the market.
As you'll learn shortly, I encourage trading a single market at any one time, using just a handful of indicators in seeking trade entries:

· The first indicator determines trend (Moving Averages)
· The second defines momentum strength (Stochastics)
· And the third defines a trading range (Bollinger Bands)

That's it. Three. (Note that the trend and range indicators can be “strengthened” by sister trend indicators such as ADX and 3-Line-Break which I occasionally use, yet they often tell the same story and simplicity remains my objective. I review the two supplemental indicators in the CD-ROM).

And one of them, moving averages, is about as basic as one can get. So why would I choose a rather simple and mundane approach to the markets when there are multitudes of other indicators available? The answer is that I'm simply attempting to leverage off historically repeatable pattern biases whose only function is to skew probability in my favor over a series of trades.

Such an approach is like flipping a rigged coin (one that is unfairly weighted toward heads) time and time again.

We know that the result will be heads much of the time, tails occasionally -- including periodic consecutive attempts -- and we really don't care if any particular toss comes up heads or tails.

One of the main reasons I encourage newer traders to focus on a single market, such as the E-minis, is that doing so fosters a suitable environment where trade probability takes precedence. By executing multiple trades of the same commodity, equity or market, using a constant pattern, trigger and stop mechanism, you get favorable outcomes more often than not. You let the sample size, time and probability essentially do the "heavy lifting" for you. In fact, while top traders continually seek a bias, many will operate successfully even without such a bias.

Why Win/Loss % Can Be Irrelevant
Over the years, many traders have asked me:

What percentage of all of your trades should be winning ones?

My response is that while it may be important to some people using certain kinds of methodologies, it isn't to me. In fact, I consider it irrelevant and potentially dangerous to fixate on a win/loss ratio.

For example, an intraday trader can win less than 50% of the time and be highly profitable. This is indeed the case for many world-class traders.

Consider the following trade sequence for an intraday scalper:

1. You enter a trade on a pullback as the market approaches a support level. But then you get stopped out when market conditions change and your premise for entering the trade is no longer valid. You break even.

2. You re-enter the trade and get stopped out again for a loss of $0.10 when support fails.

3. Then you make a final re-entry when you notice some strength coming back into the market. You then get a profitable $0.50 exit. In this case, the win/loss % was a mere 33%, with net profits of $0.40.

Indeed, one of the great advantages to trading a single market such as the E-minis is that even if you try to fight the tide for a while, you almost can't help but tire and then let the current carry you in the right direction.

Second And Third Entries
One concept critical to futures traders is that of perseverance and what many refer to as "second entries."

Specifically, the futures market is full of head fakes as traders position, test and probe anticipated market moves.

The following three-minute S&P E-mini chart illustrates such a concept when the S&Ps were testing a critical longer-term support level of 878 late one afternoon amidst significant downtrends on the 13-minute, hourly and daily charts. The green arrows reflect potential low-risk short entries assuming a high-volume trader used price crosses for triggers -- vs. shorting the tests of support themselves which typically leads to greater whipsaws -- while the red arrows reflect potential stops. Note traders using clear 5-MA crosses may have entered once and perhaps only gotten stopped once.



Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos
Network Company. All other trademarks set forth herein are owned by their respective owners.


In this case, a trader would have had to persevere and not get emotionally drained when the first two opportunities didn't lead to the likely move. Those traders who simply got frustrated and gave up after the first or second entry would have missed the opportunity. And while using volume and time-of-day can help increase your potential of locating "the" ultimate move (this move occurred when market rhythms had been leading to final-hour breaks), such indicators are only aids.

Having a strong mindset of perseverance is a critical component of any successful E-mini trader.




Part IV: My E-Mini Trading Strategies
What Studies And Indicators Do I Use To Guide My E-Mini Trading And Why?
I basically want to know three things to guide my trading decisions: trend, strength and trading range. While there are many indicators that provide this information, I've settled on a trio of indicators:
· Moving Averages to detect trend. **
· Stochastics to determine momentum strength.
· Bollinger Bands to determine range.

** I sometimes use 3-Line-Break and ADX to confirm the Moving Average
reading, yet each indicator is providing similar information, just in a different
manner.
Moving averages, stochastics and Bollinger Bands give me a snapshot of trend, strength, and trading range.
Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.



Moving Averages (Trend)

I use Moving Averages (MAs) to calculate the average value of the market over time. Moving averages take out the noise and help you to see trends more clearly. I use 5- and 15-period simple moving averages on all of my charts with the following settings:

· Simple

· Period Close

· Zero Offset

Of course, other combinations work well, and there’s no hard-and-fast rule, so I encourage you to find a combination with which you're comfortable.

I find that 15-MA does a good job of helping to define trend support or resistance. When price crosses above or below the 15-MA, that can provide a good clue that a trend is potentially reversing. An even greater confirmation comes when the 5-MA crosses above or below the 15-MA.

In addition, the slope of the 15-MA can help you define the strength of a trend. The steeper the slope, the more significant the strength of a trend may be.


Notice how the trend changes when the 5-period MA crosses below the 15-period MA.
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One useful tactic to guide entries and exits is to display the 15-period MA of a 13-minute time frame on a 3-minute chart. This is what I've done in the chart below. To approximate a 13-minute 15-period MA, you do the following:
Multiply 13 minutes x 15 Periods and then divide the result by 3.

That gives you a 65-period MA.

By the way, many traders have asked me why I settled on a 15 period MA and 3/13/60 minute charts, when many traders use different periods such as 10 or 20 and different timeframes such as 5 and 15. The reason is that the 3-minute 15MA is very close to the 1 minute 50MA (3 x 15 = 45), and the 13 minute 15MA is a good approximation of the 1 minute 200MA (13 x 15 = 195), both levels being watched by many traders.


Shortly, I'll show you how charts and MAs of multiple time periods can help you get a handle on profit potential and help you strategize entries and exits.

Plotting a 15-period moving average from a 13-minute chart onto a 3-minute chart may seen unorthodox, but later on you'll see how this enables you to stay on the right side of the main trend.
Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.






Bollinger Bands (Range)

I use Bollinger Bands to help define the current trading range and volatility. Bollinger Bands were created by John Bollinger and reflect plotted standard deviation levels above and below moving averages. The bands, which are represented below by the two thin blue lines, measure volatility, are self-adjusting, and are similar in concept to envelopes.


Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.







Settings that I prefer are:
· a 13-period close
· and a purposely wide Standard Deviation of 2.618.
While many traders use a standard deviation closer to 2.0, which will have the impact of narrowing the bands, I prefer a visual guide depicting range extremes. Note the visual differences between using a higher and lower standard deviation. As with any measure, personal preference and intent should dictate absolute settings. For example, I often prefer to limit Bollinger Bands to higher timeframe charts, but that’s personal preference. Also keep in mind that Bollinger Bands often correlate with MA resistance or support on larger time frames.

Note the visual differences between using the higher 2.618 and the lower 2.0 standard deviation. I like the 2.618 because it is a visual guide of range extremes.
Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.

Bollinger Band rules of thumb include:
1. A move that originates at one band tends to move to the other
2. Sharp price changes tend to occur after bands tighten.




Stochastics
Stochastics tell you when there are momentum excesses in the market. Stochastics are displayed in two lines typically referred to as %K and %D, are measured in units between zero and 100, with sub-20 band readings often reflecting an oversold market and 80-plus band readings often depicting an overbought market.
Many traders are stuck on the idea of using stochastics as an oversold/overbought indicator. That is, they think that if the indicator goes above a certain level, the market can be sold and vice versa.
In my experience, that approach does not work. Keep in mind that oversold and overbought markets can become even more extreme, and that readings below 20 and above 80 can remain in that condition for a long period of time.
Here are my settings:
· %K length of 15-Period
· %K Smoothing of 3
· %D Smoothing of 5




Keep in mind that stochastic settings vary from platform to platform and your chart vendor may require that you adjust your parameters to make sure you're using the same one's I use. As with any single indicator, stochastics are only relevant when used in combination with other indicators.


Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.





One particularly useful attribute of stochastics, which will be reflected in some of our E-mini setups, is when the stochastics indicator "diverges" from price near market tops and bottoms. That is, the stochastics indicator is trending lower, while price continues to make higher highs. I realize that this is a fairly well-known pattern, but I get my own unique edge when I use divergence along with my other trading setup parameters.



Many traders find divergence alone to be useful in identifying market reversals. I use it in combination with my other trading criteria and get an even greater edge.
Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.




Piecing It All Together
I view MAs, Stochastics and Bollinger Bands as the three necessary legs of a trading stool.

The stool can't stand without all three legs. Remove one and the other two quickly become meaningless.

Stochastics that appear oversold can become more oversold and continue to trend further. Positive stochastics vs. price divergence often means little until trend indicators reverse.

The Key: Monitor The Three Legs Of The Stool In Multiple Time Frames
By combining trend, strength and range indicators on multiple time frames, opportunities can begin to appear out of a chaotic market. It's also extremely important to me to understand the perspective and impact that different time periods have on my E-mini trades. For example, you'll often hear me say, "When you're chopping trees for a living, you need to make sure the forest isn't burning down!"

To be able to constantly monitor the action close-up while being aware of the big picture, I prefer to monitor three time frames:

· My traded time frame
· A shorter interval that can help fine-tune trade entries and management
· A larger time frame for a longer-term perspective.

While there's no hard-and-fast rule, combinations that you may want to experiment with include:

LargerTime Frame TradedTime Frame Fine-Tuning
Combo #1 13-minute 3-minute 1-minute
Combo #2 60-minute 13-minute 3-minute
Combo #3 Daily 60-minute 13-minute

As you work through the rest of the coursebook, it will become clear what my preferences are.





Trading Variations
Let's talk about "trading variations..."

Before we begin to explore preferred E-mini setups, keep in mind there are multiple ways to trade profitably depending on the preference and style of the trader. Let's look at varied trading styles along with their associated benefits, risks and trade-management options.
I'll highlight my favorite E-mini entries in bold. I will review them in detail shortly.

IMPORTANT NOTE: Keep in mind that you may not understand all the terms. That's because I have not taught you my key trading setups yet. I will explain it all as we walk through the examples.
Trading With An Established Trend

Benefits --Clearly defined support --Underlying momentum can compensate for less-than-optimal entries
Issues --Can get caught in emotional "chase" --Entries get riskier the further the trend extends --Markets often "chop" more than trend
Potential Entries --MA cross in direction of the larger trend --Oversold stochastics on 15-MA support --Pullback fade toward 15-MA support- Simple Market Maker type scalps with the trend’s “wind” at your back.
Potential Exits --Approaches to range extremes (Bollinger Bands, 15-MA of Larger Time Frame)
Premise Stop --Break of 15-MA Support







Trading Extremes Against The Trend

Benefits --Profit from emotional overreaction --Prices often revert to "normalcy"
Issues --Against larger protective trend --Best suited for scalpers --Precise order entry skill critical--Trade "supports" less critical
Potential Entries --Bollinger Band range extremes
Potential Exits --Support for underlying trend --Opposite Bollinger Band of range if oscillating
Premise Stop --Market Hesitation --Bollinger Band Expansion





Trading Trend Reversals

Benefits --Early entries in new trend --Strong entry and stop premise indicators
Issues --Still against existing trend --May be premature on extreme trends
Potential Entries --MA trend reversal cross --Stochastic divergence w/MA cross(one of my favorites!)
Potential Exits --Approaches to range extremes (Bollinger Bands, 15-MA of Larger Time Frame)
Premise Stop --Divergence Deterioration --Break of 15-MA Support






Trading Range Oscillations

Benefits --Can benefit during choppy markets, effectively compounding gains
Issues --Best suited to scalpers--Can get caught on wrong side of breakouts
Potential Entries --Bollinger Bands
Potential Exits --Opposite Bollinger Band
Premise Stop --Expansion of Bands--Trend Breakout




Some Favorite E-Mini Trade Setups

OK, now that we've reviewed the important cornerstone concepts and underlying framework, let's focus on some of my favorite E-mini setups and strategies. I consider them to be among my favorites because they combine probability bias with clear entry triggers and stop premises.
MA Cross in Direction of Larger Trend

This trend continuation setup involves two time periods:

1. "Traded" time frame. This consists of a longer time frame chart of a trending market that you want to enter in a low-risk, high-probability manner on a pullback toward trend support.

2. "Trigger" time frame. This is a shorter time frame chart that, for the moment, is trading in a direction opposite that of the traded time frame. In essence, the current trigger trend shows you the pullback that is occurring in the longer time frame period.

The trigger period is aptly named because it provides the signal for you to enter the trade when you see one moving average cross above or below another (which I'll refer to going forward as an "MA Cross") that aligns the trigger trend with the traded trend.
Example:

We'll use S&P E-mini (ES) charts to illustrate the use of this technique when trading the both the S&P E-minis and the Nasdaq-100 E-minis.

In this case, we're looking to enter on a pullback of an established 13-minute uptrend (Traded Period) using a reversal in the opposing three-minute trend (Trigger Period) to trigger the entry.




In the three-minute chart, the trigger occurs where the 5-MA (shown in black) crosses above the 15-MA (shown in red) midday.

We are looking to enter the pullback in this 13-minute uptrend using a reversal... ...in the opposing three-minute trend. The trigger occurs when the 5-MA crosses above the 15-MA midday.

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The beauty of this entry is twofold.

First, the cross of the 5-MA above the 15-MA that you see in the Trigger Period chart provides strong evidence that a continuation of the trend in the Traded Period chart has begun to occur. This keeps you out of the higher-risk situation of simply fading into an entry without such confirmation.

Second, once the trigger time frame aligns itself with the traded period, the 15-MA can be used to fine-tune exits and trailing stops on the trade.



This combination of trigger and traded timeframes can be seen even more clearly when combining 15-MA trend supports for both periods on one chart as shown below.



One of the questions I'm frequently asked is how does one define an MA "cross"? This is not easily answered, as there are multiple definitions of a cross, including (in the order of occurrence) an emerging price-bar cross, a completed price-bar cross, and a 5-MA cross. Yet choosing among these options reflects one of the great "arts" of trading and one can fine-tune the entry based on personal preferences with respect to the extent of confirmation desired prior to entry.

I'll often enter on emerging price-bar crosses, accepting the risk of a potential wiggle.

It's also worth pointing out that crosses down in the context of a larger time frame downtrend (the opposite of the above example) are most easily executed in the futures, ETFs, and other trading vehicles that are not encumbered by the uptick rule. Shorting a stock on a cross down in this manner is just about impossible.

Note that I’ll sometimes omit the 5MA reading on my charts (after trading for years, one can often sense where the 5MA would be). 3-Line-Break data – reviewed on the CD-ROM -- can often provide similar information.




Oversold Stochastics on Price Support

This second trend continuation setup involves combining moving averages with the stochastic indicator, using an oversold stochastic reading, and a market that is holding its 15-MA support. As with the first setup, the intent is to seek a low-risk, high-probability trend continuation entry, this time in terms of a shorter-term scalp for the nimble.

In the following example using a three-minute ES chart, we have a very strong three-minute uptrend which is testing its 15-MA support. As ES tests its critical support for multiple bars, note that the stochastic reading drops below its key 80 band level and approaches the 50 band. Now while 50-80 band stochastic readings by themselves don't typically reflect oversold conditions or result in entry triggers, they can when combined with a market that is holding price support and can result in some nice scalp opportunities for the short-term trader. In this case, the lower band provides the trigger to enter the trade in the direction of the trend, with a stop activated upon a break of 15-MA support.


Copyright (c) 2002 Quote LLC. All rights reserved. QCharts(tm) is a trademark of Quote LLC, a Lycos Network Company. All other trademarks set forth herein are owned by their respective owners.

The same methodology can also work in reverse in a downtrending market where such a setup effectively becomes "overbought on resistance." In such a case, the ingredients would include a downtrending 15-MA and stochastics which climb from extremely low bands to modestly higher bands while the downtrend support (resistance on longs) holds.




MA Cross Following Stochastic Divergence

Here's another favorite setup of mine. This situation contains the following 2 characteristics:

· A significant trend reversal
· A significant stochastic vs. price divergence

I am going to illustrate how a trading setup can have more than one possible entry. In this case there are...

...Four possible trigger entries with varying risk/reward characteristics which I will illustrate in the following pages. In this scenario, the vehicle is reversing from relatively meaningful trend.

In fact, the stronger the move and collective emotion, the better. To illustrate, we'll review a one-minute NQ chart and the significant activity following an FOMC interest rate announcement in June 2001. While the move certainly doesn't need to be of the magnitude illustrated here, it should be sufficiently strong to allow for profit potential as the first trend becomes overe