Today, I plan to share the investment insights Benjamin Graham, Warren Buffet’s mentor, gleane...
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How One Repeating Pattern Makes for Consistent Trading Profits (Part 1)
07/13/2009 10:05 am EST
The market trends and then the market moves into a trading range, resting before moving back into a trending state. It's easy for some traders to trade a trend, for other traders to trade a range, and some are even gifted enough to successfully trade both trending and ranging markets. And it is generally easy to spot the transition from a trending market into a range-trading market, and similarly, from a range-trading market to a trending market.
But most traders are frustrated when a down-trending market changes directions and then begins trending higher (the same being true when an up-trending market changes direction and begins trading lower). The abrupt turns are hard to spot, and most traders just don't know how to deal with these changes, or haven't found rhyme or reason behind them and end up scratching their head as the new trend unfolds in front of them, leaving them behind without a position.
During the crazy, dot.com stock market rally of 1999 to 2002, I made a huge amount of money trading the Nasdaq 100 futures because their intraday trends were easy to spot and their daily ranges were often 200-250 points! The money was easy, and believe me, I milked every cent out of that market until the dot.com bubble burst and the Nasdaq 100 futures daily range eroded to well under 30 points a day.
I had one rule that always served me well back then when I traded the stock index futures so actively (and in fact, I still observe this rule religiously today): The cash market in stocks open at 8:30 am CST and it takes a good 45 minutes to an hour for the larger cash portfolio traders and cash specialists to get their “books” in order. I call this the “push and shove” hour, and although I know many traders make a lot of money in the first hour of trading, especially those that can take advantage of these imbalances, I know my strengths and weaknesses, and learned early on that my monthly profits increased significantly if I waited until after that first 45 minutes to consider trades in the stock index futures. So I had a “dead period” between 8:30 am and 9:30 am each morning, and in fact, because there was so much volatility in the stock index futures, the currency trends were relatively tame during that period as well. I soon realized that the first two hours in my trading day—from 7:30 to 9:30 CST—held a smaller profit potential than the rest of the trading day. So should I just start trading later and sleep in, or perhaps just accept much smaller profits and trade during those first few hours to tune up my intraday trading?
Before deciding to just sleep in for those two first hours each morning, I decided to do some intense research. My trading is built upon two things:
- Trading repeatable patterns I can see and trade consistently, and…
- Using surgeon-like money management to control my risk.
I decided to take these two strengths and look through the available markets to see if I could find something that fit my needs and would be effective during those first two hours (remember, at that time, I didn't need more risk after 9:30 am!) I was looking for an early-morning pattern in a market that was liquid and trading actively between 7:30 am and 9:30 CST each day.
Of course, the answer was right in front of my face, since I live in Chicago, home to the largest futures exchanges, but until I began this research, this particular market had always been an afterthought in my mind. The US 30-year bond futures, traded at the Chicago Board of Trade, were (and still are) incredibly liquid. Once I began looking at them and researching for a repeatable pattern, I was surprised that I had been ignoring them. I can only say, in my defense, that as a chartist, the average ten- to 20-tick ranges available to trade during the first few hours looked rather small until I realized that each tick was worth $31.25! If I could find a repeatable pattern that captured eight ticks consistently, it would equal $250 a contract, or be the same as catching a five-point move in the e-mini S&Ps! What at first seemed like small ranges began to have an appeal. Now, would I be able to find a repeatable pattern that I could see on a regular basis and trade consistently, and one that appeared regularly in those first few hours of trading?
There are many ways to do research to identify patterns hidden within charts. I do have proprietary database programs that search for specific patterns and I have spent a great deal of money over the years developing these programs as computing power has grown cheaper and much more powerful, but to be honest, I still find my eyes are my best research asset. I have been charting commodities, currencies, and futures for more than 38 years, first exclusively by hand, and now using a mix of hand charting on paper and computer charting programs, and my eyes see things that would be very difficult for me to translate into computer language when I am first searching for a repeatable pattern. Once I have found a repeatable pattern, I am generally able to describe it in mathematical terms and have it entered into a database program that keeps track of the new pattern and its statistics. But when it comes to finding new, repeatable patterns that work, I still find my eyes are my best tools.
I literally printed out thousands of charts of the bond futures of various time frames, focusing on those first few hours, and then spent quite a few weekends going over those charts by hand, using my eyes to search for a pattern I could recognize and then doing statistics on a few candidates to find one that indeed was repeatable, reliable, and seemed to be consistently tradable.
But once I thought I had found one (I actually found three), the work hadn't ended. Would I be able to see the pattern in real time and would it play out and be tradable as it unfolded in real time on a consistent basis? Two out of the three candidates I identified were not consistently obvious to my eyes as they unfolded in real time, but one caught my eyes immediately as I watched the bond futures trade in real time, between 7:30 and 9:30 each morning for the first few months. You read that right—after all the research, after finally identifying what I was sure was a new pattern I could see consistently, I watched this pattern in real time for two more months before beginning to trade it with real money.
One last note before we begin looking at this pattern in detail. The markets constantly evolve and change, and after about three years of using this pattern regularly, I began to see it less and less. The currencies had come alive, the range of the Nasdaq futures had shrunk to an average of about 20 points a day, and the bond market changed behavior as well. Traders who don't adapt when the market changes its behavior become losing traders. When I began seeing this pattern less and less, I shifted my focus to other repeatable entries I had identified and this particular entry was put on the back burner.
But in the past six to nine months, I began to see this pattern appear more and more often as the bond market began to expand its ranges, and now I trade this pattern again on a regular basis.
Let's take a look at the pattern, which I call a “Corner Trade.” For the most part, I only use it to trade bond futures (if you trade ten-year bond futures, it is equally applicable), but I am seeing this same pattern, albeit with a slight twist, appearing now in other markets, but we’ll leave that for another article!
Here's a recent chart of the US bond futures. It is a tick-based chart, not a time-based chart, which means that I have taken time out of the equation, and as a result, price does not drift to the right when there is no activity in the bond futures.
Price made a nice move down, with easily identifiable swing highs and lows, then turned higher with no warning and left easily identifiable swing highs and lows as it moved to the upside as well.
|More tomorrow in Part 2.||Read Part 2 | Read Part 3 | Read Part 4 | Read Part 5|
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