Futures Scalping Part 2: 21 Good Ideas

One thing I hope I’ve gotten across with this blog is that there are lots of ways to trade successfully.  It’s not that there’s one magical formula, and once you have that formula it rains money.  Rather, there’s a lot of little things that you can do wrong or right.  This is very much true in futures scalping.  If you do enough of them right, you start to make money.  As you get more right, you can make more money with less downside risk.  Here’s a list of 21 good ideas that helped me move from being a losing trader to a winner.  I’m not going to provide excruciating detail on each aspect right now.  Just enough info to get you thinking about a given topic.

  1. Pick an instrument that’s popular, but not too popular.  It’s very hard to make money in an instrument where no one will trade with you.  It’s also hard to make money in an instrument that’s carefully watched by a lot of highly skilled traders.  Generally this means you’re well served by starting out with a medium popularity instrument.  I think the CME gold contract (GLOBEX ticker GC) and oil contract (GLOBEX ticker CL) are often good choices.  As a rule of thumb, instuments that have a 1 tick gap and between 5-10 contracts typically bid/offered at any given time is probably about the right level of busy for a newbie.
  2. Gather information on your instrument.  Collect the information in the “know your instrument” questionnaire.  Make sure you’ve read everything the exchange (typically CME or ICE) has to say about your product and their policies in general.  You can find tons of info on their websites.  Also make sure you’ve read whatever info your broker has on your product.  Most futures brokers have special policies around margin/performance bond and futures that require physical delivery.  You need to know these to avoid nasty surprises.
  3. Have good charting.  You’re going to need to be able to see what’s going on in terms of your instrument’s price.  This means you need good charting.  You also want the ability to display common indicators on the chart.  The easiest (but not cheapest) way to achieve this is to use a charting package like NinjaTrader.  Your broker’s built in charting may also be an option.
  4. Get visibility to multiple time frames.  When look at the same instrument charted on different time frames, you see different things.  It’s very helpful to have several visible to you.  When trading CME crude oil (GLOBEX ticker CL), I use a 5 second chart for entries and exit.  But I do a lot of my analysis on 1 minute and 5 minute charts.  That means I need to be able to see all three at once.
  5. Limit the rate at which you trade, both on a macro and micro scale.  A slow rate of relatively low risk trades with better than random win rate can make you very wealthy.  One even money bet per day with a 66% win rate for 1% of your net worth is enough to make you very wealthy in a few years.  Thirty seven even money bets per day with a win rate of 45% for 1% of your net worth will impoverish you in a few months.  One of the big strengths of retail trading is that you never HAVE to trade.  I would suggest starting traders take no more than three trades per day and before entering any trade ask themselves if this is one of the three best opportunities they’re likely to see today.  Also be willing to stop trading for days at a time during “weird” conditions – vacation weeks, major international crises that affect your market etc.
  6. Don’t try to maintain focus – get an alert when you need to focus.  When you don’t trade very often, it’s hard to pay attention.  This tedium is the primary reason most traders overtrade.  But trading is a VERY expensive way to keep yourself amused.  I find you’re much better off doing something like reading a book.  The problem then becomes how to switch your focus back when needed.  For this purpose market scanners or alert software are wonderful.  Just set the scanner to look for whatever conditions your trading system requires before you trade, and alert you when they develop.  Depending on your trading software this might be a built in feature or something you have to program.  If it’s unavailable you should get better software.
  7. Understand the daily, weekly, monthly and yearly volume profiles for your instrument.  Even if your instrument has very broad trading hours (and many do), activity levels aren’t equal through the day.  Know when your instrument is active enough to be worth trading and when it’s not.  These patterns play out on a day basis, but sometimes also a weekly, monthly, or yearly basis.  Simple volume charts (you do have a charting package, right?) on a variety of time frames will show you these patterns.
  8. Make a firm decision about when you will and won’t trade and stick to it.  There’s two reasons for this.  The first is to make sure you’re trading when your instrument is active.  The second is to keep trading contained from the rest of your life.
  9. Set, and stick to, a daily loss limit.  Traders behave irrationally when they start losing.  They trade more, on worse setups, and sometimes even with bigger size in the hopes that they’ll get back to even.  This is stupid – no one can trade well in this state.  The solution is to simply set a daily loss limit, and perhaps a weekly limit as well, and to force yourself to stop trading when they’re hit.  This way, the hole never gets too deep.  If you don’t have the willpower to set these types of limits and stick to them, you may have an addictive personality or gambling problem and should probably avoid trading at least until you resolve your psychological issues in some other venue.  The markets are a very expensive and ineffective shrink.
  10. Deal with the news.  Markets behave differently around major news.  They tend to get quiet and have wide spreads before the news, and then move violently when the news is released.  The Bloomberg economic calendar is a good place to find out about news events that may affect the US market.  My experience is that general purpose trading systems should be kept away from the news – don’t let them trade just before or after it comes out.  It is possible to make custom systems to trade news releases, and those should only be turned on when news is expected.  Set up a foolproof system so you’re never surprised by a news release.  I pre-mark my charts every morning so that 5 minutes before every major news release I’ll see a flag that reminds me it’s coming.  The same effect can be achieved with a $5 alarm clock or the software equivalent.
  11. Have a means of measuring typical price.  You wouldn’t run a car dealership without knowing what cars usually sell for, and you shouldn’t trade without knowing what typical price has been  This can be achieved via an averaging indicator, some variant on market profile, or simply by looking at the middle of the Y axis on an autoscaling chart.  But one way or another you’re going to what to know what typical pricing is and where you are relative to that.
  12. Have a means of measuring historical volatility or price change and adjust your trading to reflect it.  Some market days are just more exciting than others.  Metrics like volume averages, true range averages and standard deviation calculations on the price time series all all good ways to capture this information.  You’re likely to find that strategies which work well at one level of market excitement fail at another and vice versa.
  13. Bet that the market won’t repeat itself for too long.There are a lot more hostile markets than naive markets.  So if you see an obvious, repeating pattern it’s generally a good bet that it’s about to break.
  14. Start with one contract, and don’t trade more until you’ve had about 3 months of consistent profitability.  Most traders trade way too much size way too soon.  Many futures contracts are big instruments in terms of notional dollar value.  Trading multiple contracts before you have a track record of proven profitability is silly.
  15. Have a defined and fixed stop loss that’s put in place with every trade.  Place a stop loss as soon as you open a position, and never move it further away.  If it gets hit, don’t immediately re-enter the trade in the same direction.  This discipline puts a bound on how big your immediate losses can be, and gets you out of bad situations.  I highly recommend trade management software that automatically places your stops – not that I want to turn this post into a NinjaTrader commercial, but their implementation works well for me.
  16. Have a defined (but not necessarily fixed) profit target that’s put in place with every trade.  Know how you’re going to get out of the trade for a profit if things move in your favor.  This can be with a fixed profit target, a trailing stop loss, or a moving profit target at some expected price.  But one way or another, know how you’re going to make money.
  17. Provide liquidity except when protecting yourself with a stop.  Almost all markets have a shortage of liquidity and thus pay a premium to liquidity providers.  So whenever possible, add liquidity rather than removing it.  The big exception is for stop losses – those have to remove liquidity to work right.
  18. Develop and test your trading methodology via the trading system development process.  Don’t try to short circuit it – take the time and do the work.
  19. Get at least partial order book information for your instrument.  I don’t make many trading decisions off the depth of book information, but it is nice to have in extreme circumstances.  If you’re long and someone is offering 12,000 contracts (when typical offer is 5-10) one tick below your profit target, it might be time to re-think where that profit target is located.  You’re in effect standing in a very long line.
  20. End the day flat.  If you’re keeping positions overnight, that’s swing trading rather than scalping.  Swing trading is much more risky because you can’t reasonably bound your losses with a stop order.  It’s entirely possible the market could move an arbitrary distance over night or over a weekend.  Even if your futures market offers extended late hours, the liquidity might be so thin you couldn’t exit a position.  Because of these issues, swing trading requires extra risk precautions above and beyond those for scalping or day trading.  Be clear about what kind of trader you are and stick to it.
  21. Keep an eye on other markets.  When something wacky happens in a major market, spread trading causes it to spill over into other markets.  However it’s much more readily apparent something weird is going on if you’re looking at the market where the action started.  As a general rule you want to have the charts for at least the dominant index futures market and the dominant government bond market that are active when you’re trading.  In the US, this means the S&P 500 E-Mini futures market (GLOBEX ticker ES) and the 10 year treasury note futures market (GLOBEX ticker ZN).  You’ll probably have to buy a second monitor for all these charts – do it.  If you can’t dedicate $250 for a monitor, you’re not dedicated enough to trading to succeed.

I’m sure there’s lots of other good ideas out there I’m forgetting, but these are the ones that were important in making me a winning scalper.

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