Day trading the emini (ES) S&P 500 futures contract

While most of my futures trading could be classified as swing trading (holding positions from a few days to a few weeks) I still like to do some limited day trading in the emini (ES) S&P 500 futures contract and the S&P 500 ETF (NYSEARCA:SPY) ETF  when an opportunity looks strong.

The way I approach day trading is not the way I have seen most people approach it.  I do not attempt to stare at a computer screen and decipher 5 minute bar charts. I do not use an automated system and I am not even remotely equipped to do (or interested in doing) high frequency trading.

So what is my basic approach? It is based upon a few different factors. First, it is an understanding (based upon my quantitative approaches and intuitive experience) of what the edge for the current trading day is. I then combine these signals with my studies (and judgment) on how price action tends to develop during the first two hours of the day given the existing larger picture setup.

To break it down further, it would look like this:

  1. Assessment of overall market environment – I have labels for different market environments that alter my expectations of how different approaches will (or will not!) perform. I document part of how I think about these issues in my recent active trader magazine article.
  2. The markets swing position based upon prior day’s close.   This is a price pattern concept that usually uses no more than 5 days of trading data.  Examples of this can be found here and here.
  3. Where the market opens relative to yesterday’s close and the prior day’s high and low. I have found this information to be very significant for intra-day trading.
  4. How the first 5 to 30 minutes of the day play out.  I call this opening range analysis, and I have found it to be very significant.  An example of this can be found here.

Why focus on the morning session for day trades? As is documented in the chart below, the morning session is typically where the most volume and volatility exists on any given trading day. I don’t want to be in there thinking I can slug it out against the market’s toughest competitors all day long.  I only want to make a day-trade when I think the big institutions are going to dog pile in one direction.  To me, the only point of most day trades is to either “catch a ride” or fade an overly emotional extreme during the most volatile time period of the trading day.


Let me give an example from 1/11/2013 of how the pieces come together. Look at the following chart:


I decided to write this article because yesterday’s price action (above) closely followed the template for two different day trading concepts that I use:  Opening range analysis (which usually sets up after a significant gap like we had yesterday) and what I have labeled the “spike and climb” pattern.  The “spike and climb” is basically a “fake-out” type move against a dominant trend that sets up a squeeze move higher later in the day.  After the move down, volatility compresses and price begins to slowly grind higher. This is very uncomfortable for shorts, who often like to initiate short positions when they think the market is overbought.  As the day progresses, they see their morning session profit slowly start to erode away.  As price works higher it starts to “pop” above prior highs, and frequently ends up accelerating and blowing the rest of the shorts out of their positions.  This is a good intra-day pattern to look for when the macro environment is bullish.

This, of course, is simply a narrative that I find useful – The “spike and climb” is based upon my own experience of being short and “trapped” on the wrong side of the market. I took those experiences and was able to add my own analytical perspective, which now helps me to identify new opportunities and avoid bad trades.

By the way:  The first NAS Trading LLC subscriber report contains very valuable information for those who are interested in day trading.  Click here to subscribe.

Where do most day traders go wrong? The list could be almost endless.  Here are a few critical errors that are all to easy to make:

  • They are far too zealous to day-trade. Because the toughest competitors have more advanced technology, more capital, and a better cost structure, trying to trade too frequently or too actively will put you at their mercy and cause you to lose.
  • All too often individual day-traders use approaches that are almost doomed to fail.  It is very important to understand which market niches are available to you, and which ones are not.  I go into this very important concept in this article.
  • Looking at small bits of information that are next to (or completely) useless, while not seeing the big picture. For example: I sometimes get emails from readers asking about 1 minute or 5 minute bar chart patterns or intra-day indicators. In some of my short-term trading articles I use a five minute chart to document a particular trading idea.  However, the ideas are not really about five minute charts, they are about larger concepts.  For example, “Getting long when it looks like institutions will be dog-piling the market higher and staying long for the duration of the morning trading session” Is in an important day-trading concept. The individual five minute bars are not necessarily that important.
  • Over managing trades and going on tilt. This can happen if one is over-focused on day-trading or feeling too much pressure to trade. Just realize that for an individual trader, making trades is a business expense, not a profit center like it might be for a HFT firm.  It is best to implement a strategy in a way that lets you capture the overall concept without getting sidetracked by market noise.  For example, Staring at the quote screen or order book is not going to give your trades a special advantage; in fact it will likely just entice you to over-trade (Why do you think brokers offer these tools for free?)  Day traders need a bigger picture edge in order to overcome trading costs.
  • Not tracking results for your different trading styles. In my own trading, I have certain styles or approaches that I have a high degree of confidence in and others that are “extras” that I don’t want to lean on too much. Regardless, I keep the different things I do separate and track the equity curve of each approach. The easiest way to do this is to have a different trading account for each fundamentally different approach or strategy.

I cut back very quickly on day trading strategies when it looks like they might be breaking down. I have learned from experience that when market conditions change, day trading approaches can go from lucrative to a money pit very quickly. A perfect example of this would be the late spring and summer of 2009.

Day trading can be like the fashion business.  Selling a trendy item can be lucrative, but you don’t want to get caught with a ton of inventory when the fashions change.   In day trading we are lucky that we don’t have to carry inventory, but we do need to have the insight and fortitude to identify and act when market conditions change and our approach is no longer in fashion.   The next step is to put the finger to the wind and update your research and determine what the current market fashion has evolved into. Don’t start day trading again until you are confident you have it figured out.

My personal choice is not to over focus on day trading. I only want to do it when the opportunity looks very strong and I would basically be a fool not to take the trade. Not over-focusing on day trading is largely a business decision (Managing day trades sucks up time and mental capital, and would make it more difficult for me to manage large amounts of money down the road) and partly because I think day-trading is overall a tougher, less potentially lucrative way to trade given my skills, infrastructure, and place within the market.

Given the above, why day trade at all? Very simple: Smart day-trading strategies can make more money with less risk than any other strategy that I am aware of.  This is the positive flip side to all of the negative, difficult aspects of day trading and is why I keep it as a secondary approach.

If you are interested in this type of short term trading, I think you will like the NAS Trading report I am currently writing.  It documents the research and concepts that I “lean on” when making day trades.  I think you will be surprised to see how just a small amount of intra-day data can be used to create  trading edges or biases.  This information is also useful for those looking to manage entry and exit points for swing trades.  If you want to stay informed, sign up for the NAS Trading email list here.



Leave A Reply (3 comments so far)

  • Eric_ESA

    Hi Nat
    I’m very interested in your research approach and testing ideas. I plan to do similar things for intra-day or swing trading ES futures.
    I wonder for your back-test simulated results on ES, what is the transaction cost per trade assumptions you make? i.e. including bid-ask spread, trading slippage, commission cost etc.
    Does a total two-way transaction cost = 3 basis point make sense to you? Or it needs to be higher?

  • rick

    Thanks for this!! If you ever write a book/more articles/strategies ,etc. that you want to charge for, please let me know. I wouldn’t mind paying for that information

  • nastrading

    Good questions, but the answer is going to depend on the specific circumstances of the trader. I think about it very simply – I have found I can make a profit if my studies indicate a 5+ tick average profit. However, I have confidence in a strategy because of the basic idea that I understand and developed – not because of a backtest result. That is a critical distinction.

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