Stalking Good Trade Location

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  • on September 24th, 2010

I’m guessing I’m not alone, but the excitement of a potentially low risk/high reward idea brings both excitement and anxiety.  Excitement that we have a chance to profit, but anxiety in holding back for the right entry.  Not only do we have to consider the levels at which the idea is attractive, but we have to face that market news may drive all stocks away from our desired price and place our idea further from where we had hoped to enter.

No trader I’ve met completely ignores the S&P futures.  No matter our timeframe, we’re all trying to game it a little to get the best entry and exit conditions possible.  Contrarians want to buy on big down days, trend followers want to see evidence of strength.  How do we remain true to our idea and style, and use the macro environment to our advantage?

I rarely trade the same timeframe as Brian Shannon, but I listen to him enough to hear some of his axioms ringing in my head.  How about the following:

1) Where has it come from? 2) Where does it have the potential to go?

Isn’t that what traders and investors of all styles and timeframes are trying to identify?  It is in this spirit that a year or so ago I forced myself into a simple daily routine that helps me gain perspective on a given day’s potential.  Again, I rarely trade with the intent of a daytrade, but I also know that my success hinges on how well a new position fares in its opening days.  Better entry opens up so many opportunities, as the improved risk/reward allows larger position sizing and helps give us a patience and confidence not seen with a sloppy entry.

Here’s the simple grid I complete I take each morning to guide me to prepare for each day’s potential:

If you think this is ugly, you should see the handwritten version I actually use each day!  In any case, it gives me a chance to assess the opening few minutes and gauge the day’s potential.  Let’s revisit Brian’s questions as follows:

1) Where has it come from?

Being heavily influenced by this Toby Crabel classic, I find tremendous value in assessing the first few minutes of trading.  In these 5-20 minutes, we often see a high or low that holds for the entire day and sometimes multiple days.  On Thursday, we saw a gap down lead to what had the potential to be a decent low for the day.  So we place this 112.27 level in our grid for $SPY.  Since there was no offsetting high, I use the prior close in the spirit of Welles Wilder’s True Range indicator.

2) Where does it have the potential to go?

I think my instinct and ability to assess the morning news gives me a decent chance to guess what kind of day it might be, but why guess?  The overnight and AM news is mostly discounted by the opening, so I like to plan for what could be a narrow, average, or wide range day.  This accomplishes two things…first, I get an idea how far I am from where the normal intraday noise could take us, reducing the pressure to race into a trade.  Second, once prices pass through, let’s say, an average range day, I can quickly prepare for what may be a wide range day bringing new risks and rewards.

Thursday was an average day…we made a decent low early, and bounced into the area expected by an “average range day”.  Sure, there were pivots and Fibs and MAs at that area as well, but the consistency and simplicity of estimating range potential gives me the most confidence to attack the day.  I can’t remember who said it, but “once you decide to make a trade you become a daytrader for that moment”.  Be sure to arm yourself with solid weapons.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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