Two Day Trading Strategies You Haven't Tried

By Nat Stewart  JAN 11, 2013 3:55 PM

Yesterday's price action closely followed the template for two useful day trading concepts: opening range analysis and the "spike and climb" pattern.


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 e-mini (ES) S&P 500 (INDEXSP:.INX) futures contract and the SPDR S&P 500 ETF (NYSEARCA:SPY) 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 five-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. An assessment of the 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 their positions based upon the prior day’s close. This is a price pattern concept that usually uses no more than five 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 intraday trading.
  4. How the first five 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 a day trade is to either “catch a ride” during the most volatile time period of the trading day.

Let me give an example from today of how the pieces come together. Look at the following chart.

Click to enlarge

I decided to write this article because yesterday’s price action 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 on the open 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 intraday pattern to look for when the macro environment is bullish. If you study the preceding chart, you can see how this basic pattern unfolds over the course of the  trading day.

The "spike and climb" pattern 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. 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:
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 your 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 that 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 approach 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.

Nat Stewart runs the trading-strategy website The site’s mission:  “Help traders capture explosive moves in the forex, futures, and stock markets.”

Twitter: @NASTrading
No positions in stocks mentioned.