Before I go into the specifics of these trade scenarios using the SPX daily chart I want to make the point that I use the same strategy with the same parameters on charts on all time frames. The levels referenced in this post are based on the prior candle so the same analysis applies to monthly, weekly, daily or even intraday candles such as 60 minutes or 30 minutes.
On this daily chart the prior candle was 2u (2 up/uptrend) so I’m looking for a continuation trade. I want to initiate a long (bullish) position but I want to get it at a good trade location. When an instrument is in an uptrend it tends to find support in the 50%-61.8% retracement (half-back or HB) area of the prior candle if it pulls back at all. In a very strong trend it may find support at the prior candle’s high (or higher) but that’s not as good of a trade location if the uptrend suddenly reverses.
Scenario #1
On the daily chart (below), the assumption is that price will open below the prior day’s high and then move lower. I would simply wait to see if price pulls back to the HB zone to have that good trade location. See comments on the chart for the key trading levels.
Scenario #2
On the daily chart (below), the assumption is that price will open above the prior day’s high and then move lower. I would be comfortable taking a counter-trend short trade but I’d keep it on a short leash since counter-trend trades are like swimming upstream. Either they perform relatively quickly or I exit the position. It would also be fine to not take the short trade and just wait to potentially initiate the long trade. That decision is best based on an individual trader’s preference.
Scenario #3
It’s somewhat ironic that the most bullish scenario for the instrument is also often the worst trade. How is that possible? The closer my bullish entry is to the stop level the less my risk in the trade. Buying a breakout is frequently rewarded with a big move higher but the reversals can cause bigger losses. If I initiate a long on a break above prior day’s high then the setup is still bullish all the way back down to the HB zone. In this example, I could be initiating a long at or above 3937.23 with a stop below the 61.8% retracement level of 3917.79. That’s a 20 point wide stop. Then what do I do if I’m stopped out and then price reverses and moves higher again? Jump back in on the long side? Then, if it begins dropping again I’m just getting chopped up and buying at the highs and selling at the lows. Not a good experience and one I’m sure we’ve all had a time or two. Am I right? That’s what I thought…
So that’s three common scenarios and how I trade them. Note that even though I’m describing these trades using the daily chart I can actually day trade these setups. Day trading using a daily chart? Seriously? Yes! Most traders are under the misconception that in order to day trade they have to use 5 minute to 15 minute candles and that’s just not accurate. They get caught up in the smaller picture and quickly lose sight of the bigger underlying trends in the instrument. For example, let’s say they see a short setup on a 5 minute chart and initiate a short position. What’s wrong with that? Well, if the 5 minute short setup happens to occur while price is trading above the prior day’s HB and the prior day was a 2u candle I’d estimate their chance of success as pretty low. They’re trading against the daily trend. Which do you think is a more powerful trend, the 5 minute or the daily? At the very least the 5 minute trader should only be considering long setups if the longer term charts are bullish. Better yet, just use the longer term charts to trade off of!
Finally, the time frame of the trade is based on the duration of the option position that I utilize! Please read that sentence again because it’s one of the most important things you’ll ever learn about option trading! Seriously, read it again! I’ll wait……………………………………………… Ok? So, what does that mean? In the above scenarios I’m initiating a long position. That can certainly be a day trade if that’s what I want. However, that chart setup could also be the beginning of a 10% move higher in SPX. We don’t know how far that move higher could go. Why should I limit myself to just a day trade? If I want the day trade I could buy some 30 Delta Calls or use Vertical Call Debit spreads with just 1-3 days of duration. At the end of the day I could either exit the position (a true day trade) or I could DH the trade to get to zero cost and make the risk in the position a day trade while still holding a bullish position for another day or two. I could also instead buy a 30 Delta Call (or spreads) with a month or even a year of duration to setup a swing trade. If price moves higher that day I may be able to get to zero cost (or at least reduced cost) on a trade that lasts a year! Now, I’m more than just a day trader? I’m a long-term swing trader using the same chart setup as the day trader. I could even initiate a position using multiple duration options to blend the position as partially short-term and partially long-term. Think about it. Ask me questions on the twitter feed if you have them!