Friday, 26 August 2016

Day Trading: Scalping Strategies

In this post, I summarise the main points from a video on whether Scalping is "legit". This video was presented by John Grady from No BS Day Trading. 

John discusses the various strategies which are used by pro traders. In fact, their own words are used in this blog post through interview and article excerpts. The aim is to prove that scalping is the way they trade. John's video provides insight into the trade management strategies of individuals who trade thousands of contracts. It covers accumulation/distribution, squeeze plays, reversing positions and moving the market as a result, averaging in an attempt to halt a move and turn losing trades into break even trades.
Trading Indicators

The reality is that the depth of market is really the most simplistic of trading indicators. It is also the most pure form of information. The reality is that markets is nothing more than an auction. People wanting to sell, people wanting to buy. Then there is a transaction when prices match. What you see in charts and other information is an extrapolation of the fundamental information in the order flow and trying to reduce it into a pattern, etc. This point was covered in my previous blog post. 

Proof of Speculators

Looking at the 10 year futures, the total volume was 1,313,134. That is the number of contracts traded on that day. The total open interest is 2,370,769. However, the change in open interest was 25,624. Your open interest change is less than 2%- less than 2% of your contracts traded were taken and held over night as open trades. The other 1.2mill+ were in and out closing on the same day. Therefore the majority of trading can be classified as speculation. 

Size Moves the Market

"What I've seen is that traders who don't have a strong trading methodology are often suckered down the path that the issue is their psychology. I, personally, have found it easy to locate good material about trading psychology whereas it has been very difficult to find people who can exercise and teach a winning trading methodology (at least when it comes to day trading)."

There are tonnes of material out there focused on psychology, risk control, etc. but that stuff is the easiest stuff to learn- it is easy to break down mathematically or scientifically. But when you get into the trading, you have discretion involved. You are trying to anticipate the future and this is not easy. Even algorithms are based on discretion. 

When you read interviews and articles by traders who have made it big, a lot of material doesn't make sense because there is no context or frame of reference. They have not seen the business from the inside. They haven't traded size or seen someone trade big size, or worked for a firm or bank that does major trades. 

It seems that what John is promoting is watching the order flow over time will help you put on good trades as a scalper. 

The best interview with Jack Schwager and Tom Baldwin. It sums it up perfectly.
Jack: "How did you figure it out?"
Tom: "It's like any other job. If you stand there for six months, you have to pick it up."
Jack: "How do you make your decisions?"
Tom: "You see the orders and you just trade it."
Jack: "How is size an advantage?"
Tom: "You've obviously never traded on the floor."

When you read through numerous interviews with traders, what they all say in common is that size moves the market. 

Looking at the screen shot, on left hand side, it's the 10 year treasury, middle is the 30 year, then 5 year treasury.

The Flipper- Paul Rotter

John is not saying that scalping is the only way to make money day trading. He is saying that you must understand the mindset of your competition if you want to beat the game and a large number of your competitors are scalpers who trade huge size. 

There is a guy called the "Flipper". Why is that his nickname? What he does it flip. Pretend you have the Bund trading near the support level (the level where most buyers tend to enter the stock). The Flipper might have bids in all three markets, giving the illusion that the market is strong. But, in reality, he has been getting short. When he feels the time is right, he get rid of his bids and then offers several thousand across all three markets. He is flipping his size. This triggers a domino effect. Other day traders sell to be short, people with weak long positions sell to get out because they don't want to lose any more money. While everyone else sells, the Flipper buys back his shorts and profits from the move he himself actually helped trigger. How does he trigger it? He trades size. 

One Eurex trader states that "You should see giant orders on one side of the market that would flip and go the other way". The traders, and a former Eurex official say someone was posting massive buy orders, waiting until the market moved towards that price and then selling instead- a massive head fake. The flipper does so much volume in the bund, boble and schatz that he's able to influence the whole yield curve and catch people out. 

You can see in the first profile, the market is at a high. You have a flipper and they sit here placing big orders (4312, 4794) at the high of the day, and in the 30 year- 1373 and 1334. It's an illusion sometimes. These large sell orders gives the illusion that the market runs into resistance and hold the market down. This keeps the market weak and people will sell right below it. But the flipper is actually buying between 25 and 26. Then he starts bidding his market up towards his own offers. When they get to the offers, they pull the offers. That 4794 size might disappear to say approx 1000. All of a sudden it turns from a market looking like it had resistance and now it is popping through the highs. The flipper who was long down in low prices then turns profit at 285, 290 and makes money. He plays both sides of the market. That is what flipping is and it happens on a daily basis. 

For an individual, the Flipper's scale is stunning. Last year, his personal trading volume alone accounted for about 180,000 contracts a day, or almost $70 billion on peak days, dwarfing all but the very biggest institutional players. He claims his average market share in the German bund was around 10% for many years. This is impressive not from the number alone but the fact the Bund is the world's second most traded futures contract after the Eurodollar. He mainly used boble and schatz for hedging purposes. 

In an interview with the Flipper (Paul Rotter), he states that his tactic is some kind of "market making" where you place buy and sell orders simultaneously, making very short term trading decisions because of certain events in the order book. For instance, he usually has a lot of orders in different markets at the same time, pretty close to the last traded price. The resulting trades are usually a zero sum game, then ultimately make a decision for a larger trade once he gets a feel for what is happening. 

So how long is he usually in a position? Paul is only looking for the next 3 to 5 ticks. Trend plays are rare, and it's a constant filling in different markets on both sides which causes constantly changing positions for hours. Opinions change several times within a minute, which is common when making short term trades. Keep in mind Paul Rotter is your competition. 

Tom Baldwin

Tom Baldwin says that trading not to lose from the floor point of view you are going to do what you have to do to not lose money. That's the goal. In doing that you end up making money because you are getting in positions that are the right way. 

If the initial trade is wrong and I lose money I don't think: I'm short 900 and its 5 ticks against me, I'm going to buy my 900, count up my losses and start over. What I do from a floor point of view is trade the position. That might involve buying 3000 at whatever price to get out, carry the market with me and sell it higher. When you are wrong, you are going to make the market move- people who are wrong generally move markets. So if I'm going to buy 900, I might as well buy all I can, it's probably just going to be around 1500 and in the process it is going to move the market and then I will make money on what I end up being long and then if I get reinforced by the rest of the world and they continue to buy, well I will just continue to buy. 

So what started off as a losing proposition, being short, turned out to be a big winner. His size helps to cause the break through to the highs. Everyone behind him carries it higher. 

Harris Brumfield

Interviewer: Did you trading style change over the ten years you were on the floor?
HB: Well, I changed stuff all the time, but the style itself- being very active, putting on position trades and scalping around them- never has changed. 

So, his basic strategy was trying to pick a direction, but when picking the direction, he is scalping around it all the time. 

Interviewer: What was the typical size for you?
HB: In the 10 year T note pit, I participated in about 20% of the volume, on average. With the Bund, I traded as many as 130,000 sides in four hours. 

This is another example of a trade who trades huge size, and is basically a scalper. He talks about moving from the pit to the screen- "also, the funds could be anonymous on the system, which allowed them to sell 30,000 and buy 20,000 instead of just selling 10,000- they could bluff and get away with it. They can't do that through the phone clerks and the pits- you can pick them off all day long." 

Basically, they work orders on both sides to net out to net 10,000. Looking at the screenshot, people ask how do we get 46163, 46124 size between two prices. The answer is that they are working an order to net out a certain amount. It is intentionally designed to confuse new traders. They don't understand that in the game, it's not just all in or all out. This is a poker game. Say a guy thinks prices are going up. He won't just sweep the market and buy 270, 275. That is too much risk and will move the market against himself. He will linger back and sell some at 255, if he can hold the market down, he can buy some at 240, 245. Then he does it again. Sell, buy, sell, buy. Only every time it goes up, he sells a bit less and buys a bit more. So that, over the course of half an hour, he nets out to be long. He tries to sustain the highs hoping he can create a move to break the highs. And then he gets paid from his positions at 240, 245 and break even at the higher prices.

The New Market Wizards: Conversations with America's Top Traders

Bill Lipschutz was not actually a scalper. But if you read the interview, you start to realise what he is talking about in reference to size and how it moves the market. He was basically short the dollar and got trapped in a bad move against him. 

What he says in this interview is "All I wanted to do was to make it through to the Tokyo opening at 7pm for the liquidity. If you really have to buy $3 billion, you can do it in Tokyo, you can't do it in the afternoon market in New York- you can't even do it on a normal day, let alone on a day when major news is out. My strategy was to try to cap the dollar in New York. Normally, if you sell several hundred million dollars in the afternoon New York market, you can pretty much take the starch out of the market. I sold $300 million, and the market went right through it."

What is he saying? Looking back at the screenshot (even though it's for Treasuries, not dollars), he was short in a big way. The market is heavily moving against him. If he can sell $200-300 million of the dollar, he can stop the market going up and slow down the market through the overnight. As it turns out, the market ignores him and keeps going up. There's nothing illegal about how he is trying to cap the market, you can usually do it with that size. They pick spots where they know that their size can influence the market. They hope they have reinforcement behind them. Sadly for Bill, he did not. 

HFT: Spoofing

It's funny how regulators are saying they are "catching up" with sending false signals on the market when this practise has been happening ever since the inception of markets. It's just easier with electronic markets, because nobody knows who you are when you place the orders. But this tactic was used in the pits- you would have a trader who used 5-6 brokers to help him execute his trades. So, he might be wanting to sell 2000,3000 contracts, then have brokers come in that work for him who bid right beneath him, then he would get his contracts off and the brokers then lower their arms. It's the same thing. Regulatory agencies are trying to squash this type of action, but right now it is still rampant. 


Another misconception is that computers are basically the same as people were, trying to get the best price, they will also get out when momentum stops. That's why you see more range, more choppy  days and it is hard to get follow through with more and more people playing for shorter term moves. It leaves you in the position where if you're going to be a day trader, you need to at least begin trying to understand the mindset of Paul Rotter, the Baldwins, etc. Those are the guys who influence the market. If they make trades that influence the market, you want to ride their coat tails. Be in the same direction as them. 

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