Applying Black Jack Principles to Intraday Trading

I appreciate & enjoy the good fortune of working with traders of all age, background life experiences, trading experiences, various financial markets traded, levels of skill, etc. The entire spectrum, the whole gamut. One of many excellent topics of discussion shared is profiled in a recent email exchange below:

(From “G”) I have followed your blog and newsletter for some time. Thank you for your generosity and straightforwardness. A lot of your information has been very helpful.

In your recent weekend video you talk about taking 4pts out of the ES and calling it a day. Accepting that you may miss some opportunities the rest of that session but also preventing giving profits back. This is a concept I just can’t wrap my mind around. Let me explain my thinking and hopefully your reply will shed some light.

Assume we are talking about a consistently successful trader. He takes his first position around 9:50am and quickly snags 4pts in the ES or 2pts in the TF, same difference. Why would he want to limit himself by setting a daily goal. The session has just begun and there are likely several more opportunities like most trading days. Sure some days he may lose sync and end with a loss. If he is actually a consistent, winning trader many other days will be maximized to their full potential.

I find this concept very similar to professional poker. I have personally played high stakes cash for years now. I would never leave a game I have an edge in while my intuition feels in tune. It’s all about maximizing profits during those times. Granted I risk the profits I have already made by continuing to sit, but opportunity exists and I have to play to win. What is accomplished by cashing out and running away from +EV opportunities? All the other top pros I know embrace the same concept. It’s the marks that will instantly run when they double up. Emotion takes over, and hanging onto their profits for a day or two provides a false sense of security. They are ‘winners’, at least for a moment.

If you see a good setup and you already have your 4pts for the day, what is accomplished by shutting down? There is no reason the next setup can’t be better than waiting an entire day. I must be missing something, and look forward to your thoughts. Best regards, G

Minimum Comprehension Required

First let me thank “G” once again for an excellent question, well-worded with great thought. It’s always a pleasure visiting with traders in this manner. We’ll answer this from several directions, with this opening caveat. What we’re going to discuss is beyond comprehension for many traders… depending on their level of trading experience. Many veteran traders with plenty of in-trenches experience know will nod in agreement. Others will simply not grasp the concept at all. Months or years from now, some will think back on this topic and have a much clearer understanding than is possible right now. The difference maker will be live-trading experience, day by day over time.

Bite-Size Math

The general idea is to target a modest daily trading objective, one that can be consistently reached through normal to high volatility stages of a market. Instead of trading all day – every day seeking max potential profits from every turn, the idea is to take out modest chunks of gain from each session and then reduce trade size or cease trading altogether. Treat each session as an opportunity to wrest out reasonable profit objectives as a successful outcome, rather than measuring success as how one’s actual realized performance was based on max potential inside every twist & turn price takes.

With that disclaimer = warning and brief explanation in place, let’s break down the concept of “Playing 21” with a daily scale of profit performance outlined. By no means is this any attempt to project income or performance… it is merely a baseline table for discussion.

21 trading sessions (on average) per calendar month
Profit Objective: +4pts ES (+10pts NQ, +2pts TF) in any manner accrued intraday
Profit Objective $: $200 per contract

Account Risk: $5,000 balance per one emini contract
Initial Stop-loss Per Trade: -$100
Initial Risk Per Trade: -2% starting balance

Max Objective Realized: +80 ES / +40 TF / +200 NQ points per month
Max Objective $ Value: +$4,000 monthly r.o.i. / +$48,000 annualized r.o.i
Max Objective $ Value: +80% monthly r.o.i. / +960% annualized r.o.i

It bears repeating that the scale above is not a projection of possible income our trading outcome. It is merely a baseline scale of what is possible (albeit improbable) for someone to actually accomplish. But we’ll leave the improbable discussion for later. Let’s talk about the possible aspects for now.

The top-performing S&P 500 futures trading CTAs with >$1mi to <$10m a.u.m. accomplish somewhere between +100% and 200+% r.o.i. annually. In other words, that’s the cream of proven crop… something to be measured against. It may exist, but I have never seen where a CTA has acheived +1,000% annual returns proven through audit. If the low-bar achievement of +4pts ES per session as a goal is roughly five times or 500% greater than this type of top-line professional-traders’ performance return, would that be good enough for any of us respectively?

Black-Jack… Not Poker

Poker is all the rage, and of course many traders love to play that game. For sure the various mental & emotional pitfalls are identical for both. But that’s pretty much where the correlation ends. Poker is a game played with one deck of cards that gets shuffled (restarted) after every hand dealt. It is a new game, a new day completely divorced from the prior activity from each shuffle onward. To compare a game of poker with a intraday trading session, you would have to reset the clock and begin each trading session anew after every trade. That’s essentially what happens to the distribution of cards after every hand of poker played.

While there are parallels between poker and trading, I’d say the greater correlation lies between blackjack (21) and trading. In each game you have the market (house) other traders (players) at the table who can profit or lose alongside you with no affect on your outcome.

Assume you and I are playing blackjack at a high-stakes game. There is a three-deck shuffle… not an endless deck. When the three-deck shuffle is played through, the “session” ends and closes for further play. Obviously that cannot happen in real life blackjack, because every player with a smattering of card-count ability would eat the house. But that’s exactly what happens via intraday trading. The emini markets may trade around the clock through globex sessions, but hours outside the cash session of 9:30am ~ 4:15pm est are usually muted range with minimal price swings.

Cards In Play

Back to the blackjack table. If we played through a three-deck session from start to finish, what would be the game-plan? Count the high cards out versus pending and press the good hands when given. We also know that a finite amount of good hands are possible in any three-deck sit by pure statistical odds. Sometimes we’d have no good hands dealt at all. More often there’d be one good hand for a player through that three-deck session. Most often there would be two – four solid hands to profit from in a three-deck sequence. And once in awhile, there would be five or more potential winning hands dealt through the sequence.

If we drew a bell-curve graph of the long-term statistical outcome of average potential winning hands through a three-deck shuffle game, we’d see outliers of 1 or 0 and 5 or more on opposite ends of the skinny extreme. We’d observe +2 to +4 potential winning hands in this equation as the fat part of that statistical bell curve. Ya follow me? Good to see you’re still here… I’d opine many others have left us to go seek the next forecast on which way markets may be headed next.

We can take the average intraday trading session and derive similar results from. Examining each individual trading session for any period of several calendar years or more, we’d find that a vast majority of them have two to four price swings that offer plenty of opportunity to capture +$200 per contract in whatever emini symbol desired. Emphasis on potential as the key. Financial markets do not have continual, unending price movement from bell to bell or through infinity overnight. The fundamental fact is, stock markets make directional (expansion) moves (good cards) a minority of the time while spending a majority of time moving sideways in consolidation (bad cards) to prepare for the next movements.

Stock market “decks” are shuffled by known and unknown events. But there is a limit of shuffle of decks played intraday. When the closing bell rings, cards are dumped and the dealer walks away. Players can deal their remnant cards amongst one anther (globex session) but nothing of consequence will usually happen until the dealer returns with full deck tomorrow (cash session) to resume play. Pure intraday traders do not have unlimited favorable profit potential… the upside is capped with finite time restraints. No different than a three-deck shuffle in blackjack. There are only so many face cards in a deck, only so many dollars at work in the market from start to finish of the individual game (session) sequence. Any given game (session) may have biggest price swings (face cards) distributed early, middle or late in the session (game). But there is a fat part of the bell curve that states, over the long-term time frame, a limited number of profit opportunities will be present on average. Equally rare are the occasions with no opportunity and massive numbers of opportunity per individual session (game).

That statistical fact of long-term price behavior in stock markets doesn’t readily compute with traders. Why? Because they tend to focus on each single session, each individual sequence as most important than any other. THIS might be the day where countless high-profit trades are offered. THAT might be the day where countless high-profit trades are offered. When the bells ring, tapes start moving and dollar values dance through the trading domes, long-term stats of probability are out of view. Adrenaline rushes, vision narrows, blinders go on and the gambling begins.

For sure there are trading days where price action matches up to any particular style or approach in perfect fashion. Every wiggle & swing offers easy money, all day long. Those are the events which tend to stick on our minds most… it’s a greed = ego kinda thing. What the human mind easily releases are the vast majority of days where give & take, give & take are played. The fat part of that bell-curve normal price behavior where a trader has two, three or four clear opportunities to profit.

If we know that there are limited price swings, aka profit opportunities inside each trading session, we therefore know that every price move completed is that much closer to nil opportunity left within that day. Said differently, once we see price move +8pts ES from the open, -10pts from that peak swing high and then +8pts from that swing low by 1pm est, statistical odds are a majority if not all of the price movement has been completed. Of course their are outlier days where several swings both directions or in pure trend fashion will happen. Sometimes weeks or even months at a time are unusually volatile and active. We already agreed to that earlier when looking at the bell-curve of activity over time. We also know that stock markets in particular and any financial market in general does not make big directional swings all day long. We know from visual proof recorded on charts for all to see that most of the time, most of the time… most of the time there will be two, three or four swings and that day is done.

To summarize, intraday trading sessions have limited opportunity for price movement = profit as restricted by time. Of course there are periods of higher volatility that offer more profit potential than usual, but the concern of any serious trader is focused on all market behavior through all phases of low to high volatility range. Poker players have a “new day” each time the cards get shuffled. The same statistical odds for probability exist each time, seamlessly and endlessly. Not true with financial markets. There is a decreasing opportunity for profit from the first price swing higher or lower onwards. Some sessions offer no more than one… while others offer more. That is the fundamental difference between playing poker and trading stock markets from 9:30am EST through 4:15pm EST side by side.

Net-Loss Days Began Profitably

A curious phenomenon exists within most intraday trader’s evolution. I first heard of this from several different (unrelated) brokers who noted it across all financial markets: stocks, commodities and currencies. At some point during a given session, most net-loss days for a trader were at one point in the given period, net profitable. In other words, the day ended in net loss AFTER being net-profitable to some extent that day.

Now I found that information interesting, but didn’t really internalize it until looking back through my own trading records of performance. Picking out all net-loss days, I did find that most of them, more than 75% of the sessions that finished in red were indeed at some point net profitable (the remaining 25% or so of net-loss days began in the red and never once went beyond breakeven at peak equity highs). A few of them from this group were slightly profitable. Many of them were at least +$200 per ES contract or better. A few of them were at least +$400 per ES contract or better.

Here’s something that smacked me right in the face upon examining my own personal data… something which had never occurred to me before. Almost all of my moderate to large-loss days began with modest to solid profits, early. The day began very favorable off the open. I enjoyed solid gains early. I was confidant and expectant of more success to come, possibly one of those personal-record profit days. In a few cases those record profits showed. But… in most cases, the early peak-high equity curve dove straight down into a crater from there to the close.

Why? Was it me, the market, or both?

Part II: Riding The “Chip-Stack” Curve

We’ll talk about the human-factor part of trading, trade management and self-management next time. Click here to read Part 2.

Austin Passamonte is a full-time professional trader who specializes in all commodity markets. Mr. Passamonte’s trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. Click here to visit CoiledMarkets