Most strongly trending markets have small pullbacks before resuming their overall trend. By identifying and properly entering the market on these pullbacks, you can often ride a strong move while keeping your risk very small.
For the S&P Momentum Day-Trading Strategy, we use a 20-period moving average to define the trend. On an intraday basis, moving averages do a better job of identifying trend direction than ADX.
After defining the trend, we then use a three-period relative strength index (RSI) to identify if the market is overbought or oversold. Finally, we will combine the moving average and RSI with pattern recognition to trigger a signal.
Here are the rules:
- We will use 20-minute bars for this explanation. Obviously, 5-, 10-, or 15-minute bars also can be used.
- If the bars are trading above the 20-period moving average, the trend is up; if they are trading under the 20-period moving average, the trend is down.
- If the trend is up, we will wait for the three-period RSI to move under the 30 level. If the trend is down, we will wait for the three-period RSI to trade above the 70 level.
- For buys, when prices are above the 20-period moving average and the RSI is below 30, we will buy one tick above the previous bar on the next two bars only. For sells, when the bars are below the 20-period moving average and the RSI is above 70, we will sell one tick below the previous bar on the next two bars only.
- Risk no more than the size of the previous bar. This means if the previous bar’s high is 1,072.50 and its low is 1,070.90 and you go long at 1,072.60, your protective stop should be near
- Where you exit is a personal choice. One idea is the 2-for-1 Money Management Method, which liquidates half the position when the profit is equal to the initial risk (the difference between the entry price and the initial stop), moves the stop immediately to the break-even level, and then uses a trailing stop to protect profits on the remainder of the position.
Here are a couple of examples from the June 98 S&P contract.
Figure 1. June 98 S&P futures, 20-minute bar. Source: Bloomberg LP.
- The market is trading above its 20-period moving average.
- The RSI is oversold.
- Buy, as it takes out the previous bar’s high. Your stop will be near the previous bar’s low.
- The 2-for-1 money management locks in profits on half the position. The stop on your other half should be raised to at least break-even, assuring a profitable trade.
Figure 2. June 98 S&P futures, 20-minute bar. Source: Bloomberg LP.
- Trading under the 20-period moving average.
- The RSI touches the overbought level.
- Not filled, as it doesn’t trade under the previous bar.
- We move stop to just under the previous bar and get filled at 1,111.80.
- Profits are taken on half the position.
- A five-point move within one hour.
- As you have seen, this approach risks small amounts to make large amounts.
- Protective stops are the key to successful trading. As soon as you are filled, place your stop; this is a rule you should never deviate from.
- This method has been successful (slippage and trading-wise) in the Dow futures contract as well as the S&Ps. In fact, pullbacks on strongly trending securities are an inherent feature of all markets. This strategy exploits this feature. Even though we showed it only with the S&Ps it can just as easily be applied to the bonds, currencies, and other liquid markets.