Great post Ant. I would like to add my inputs here as Ant brought up some great points and steps of a mind of a discretionary trader. First, I think relatively new traders can become overwhelmed with processing a ton of info and market data to make a decision to enter/exit in a split second. Perhaps this is why many traders fail to become experts in discretionary trading. But all it takes is experience, pouring over charts, and thousands of hours of screen time tick by tick. In other words, it can be done.
Here are a few of my thoughts on what makes a good discretionary trader. I think electronic discretionary trader share similarities between floor traders. While floor traders have the advantage of reading emotions and psychology directly on the floor (also order flow), discretionary traders can also read this behavior through price action (charts). Like ant mentioned, price rejection vs price acceptance, understanding where stops are, spotting short covering vs long liquidation, order flow through tape, etc... Luckily for electronic traders, we can draw lines, fibs, etc.... all these handy tools available directly on our charting packages. What Im trying to say here is that once electronic traders understand the behavior of the markets (whether it be through market profile or pattern recognition) our edge is no different from the edge of floor traders. (only commission costs)
Listed below is a few things that I apply in discretionary trading. Speed of execution is important and it all boils down to making a buy/sell decision by processing all these information in a matter of milliseconds to seconds. (may duplicate Ant's list)
1. Understanding the type of market. Are we seeing a balanced market? Is there only short term market participants trading? Are we seeing short covering at the opening due to the fact that the past few trading sessions were all decline? Is today long liquidation? If so, why would you support and look for a long setup when you know a few thousand contracts may still be on the sell side? etc...
In quiet morning sessions, short term traders may be trading against each other only. However, any range extension in the afternoon with price acceptance will indicate longer term market participants became convinced and stepped in to buy or sell. Doesnt this indicate traders trying to hold overnight positions?
2. Once identifying the type of market, how will you play this market? If its balanced, you may consider fading the previous day high/lows. Or if the previous day range was wide, you might look for single run trades instead of homeruns. If the markets broke out of the previous day range, you may look for pullback strategies. Did the markets rally in the morning with internals bullish? Perhaps you might want to capture a retracement after profit taking clears. Discretionary trading is all about strategy, strategy, strategy. And thinking of a new strategy 3 steps ahead of your opponent. You must have a plan on what to do before the markets react.
3. Pattern recognition. This does not have to be Market Profile pattern recognition. As a matter of fact, I do not even use a real-time MP chart. Instead I can simply visualize a mp chart of candlestick charts. Howevever pattern recognition in terms of candlesticks is important as well. Not 3 bar reversal patterns, bullish/bearish elgufing, etc.. but a group of bars in general. For example, if price is testing the high of day but I am not seeing that many sellers and candles are sort of clustered up at the top of the range... this pattern indicates strength. I may buy before a breakout and sell to breakout momentum traders. Recognizing candle formations in clusters is what I am referring here.
4. Trading psychology. We are not trading the markets. Day trading futures is about trading other traders. Whoever outhinks their opponent is going to win. Therefore it is important to understand the psychology behind price action. Now some traders may do this through candles which is good. Others might spot higher lows/lower highs and determine whos winning, bull/bear confidence, etc... But traders need a way to understand the confidence, pain, euphoria, of traders who are behind each price move.
5. Think alone and not with the herd. If stop placements are at the same locations with the herd, if entry levels and exit levels are the same with the herd, the professionals are going to eat your money. I dont recommend anyone to try to catch a falling knife (though I tend to find catching bottoms easier than tops) but you need to be a few steps ahead of the herd.
6. RULES! Yes, I think discretionary traders need to develop strict rules. NOT on trading setups entirely but on risk and money management. New traders who go down the path of discretionary trader without proper money management are going to fail. Lets say you use 2pt stop on the S&P and get stopped out 3 times in a row? You are down 6 S&P pts all of a sudden. What are you going to do next? New traders are most likely going to continue to trader throughout the entire day to make up that loss and likely resulting in a combined loss of over 12 S&P pts in one day. Now that is financial suicide.
So money mangement is important. You should understand your discretionary trading to a point that if you experience 3 losing trades in a row.... you are probably not in sync with the markets today and best to reassess your strategies and maybe come back in the afternoon to approach trading. In other words, discretionay traders with proper money management should become more defensive if you are experiencing a string of losses. You may decide to trade more conservatively for the rest of the day and look for that 1-2 setups that you know are good instead of trading aggressively. Discretionary traders must realize the days when things seem off from days when things are hot. Sort of like Michael Jordan where he would go on scoring on hot days but on cold days will look to assist other players more. You can still make money on cold trading days!
7. And finally VOLUME. If you have no idea how to read volume, I personally think you need to find another job. lol Ever watch bloomberg and see the market analyst pulling up a candlechart with no volume? I would fire him on the spot. Volume is as important as price. Those two should never be seperated.
Happy trading
