July 28 2010 ES VS. TF Post

Double posts tonight. The overlay and trade post below is a good one and definitely worth reading as well.

This turned out to be a huge amount of information and requires more focus than many will give in one read.

I have had a few requests to talk about the differences between the ES and TF. I will start by reviewing my thoughts on pros and cons and then move on to my interesting conclusion on the ES after months of fighting. Lastly, I will address a question about stops.

ES vs. TF

The major difference between the ES and TF is the volatility and liquidity. There is less liquidity on the TF thus more volatility.

On average, the TF moves twice as far as the ES on a given move. Often the TF will move the equivalent of 6-8 ES points while the ES is just grinding and congesting.

While the indexes almost always trade in the same direction and macro pattern, there is a significant difference in key areas like breakouts and reversal points.

I find that reversals and continuations are much clearer on the TF. Then once you enter a trade, the TF produces a result much faster with limited retesting of my entry point once I have obtained a positive excursion.

This leads to far less management issues such as scratching winners and having positive excursions turn into losers. The primary reason is that the TF produces so much more bang for the buck that psychologically, I can scalp it while still feeling that I caught a reasonable move.

Dollars should not matter in trading but when you trade small size like I do, it is tough to take a $75.00 profit per contract on the ES. It feels useless because you can lose that quickly.

The equivalent move on the TF is usually $150.00 - $250.00 per contract. That feels more significant thus allows me to exit trades on the TF sooner than I would have on the ES.

This by itself should not change anything but it just so happens that a missing aspect of my trading was early profit taking. In fact, based on the results I have been getting, it is possible that this was the elusive problem and key to solving the divergence between my analysis and my performance.

Only time will tell.

Basically, what I am saying is that the TF is faster, crisper, and less mushy than the ES. What does less mushy mean?

Less mushy to me means that the TF oscillates, extends, breaks out, and trends. The ES primarily sweeps, sweeps, and sweeps for stops then breaks out, congests, backs and fills, then trends.

Many may not get this but try to think about and visualize what I just wrote.

It is the constant sweeping that makes the ES so difficult for me. I usually get the analysis right from point A to point B but a positive outcome depends on how you manage the trade from point A to point B.

I have some deep analysis about the differences in overall structure of the two indexes that I want to review at a later date. It has to do with how the structure is stacked relative to extensions, extension retests, previous support acting as resistance and vice/versa, and how the price travels from your entry point relative to your expectation.

I am going to name this study and start working on a methodology around it. I can not properly put it into words yet.

The other observation with the TF is that I am playing mostly for pattern and retest opportunities with bias than overall zone and direction.

This in itself needs to have a dedicated post.

My Conclusion About The ES

It is tough for me to say what I am going to say about the ES because I am stubborn and have been fighting it for months.

I simply think that there is far less edge for a one entry/one exit trader available in the ES when compared to the TF. I will add to that by stating that I think the ES is also tougher to trade right now than the TF (for somebody who knows what they are doing).

It is hard for me to accept that my execution and feel is not universal and that I can get better results on one instrument as opposed to another using virtually the same technique.

I can reconcile this by acknowledging that the difference in performance is due to there being something about the flow and tempo of the TF that better suits my psychological capacity to execute my exits.

Basically, the TF and likely most other lower liquidity and higher volatility instruments cause me to naturally do something that I can not consciously fix about my trade management.

I will take that and am not going to question it much further. My mind is getting so vast with knowledge from all my analysis that I risk going into gridlock so things must be kept simple.

This confirms what a couple other more widely read bloggers have said about trading literally being 95% mental and a matter of how you play the game. I believe this.

However, I also believe the 5% needs to include a sound understanding of how price works and moves which very few traders I speak with have.

What is causing less edge on the ES? I believe it is do to the fact that there are so many players involved. Massive amounts of retail traders giving away money to highly complex computer programs run by quants who have virtually unlimited risk and capital.

Does that mean a trader can not win. Absolutely not. I believe some do.

However, I have NEVER seen a one contract trader do anything on the ES. I read about supposed successful ES traders who trade huge size and scale in and out say they could it one entry/one exit but there is not one single chart out there is cyberspace demonstrating this.

Everybody that is public takes small profits on 1/3, then takes off another 1/3, and holds the smallest portion of the position for the move. This is insane and I would like to see executions of this strategy day in and day out for a months.

I think is sells well and performs like crap. That is why nobody posts it. It does not hold water like most strategies. You need to be mentally tough, no mechanical procedure can make up for mental inefficiencies.

Once I acknowledged this, I started molding my own trading style to something that can perform while trading just one contract or using a one entry/one exit style with multiple contracts.

The ES is just too damn efficient right now and conflicts with my style.

By being too efficient, I mean that the opportunity to enter a trade and successfully exit with a booked profit on the ES is very limited and does not occur frequently.

Basically, there are limited wholesale opportunities and the efficient market corrects them quickly. You have to be extremely skilled to catch these inefficiencies. More skilled than I am to do it enough to make a consistent living off small size on the ES. Probably more skilled than I will be one year or even two years from now.

That is a tough admission to make. The caveat to this is that I am talking about winning with smaller risk.

I think I could stomp the ES if I could swing trade and had the courage to take 6-10 points risk frequently. I can not do that right now. I have limited resources and just plain have not adjusted to taking that kind of heat yet. I will over time.

This is an important statement...I think the real edge in the ES for a tight risk trader is a matter of 2 or 3 ticks per trade and it takes great skill to capture it.

I think a good edge can be produced consistently be either scalping rapidly and scratching often of taking large risk and swing trading. Nothing in between.

Thus, my attempted hybrid strategy and tendencies to mix and match big winners with smaller scalps is a dud for this trader with 3 years of experience. I think thing might be different in the future.

I thoroughly believe in the 10,000 hour theory that I will not get into now.

In conclusion, the ES has limited edge for tight risk and is extremely hard to capture (we know that).

The TF has clearer entries and produces more bang for the back. Most importantly, it forces a correction in my trade management that i can not make on my own.

STOPS

I get this question a lot and think it is best to keep my answer simple.

The best stop is no stop. Anywhere that YOU want to put a stop is where the price will likely go to prior to moving in your direction.

The market is designed that way. It is a big game of sophisticated machines trying to fake you out and take your money. They know exactly where you want to enter and exactly where you want to barf out of a position.

Stops are merely risk management tools. The best stop is to cut the trade once the overall premise has failed.

I hate when professionals say what I just said but it is true. This can lead to giant stop outs but will avoid pulling yourself out of many losers.

A more practical approach is this:

Use a very tight stop or a very large mental stop and nothing in between. Do not enter your entry order with a tight stop order. If you must have a stop enter a catastrophic stop.

Best Stop Advice I Received

Stop your self out, do not let the trade stop you out.

When you are ready to exit, let the current bar close and place your stop below that.

I Actually Give Numbers:

I know many just want a number so here it is.

If you had to pin me down and demand a number, I would say optimal stop on ES is 2.5 points and never less or 5 + points. Nothing in between.

Optimal TF stop is 12 ticks and nothing smaller, 22 ticks if you want to give it room, and 4 ticks below a retest low for optimal results. This much room can lead to a significant single trade loss though.

I really think stop outs should be manual and only after you trade is clearly not working. The most destructive thing early in my trading career was a mandatory 2 point ES stop. It caused me to take all my losses and get taken out of all my winners.

Remember that the price never does the same exact thing twice and is rapidly evolving. If a pivot is put in that is obvious, the price will often probe for stops 2 or 3 times before moving on. Often pushing deeper each attempt.

My Project

I have shifted my trading operation to refining the way I exploit the inefficiencies of the price. Period. This can be ticks on a fast time frame or a swing trade on a large time frame.

Once you have a sound understanding for structure and direction, you still have a long road ahead in learning how to engage the other players and actually booking a profit consistently.

The odds are stacked way against you even if you trades have a built in implied edge. This is due to the mental aspect and the winners on the market know exactly how to exploit that.

I am working on finding a way to manage these inefficiencies that has the least mental difficulty in execution. Once this is achieved, I will start accomplishing my goals.