MASTERING THE TRADE PROVEN TECHNIQUES FOR PROFITING FROM INTRADAY AND SWING TRADING SETUPS JOHN F. CARTER McGraw-Hill New York Chicao Sap Franeikco Lisbon London Madi Mexico City Milan New Delhi San Juan Seo ‘Singapore Syaney TorontoACKNOWLEDGMENTS Writing and trading have a lot in common in that they are essentially solitary professions that are made much more enjoyable by anyone who is willing to lend a helping hand. In regards to this project, I would like to first thank Hubert Senters and Priyanka Rajpal for holding down the fort while 1 was “working on the nightmare.” Also thanks to your contributions to this project, which helped to keep me sane toward the end when things were getting crazy, Although the book deadline was firm, July Soybeans were moving and I couldn’ just ignore them. Thanks to Kira McCaffrey Brecht, Gail Osten, and everyone at SFO Magazine for help- ing me to realize that writing about trading could be a worthwhile thing to do. Larry Connors and Eddie Kwong at Trading Markets for advice along the way and for keeping me on track with this original project, snaking sure I didn’t spend a lot of wasted time reinventing the wheel. Kelli Christiansen at McGraw-Hill for initially contacting me about this project and turning it from idea into reality, and to Executive Editor Stephen Isaacs at MeGraw Hill forhelping to keep this, project on track. 1 thought I could rest easy once I completed the first draft, but little did I know that the real work was about to begin. Thanks to Bill Shug, Tim Sambrano, Pamela Snelting, and Don Allen for reading early drafts and providing feedback. Also thanks to the staff at McGraw- Hill, who performed the herculean task of bringing this book to life: Scott Kurtz, Editing ‘Supervisor; Maureen Harper, Production Supervisor, Roberta Mantus, copy editor, and Erie Lowenkron, proofreader. Thanks also to Mark Douglas for insightful feedback in the Tater stages of the project. For help with my trading and trading related projects along the way, I'd like to thank Marcia Wieder, goddess of Maui, for kicking things off in regard to my leaving corporate America and trading full time. Scott Sether, who was truly in this from the beginning, for helping to redefine the term “market research.” Tracy Alderman, Rosa Hernandez, and Michael Duwe, for helping to get things kicked off. Page Rossiter, for keeping me on track during the transition, Skip Klohn, as an early mentor in the process. Eric Corkhill ... where do I start? Thanks for acting as a consultant on a multitude of topics, and thanks for giving me enough red wine so that I only remembered the good stuff the next morning. ‘Thanks to Barbara Schmidt-Bailey and Jetf Campbell at the Chicago Board of ‘Trade, and Marty Doyle at One Chicago for good ideas and great feedback along the way. John Conolly, for a multitude of solid insights into the business, To the gang at Mirus, for continued support. “To the gang at Newport, for clarifying what not to do and how not to do it, Cooper Bates, for keeping me on track on the meaning of it all. Steve Patrow and Becky Herman, for keeping things entertaining while 1 was in the beginning stages of this journey. Of course, it makes sense to thank family members where appropriate. Thanks to my mom, Francie Cobb, for supporting me while I “did my thing” along the way, even if it was some- times scary to watch. Thanks to my step-father, Lance Cobb, for being a father and introducing viivill ACKNOWLEDGMENTS ‘me to the world of financial markets at an ewly age. To my brother, Jason Carter, for being a great sibling. I's nice to have another person in the world who understands. Maria Carter, my wife, for her unflinching support in the face of it all, and also for becoming passionate about the Home Decorating Channel while her husband played “catch up on the book” over the weekends. Next time I swear we'll ust go to Hawaii, I'm pretty sure I can write and drink Mai Tais at the same time, ‘Thanks also to the memory of my father, Bill Carter, who was taken away too soon, but in so doing passed along valuable lessons to his kids. And to the memory of Joanne Wolfram, a good friend, who reminds us all to live life while you have the chance.CONTENTS Acknowledgments vii Foreword by Peter Borish xvii Introduction xix PART 1: Trader's Boot Camp | Chapter 1 Markets Don’t Move Because They Want To, "They Move Because They Have To 3 Average Trader Profile: The Wrong Skills in the Wrong Place at the Wrong Time 3 It’s All About Pain and Suffering 4 ‘The Case Study You Won't Read About at the Harvard Business School 6 ‘Trading Rules for Selis/Shorts (Buys Are Reversed) 13 It’s Not the Economy, Stupid 15 Psychology 101: What They Didn’t Teach About Trading in School 17 Emotions Are Fine at Weddings and Funerals 17 Show Me a Guy with a System, and I'll Show You a Guy Who Is Welcome in My Casino 18 ‘The Right Mental Outlook for the Markets: Don’t Tum on Your Computer Without It 19 Phase I Trading: Destined to Lose—Traits ‘That Make a Person a Success in Life Get Them Killed in the Markets 22 Phase Il Trading: Fear-Based Trading or, “Everything I Touch Turns to Crap” 25 Phase Ill Trading: The Search for the Holy Grail: Holding. ‘Your Breath Is Not Advised 25 Signs That a Trader Is Stuck in Phases I, HL, or Itt 27 i Paper Tradi Why It’s More Worthless Than an Iraqi Dinar” 30__ CONTENTS Chapter3 ee Hardware and Software—Top Tools for Traders 35 Hardware—It's All About the Ram 35 ‘Taming the Technological Beast: Key Things Every Trader Should Know to Keep Their Computers Alive and Well 39 Turbo Charging the Trading Computer 42 ‘The Back Up Plan: What to Do When Your Computer Crashes or the Power Goes Out—Because They Will 43 Not Ail Quotes Are Created Equal 45 A Bad Execution Platform Can Inflict Capital Punishment on Your Account 46 Opinions Are Like Bellybuttons; Everybody Has One 51 Establishing Priorities: If You Are Getting Interrupted During the First ‘Two Hours of Trading, It Is Your Fault 52 Why Watching Harry Potter on DVD after 12 Noon Eastern Is Better Than Watching CNBC 53 Chapter 4 a ee ee Markets 101—Understanding the Basic Mechanics of the Markets Discussed in This Book 55 “The World Beyond Stocks and Why It’s Important 55 Markets are a Reflection of the People Who Trade Them. Is Your Competition Wired on Starbucks or Methodically Filling in a Crossword Puzzle? 57 Futures 10159 Ina Nutshell—What Traders Need to Know 60 ‘The Mini-Sized Dow vs. the E-Mini S&P 500 64 Liquidity Is King 65 Contract Specifications—What a Trader Needs to Know to Trade Key Markets 70 Forex for Newbies 74 ‘This Is How Forex Moves Are Measured 77 How to Hedge Your Own Life in the Forex Markets 79 For Traders, This Is All You Need to Know 81 Chapters ‘The Stock Market Is Now Open—Seven Key Internals to Gauge Intraday Market Direction 83 Musicians Know How to Read Music; Traders Must Know How to Read the Markets 83 ‘TICKS-—They Can Run but They Can't Hide 84CONTENTS: TIKI—When Only the Fastest Heads Up Will Do 90 TRIN: Like High School, Its All About Pressure 92. TRINQ—The TRIN for the Nasdaq 96 Pav/Call Ratio—The Keys to the Kingdom 97. Sector Sorter List—Beauty Is Not Only Skin Deep 104 This Is How You Know It’s Going to Be a Choppy Day 104 Putting It All Together—Sizing Up the Trading Day from the Opening Bell 107 Listening In on the Floor—The Value of Pit Noise 110 PART 2: Specific Intraday and Swing Trading Setups for Futures, Stocks, and Options, and Forex 113 Chapter 6 ‘The Opening Gap: The First and Highest Probability Play of the Day 115 ‘Trading Without a Specific Setup in Mind is Like Hiking in the ‘Amazon Without a Compass 115 Not Ail Gaps Are Created Equal 117 Trading Rules for Gap Down Buys (Gap Up Sells Are Reversed) 120 Who Is Getting a Spanking and Why? 121 Specific Examples of Trading the Gap 122 What to Do with Unfilled Gaps 128 Strategies for Those Who Can't Trade Full Time 131 Position Sizing with a $100,000 Account 131 Summing up the Gaps 131 Chapter 7 Pivot Points—Great for Trending Days and Even Better for Choppy Days 133 Beating Indicator-Based Traders to the Punch 133. Not All Pivots Are Created Equal 134 Here’s Exactly How I Set Them Up on My Charts 135 ‘The Psychology Behind the Pivots—Who Is Getting Bumed 140 ‘Trading Rules for Pivot Buys on Trending Days (Sells Are Reversed) 142 ‘Trading Rules for Pivot Buys on Choppy Days (Sells Are Reversed) 143 Trailing Stops in This Fashion Is the key 157 ‘Tips and Tricks for Using the Pivots 158xii CONTENTS, What about Fibonacci Numbers? 159 ‘Summing Up the Pivots 162 Chapter8 . oe Scalper Buys and Scalper Sells—When Only a Quick Confirmation Will Do 165 Identifying and Profiting from Changes in Trend without Catching a Falling Knife or Stepping in Front of a Freight Train 165 Tick Charts Are Best for Scalping 166 ‘Trading Rules for Buys (Sells Are Reversed) 167 Specific Examples of Sealper Buy and Sell Setups 167 -alper Buys and Sells 184 Increase Probabilities of Success through Multi-Setup Combinations 184 Summing Up the Chapter 9 ‘Tick Fades: Taking the Opposite Side of the Newbies 185 “The Number One Action Alert Available Today 185 ‘Trading Rules for Sell Fades (Buys Are Reversed) 186 Specific Examples of Tick Fade Setups 187 Summing Up the Tick Fades 198 ‘Chapter 10 ‘The Squeeze: Getting Positioned for the Big Market Moves 199 Day Trading Versus Swing Trading 199 Redefining Volatility—How Narrow ts Narrow? 200 Getting the Heads Up for a Potentially Larger Move Before t Occurs 201 ‘Trading Rules for Buys (Sells Are Reversed) 202 Summing Up the Squeezes 221 ‘The Key to Getting Positioned before a Market Crash 222 Strategies for Those Who Can't Trade Full Time 225, A Note on the Squeeze Indicator for TradeStation and eSignal 226 ‘Chapter U1 Brick Plays—Letting the Markets Stack Up 227 Using Bricks to Capture Intraday Reversals in the Mini-Sized Dow 227 ‘Trading Rules for Buys (Sells are Reversed) 228 Summing Up the Bricks 236CONTENTS xiii Chapter 12 ‘The Ping Pong Play—Batting the Markets Back and Forth. .. All Day Long 237 ‘A Trading Channel That Moves and Adapts to the Markets in Real Time 237 ‘Trading Rules for Buys (Sells Are Reversed) 238 ‘When You're Dancing with the Market, It's a Good Idea to Let It Lead 248 Chapter 13 ‘The 3:52 Play: Capping off the Day with a Fine Cigar 249 ‘This Is Where the Other People Start to Panic 249 ‘Trading Rules for Buys (Sells Are Reversed) 250. ‘Summing Up the 3:52 Play 261 Chapter 14 Box Plays—On Days When the Stock Market Is Dead in the Water, Look to Currencies 263 Measuring the Length of the Move Before It Occurs 263 ‘Trading Rules for Buys (Sells Are Reversed) 265 Summing Up the Currency Box Play 280 Chapter 15 _ HOLP & LOHP—Catching Trend Reversals without Getting Smashed 283 Buying a Market Just Because It Is Cheap, or Shorting a Stock Just Because It Is Expensive Is Dangerous—Unless It’s Done Like This 283 ‘Trading Rules for Sells (Buys Are Reversed) 284 ‘Summing up the HOLP and LOHP Plays 297 ‘Chapter 16 Propulsion Plays—Swing Plays Using Stocks, Single Stock Futures, and Stock Options 299 Setting Up for the Bigger Moves in Individual Stocks 299 “The Trader's Guide to Single Stock Futures 300 ‘The Only Way to Play Individual Stock Options 303 ‘Trading Rules for Buy Fades (Sells Are Reversed) 307 ‘Summing Up the Propulsion Plays 321xiv - oo . ___ CONTENTS Following in the Footsteps of Elephants 323 Specific Examples of Market Profile in Action 324 Summing Up Market Profile 330 PART 3: Heading Back Into the Real World of Trading 333 (—Creating a Game Plan for the Next Trading Day 335 Like Running a Credit Check, to Understand What the Market is Going to Do in the Future, It Helps to Understand Its Past 335, Monthly Chart Analysis 336 Weekly Chart Analysis 338 Daily Chart Analysis 340 60-Minute Chart Analysis 341 Daily RSI Chart Analysis 342 60-Minute RSI Chart Analysis 343, Index Radar Screen Alert 44 Sectors and Key Stocks Radar Screen Alert 344 The Key to Reading Daily Volume 346 ‘The Key Price Levels to Know Each and Every Trading Day 346 Pivot Numbers, of Course 348 Key Sentiment Readings 348 It's 2 Good Idea to Know What These People Ate Doing 352 Miscellaneous Items 353 What Does Your Mother Think? 353 Summing Up the Premarket Checklist 354 Chapter 19 ‘The Trader’s Business Plan 385 — Who Gets to the World Series—the Team with a Plan or the ‘Tea That Decides to Wing 12 355 Why Am I Trading Again This Year? 356 Happy Wife, Happy Life 357 ‘What Markets Am I Going to Trade? 358CONTENTS Why These Markets? What Specific Trading Strategies Am I Going to Use? 358 How Much Money Am 1 Going to Allocate to Each Trading Strategy and Setup? 359 ‘What Execution Methods Will I Be Using? What Parameters? 359 How Am I Going to Track and Rank My Trades? 360 ‘What Are My Drawdown Rules? 361 What Are My Profit Rules? 362 ‘What Is My Office Setup Going to Be Like? 362 What Are My Rewards If My Trading Is Going Well? 362 Are There Any Groups, People, or Organizations I'd Like to Help Out This Year? 363 ‘What are My Specific Plans for Staying “On Plan” Throughout the Year? 363, What Am I Doing About my Physical Health? 364 Concluding Thoughts on My Plan 367 A Sample Plan from a Beginning Trader 368 Summing up the Trading Plan 378 ‘Chapter 20 When It’s Not Working for You, No Matter What You Do 381 Will Cry for Food—Using Your Emotions to Make Money 381 ‘The Four Seasons Hotel Trade 382, ‘Thank You, Sir, May I Have Another? 382 When I Tick, You Tick, We Tick 382 Dive, Captain, Dive 383 High Five, Baby 383 Discover Your Personality Type and Find Out If It's Holding You Back 383 Personality Types and Trading —What You Don’t Know about Yourself Can Hurt Your Trading 386 ‘Trading Really Isn't For Everyone—Alternatives to Consider 388 Chapter 21 Mastering the Trade 391 Amateurs Hope; Professionals Steal 391 40 Trading Tips for Maintaining a Professional State of Mind 392 Surviving the ‘Trader's Journey 396 Conclusion and Final Thoughts 396 Index 399FOREWORD Tn early 2003. 1 was attending an online trading conference in an effort to educate active traders on a new class of products called Security Futures. I had joined OneChicago after having been in the managed money business for over 20 years because I believe these products will enhance equity trading in the cash, futures, and options markets. Having avoided these events for ‘many years, I was surprised when I had the pleasure of listening to someone who was incred- ibly articulate and thoughtful. | said to myself, “He really gets it.” John Carter Was not speaking about security futures, but rather he was presenting his intellectual framework and approach to trading. It is a method to which I relate strongly, so T introduced myself. We spoke af length on many subjects, including the idea that his method- ology could be applied to security futures and that successful trading is one long journey, not a destination. John became an early supporter and trader on OneChicago, another indication of his innovativeness. We have continued to exchange ideas, and therefore 1 was honored when John asked me to review Mastering the Trade. 1 judge a book on trading according to one simple criterion: Have I learned something new? Mastering the Trade not only introduces new concepts, but is insightful and easy to read. ‘This is indeed a rare combination in the wading literature. In addition, John stresses that there is neither a single approach nor a single answer to successful trading. In fact, he emphasizes that before one can be a profitable trader, one must fully understand one’s own personality. Every decision from the holding period of a trade to the amount of one’s capital to risk per trade is a reflection of the inherent preference curves of the trader. In fact, Mastering the Trade begins by emphasizing the importance of the proper approach to trading prior to discussing methodology. ‘Once the book turns its attention to the process of trading, it sparkles once again. Regardless of how long one has been in the markets, there are new approaches or enhance- ments to existing ones that I find quite beneficial. For example, as an active participant in the stock index futures markets, John’s unique application of extreme tick readings is very insight- ful. I can then decide whether to apply it toward my own trading, test it further or ignore it entirely. The beauty of trading is that there is not one size that fits all and John does not try to force fit his ideas on anyone. They are presented, discussed and then demonstrated. Amazingly enough, every trade is not always a winner, The set-up is a probability outcome that if followed over time should lead to trading success, That is the essential message that John drills repeatedly, Bad trades happen all the time; it is how one reacts to them that determines future success. Another point that Mastering the Trade makes is that there is no a single answer to the question: Should one be short or long market? There are always valid reasons to be both ways. ‘The markets provide some clues, but ones trading style needs to provide the rest. That is why John shows how to use everything from monthly charts to one-minute pivots. A full-time trader