- 2000: Volume 9, No. 1 Day Trading the S&P 500

Trading successfully on a consistent basis requires a fundamentally sound trading plan that retains its functionality under all trading conditions. Much like a baseball player a trader must hone fundamental skills and be able to execute them when the market comes into play under their trading parameters. It is irrelevant whether you are a short-term or long-term trader; the foundation of all successful trading plans contains the same disciplines. Identifying market momentum will be our focus.

We define momentum as the cumulative participation by institutional traders. Institutions have the best information resources available for determining likely market direction. They react first to all domestic and global information deemed to have an impact on current price levels. With abundant human and technical resources, they are able to effectively monitor all market segments impacting stock index prices. We attempt to quantify their reactions fundamentally and technically.

By interacting with order flow, we are able to observe and filter this activity. The product of these observations results in our fundamental understanding of the underlying momentum currently driving the market. Technical analysis is used to study price action to help us anticipate and define specific price levels where significant shifts in momentum are expected. These price levels result in exit or entry levels for our trading activity. Our combined fundamental and technical analysis manifests itself in our Momentum Indicator. Momentum swings in the S&P 500 pit are frequent and often violent resulting in endless opportunities, the Momentum Indicator keeps us aware of when these shifts are most likely to occur. Just like the batter in baseball working the pitcher into an advantageous count, we use the Momentum Indicator to help us wait the market into an advantageous trading position.

We keep our trading strategies simple; we look to buy breaks with momentum (market strength) and sell rallies with momentum (market weakness). The Momentum Indicator helps us identify the most efficient price levels for us to enter and exit our trades. Just as important as it is to know when to trade is knowing when not to trade. Just like the batter waiting for his pitch the trader must wait for their trading signals. While trading in the pit, it is especially challenging to keep yourself from getting drawn into trading at levels where low market liquidity exists due to a lack of institutional participation. Under these conditions locals are forced to trade against each other resulting in unprofitable and inefficient trades. The Momentum Indicator contains a neutral area, which highlights when these trading conditions are expected to exist. What characterizes the neutral area is that it represents where we anticipate the market to be in transition from buy to sell or sell to buy. The neutral area puts us on alert for significant market reversals. We look for the institutional activity to consist of stops as the market initially trades through these levels and then we look for large limit orders to materialize as the market retraces after initial penetration. It is the existence or non-existence of these orders which validates or invalidates the momentum shift.

Another key element of a good day trading plan is being able to quantify the strength of market momentum. Trading volume is key. Unfortunately, it is difficult for the trader at home to quantify the volume that is taking place in the pit at any point during the trading day. The pit trader keeps himself apprised of current volume by interacting with the order flow through his own trading activity. As volume increases momentum is validated allowing the trader to be more aggressive in pressing their position and increasing their profitability. In turn, low volume alerts the trader that momentum may be weakening and starting to shift. This should result in the trader becoming more conservative in evaluating trade initiation opportunities. The ability to be aware of the rhythm changes in the market breeds consistency.

Going back to the beginning, we talked about the importance of fundamentals. They are critical to trading development and survival. We feel that developing a trading plan based on market momentum gives us the ability to perform successfully on a consistent basis. It is this consistency that makes us confident traders. Once a trader has gained his confidence, he becomes patient. A patient trader has the ability to consistently wait for the market to provide him with the most profitable trading conditions that are defined by his trading plan-much like the batter knowing when he is going to get the fast ball.

Ray Burchett and Steve Prosniewski are the co-founders of www.localknowledge.com. Local Knowledge was created to provide the off-the-floor trader with access to information that until now was unavailable. Local Knowledge is a quote vendor, and offers the Momentum Indicator, analytical charting software, pit commentary, and news highlights. A five-day free preview, complete with all LK services, is available at www.crbindex.com under recommended Services.