It’s nice to have friends in high places, and when the Pit Bull talks I have to listen.

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ES-06-13-5-Min--6 13 2013

Whatever your trading method, when the S&P looks the worst you have to fade the trade. That’s exactly what happened over the last two days. On Wednesday, the S&P poured lower all day, closing on its low at 1609.50. It then sold off sharply overnight to 1591.75. Then yesterday, it opened lower, but still above the Globex low, and rallied all day.  

Just when you think they are no good

Good soldiers hold their ground, and so far this year the S&P has held its ground. What has made this so  hard to trade is we can see the sea change, but as soon as it started to develop, new price action started to show something else. The ESU (the September mini-S&P future) — not to mention everything around you — said the S&P would go lower.

That’s when you have to start buying. That’s precisely what happened on the previous selloff down to 1597, and it happened again this week. This erratic stop-and-go price action has become unpredictable and made for some very large downside false starts.

Trend day up / trend day down

While I have been in the S&P futures since 1985, the current price action is about as confusing and irrational as I have ever seen. Of course it’s impossible to catch every twist and turn, but generally when you figure out the trend it becomes easier to trade.

The last few days have not shown us a clear trend. Instead, it has have been a perfect example of something we rarely see: the S&P going from a sharply lower, trend day down to a nonstop trend day up.

Not technically driven

While we fully believe in technical analysis, we don't believe that the last two days had much to do with “levels.” Sure, Wednesday’s high bounced up against a moving average, but when the e-mini S&P starts moving hard in one direction it's important to remember that 70% of the volume is program and algorithmic trading.

So when the S&P goes sharply lower, most of that 70% is algos searching for sell stops and sell programs. Additionally, it’s not just the algos that get turned on at 8:30 and turned off at 3:00. Retail traders are fighting in there as well, reading or not reading the news, reacting or not reacting, each running his own fuzzy mental algorithms.

Pulling the trigger

One of the most important rules the Pit Bull (Marty Schwartz) has taught me is self-preservation. Just because you have the money to risk doesn't mean you have to put it on the line. Over the years I have seen so many good traders both on and off the floor self-destruct. And why? Because they thought they were smarter than the markets. Most good traders are smart, but when the markets prove them wrong, they’re also smart enough to get out with money left. They live to fight another day.

On Wednesday the Pit Bull had a big crude oil position on that he had been fighting to protect both on the up and the down side by selling calls and puts. It’s a classic spread, not for the faint of heart, but one experienced traders can use effectively. When crude sold off he rolled lower and sold futures.

This is one of the hardest games in the world to play, and Marty Schwartz is one of the best individual players in the game. After watching him get whipped around by what he calls the “crude oil algos,” I felt strongly that it wasn't the downside he had to worry about.

The Pit Bull reacted to the down move falsely created by the algo selloff. The next day he was scrambling to get out and start protecting the upside. In this kind of massive adjustment, the only one that wins is the clearing firm.

As crude started to rally this week he started to scramble to the upside. He was trading thousands of contracts. When he got me on the phone I could hear that his voice had changed. I have known him for 25 years so I know how he sounds when he is shaken.

He adjusted his position, in part because he had to fly to France to see his horse race. I congratulated him on a smart move. He had narrowed the position down to making $400 to $500k and risking “only $1mil.” I was happy to hear that, but I know that’s not how he trades. I told him so and, sure enough, an hour later he called back and said, “I took down all the upside call risk,” meaning he had bought back all those short calls, leaving only the puts he had sold down at strike prices of 90 and 88 bucks. If Thursday’s uptrend continues, those calls would have increased in price and he’d be at greater risk. He was humble enough to acknowledge that.

He made a hard decision to maintain the winning part of the position going into today’s CL option expiration and take off the other side of the spread. Now he can keep the premium he collected on the puts. He made a conscious decision to take down the riskier part of the position before it forced him to react, buy futures and roll higher.

Moral of the story? Let me just paraphrase what Marty chose to write in the final paragraph of his book. That he chose this to be the closing thought says as much about its importance as the idea itself.

He said you have to choose between your need to be right and your need to “hear the cash register ring.” The next time (and it will be soon) that your ego tells you to hold on because you’re just a few more bars away from being proven right, ask your ego a simple question: How much are you willing to pay for the feeling of not being wrong? Is it worth more to you than the feeling of being out safely with money in your account? You can be wrong a lot of the time about market direction and still be profitable — but only if you master your ego.

Our view: Yesterday's big rally in the S&P has helped push Asia and Europe higher this morning. We have several economic numbers this morning and the Ned Davis S&P cash study shows today being up 16 / down 12 of the last 28 occasions. The erratic stop-and-go price action has made it very hard to predict. Our view is to sell the early rally and buy weakness. As we head into the June quarterly expiration and the Ned Davis S&P cash study showing 4 out of 5 days next week being up, we have to agree with the Pit Bull that the S&P may attempt a run at 1650. As always, keep an eye on the 10-handle rule and please use stops when trading futures.

Ned Davis June Expiration Study

Friday up 16 / down 12 / last 28

Monday up 16 / down 12 / last 29

Tuesday up 18 / down 11 / last 29

Wednesday up 12 / down 17 / last 29

Thursday up 18 / down 11 / last 29

Friday up 20 / down 8 / last 29

Ned Davis expiration study for June: https://www.mr-topstep.com/index.php/equities/3260-expiration-study-for-june

  •     It’s 8 a.m. and the ES is trading 1634, down 2.75 handles; crude is up 48 cents at 97.17; and the euro is down 32 pips at 1.3314.
  •     In Asia, 10 out of 11 markets closed higher (Hang Seng +0.39%, Nikkei +1.94%).
  •     In Europe, 11 of 12 markets quoted are trading higher (DAX +0.39%, FTSE +0.07%)
  •     Today’s headline: “S&P 500 Futures Steady; Asia and Europe Bounce”
  •     Total volume: 2.34mil ESM and 32k SPM (27k SPM/U spreads traded)
  •     Economic calendar: Producer Price Index, current account balance, industrial production, consumer sentiment
  •     Fair value: S&P -0.41, NASDAQ +0.60
  •     MrTopStep Closing Print Video: https://mr-topstep.com/index.php/multimedia/video/latest/closing-print-6-13-2013

Danny Riley is a 34-year veteran of the trading floor. He has helped run one of the largest S&P desks on the floor of the CME Group since 1985.


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DISCLAIMER: The information and data in the above report were obtained from sources considered reliable. Opinions, market data, and recommendations are subject to change at any time. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any commodities or securities.



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