Time-tested rules for the S&P and some newly emerging ones

Danny Riley, Marlin Cobb
June 11, 2013

Everything has rules. Even in the mayhem of the S&P pit, there were rules. If you tried to stand in someone's spot in the pit you were breaking the pit rules. When you're driving, it's the rules of the road. When you get married it's your wedding vows, and when you’re trading the rules are called trade management.

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In order to be successful you have to have some type of methodology, something you depend on and follow.  With all the algos and program trading it can be very confusing -- one second the S&P looks terrible and the next it’s ripping higher.  It can be a very difficult process, and in it, like everything, there must be RULES! When we made the MrTopStep Trading Rules 101 its sole purpose was to share some of the trading rules we have used on the trading floor for the past 30 years.

After many years of trading and getting burned we finally figured out that there are certain patterns that exist and that if you pick up on them right away it can seriously help your trading and help keep you out of harm’s way. The rule we want to point out today is called the “10 Handle Rule.” This rule dates all the way back to the late 1980s, when index arbitrage was the craze in the S&P futures.

The pit

Even back in the ‘80s program trading was not a popular practice. The big investment banks like UBS, JPM, Deutsche Bank, and trading firms like Spear Leafs did index arbitrage trading, otherwise known as “program trading” and not to be confused with algorithmic trading. I did thousands of index arb programs; you know why? Because I had both sides of the trade -- the big hedge fund selling thousands of S&Ps and me lining them up with program bids for sell programs in the S&P. After executing so many all buy and sell programs in the S&P, I saw certain patterns starting to develop. After I sold 1,000 or 2,000 big S&Ps I noticed as I got to the end of my futures sell order the bids in the S&P become more concentrated. And knowing that I didn't have any more futures to sell that the S&P would snap back http://mr-topstep.com/images/pdf/MTS-Trading-Rules-101.pdf  -- see 10 handle rule.

Pattern recognition

Years ago I worked for a well-known desktop trader by the name of Rick Barns (Ricky the Rocket). He had 30 large screens up and would trade as many or more markets at once. I worked for Rick in the bonds and then in the S&Ps. Rick was fond of sliding a chart in front of me and asking me what I was looking at. The reason he would do that is because he thought I was good at picking out overbought and oversold levels. After more than a year of testing he he concluded that it was not the charts I was reading, it was the boards. After many years of seeing the last 5 or 6 trades on the board I had developed something he called “pattern recognition.” And that is still one of the main tools I use today.

In the end the old saying “patience is a virtue” never rang more loud and clear in the futures markets than it does today. To be a winner, traders must employ all the tools they can. At MrTopStep.com we do our very best to help explain what were are seeing and feeling on the trading floor and how it may help you as a trader.

Our view: Asia closed lower and Europe is down across the board. After a two-day, 51-handle rally  the S&P struggled late in the day and is down sharply after the BOJ decided not to follow up with its $1.4 trillion stimulus program, which spooked the global markets. Turnaround Tuesday has been up 18 out of the last 21 occasions with a daily average gain of +9.3 handles and an average daily loss of 3.9 handles. Yesterday when the futures were up we called for selling the early rally and buying weakness, which was right on. With the futures down this AM our view is to buy the early weakness and sell the rally. While the talking heads continue to say the economy is doing better, there is still a ton of uncertainty out there. As always, keep an eye on the 10-handle rule and please use stops when trading futures.  

  •     It’s 8 a.m. and the ES is trading 1627, down 15 handles; crude is down 1.11 at 94.66; and the euro is up 12 pips at 1.3274.
  •     In Asia, 10 of 11 markets quoted closed lower (Hang Seng -1.20%, Nikkei -1.45%).
  •     In Europe, 12 out of 12 markets are trading lower ( DAX -1.69%, FTSE -1.61%).
  •     Today’s headline: “BOJ Disappoints, S&P Futures Seen Lower”
  •     Total volume: 1.8mil ESM and 14k SPM (6.6k SPM/U spreads traded)
  •     Economic calendar: NFIB small business optimism index, Redbook, wholesale trade, 3 yr. note auction
  •     Fair value: S&P -15.91, NASDAQ -30.79
  •     MrTopStep Closing Print Video: https://mr-topstep.com/index.php/multimedia/video/latest/closing-print-6-10-2013

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.

MiM Update - RedlionTrader

I did a weeklong tracking of the MiM and we did pretty, pretty good. For those of you who are reading for the first time and say, “What is a MiM?” you can go to http://closingimbalance.com for the answer to that question.

There are people signing up and some of them are reaching out and asking “How do I trade off the meter?”  What I really want to say in response is: You are a trader, you see traders making money with new data, figure it out.

There is no owner’s manual for the MiM, the data is brand new.  After a month or so of watching the data and a week of really collecting it, I have come up with some rules of thumb. These are my rules.. If you are going to trade it, you need to make up your own rules.

  •     There is no bias unless the meter reads +/-66%.
  •     There is no bias unless the imbalance is > 150MM.
  •     No bias is in itself a signal.
  •     I like trading 3:20PM ETs and taking some at the 3:45 release and then decide about riding into the close.
  •     Exit if you lose the bias.
  •     Size matters, as does the current day’s price action.
  •     Write your rules on a white board until they are ready for stone and then put them down with pencil.

So, with those rules in mind, here are the charts for last week and some of my notes on what I was thinking going into the FH (final hour):

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(Text version) Monday: SPX opened, volatile morning market, then run up into the close.  The MiM swung positive and I took a 3:20 type trade with the meter.

Tuesday: Market was weak and sold off most of the day ... we were surprised to see the imbalances come in on the long side and we took the reversal into the close trade around 3:20pm, exiting early on a squeeze before the MOC data came out (it was an NQ trade for +13).

Wednesday: The markets continued Tuesday’s selling all day long, closing on the lows and making a serious move down.  We waved off the trade as we were not impressed with the size of the imbalance for such a small move.  

Thursday: Thursday, we showed a slight negative imbalance, the GM addition to the SP500 had the data skewed and as a result there was no trade on Thursday. Had we been long on the day, the lack of bias itself was a signal of trend continuation.

Friday: Again, an early positive imbalance.  We actually took a position before 3pm and then added to it as we went into the close and took +4 ES.

I share with you this data as an example of how I approach working with this brand new market data, a peek at how I do my homework as I figure out how to trade it Redlion-style.  I don’t mind sharing and hope you will share, too, as we can all learn.  This data is awesome.  It is early and it is new.  That is what edges are about.

In the meantime, for those that want an instruction manual, as soon as Big Papi finishes showing me how to slam a baseball, I will sit down with you and show you how to trade the MiM.

- Marlin aka RedlionTrader


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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.