Day Trading Stock Index Futures: READING THE MUSIC OF THE MARKETS:

by: John Carter

Wondering whether you should take the setup? If you know what you're doing, the TICKS indicator trading software can help.

Cream rises to the top. For anyone who trades the stock index futures intraday, there is certain information that can lift a stock index futures trader away from the slogging masses and propel them to the top of the heap. Not understanding this information and then going on to trade the mini-sized Dow (YM), the E-mini S&P (ES), the E-mini Nasdaq (NQ) and the E-mini Russell (ER) stock index futures intraday is like not knowing how to swim and then hoping to qualify for the 100-meter backstroke at the upcoming Olympics in Beijing.

Read the Internal Clues There is another critical reason for thoroughly understanding the key internals while day trading stock index futures. For my trading of stock index futures, I have a series of setups that I follow each trading day. (Some of these setups, such as "squeezes, pivots and gaps," are discussed in detail in previous issues of SFO. See March 2005 article, "Trading the Euro: Box It, Squeeze It, Love It, Leave It.") Although these stock index futures setups are mechanical in nature, I get my edge by using key internal readings to filter whether or not I will take the stock index futures setup. Every single stock index futures trading day is going to present setups on the long side as well as setups on the short side. By understanding how to accurately interpret these internals, a stock index futures trader will know the following:

• Stock index futures: Which days to ignore all short setups
• Stock index futures: Which days to ignore all long setups
• Stock index futures: Which days to focus on setups that do best in choppy markets
• Stock index futures: Which days to focus on setups that do best in trending markets

TICKS: They Can Run, But They Can't Hide

The TICKS (TradeStation symbol $TICK) summarize the number of stocks on the NYSE that are increasing in price versus those that are decreasing in price from the previous price quote. Many times this is not purely buying and selling, as an uptick may only represent that the ask was hit, while a downtick may only represent that a bid was hit. This type of information is like learning that Britney Spears is pregnant. In other words, who cares? Yet I've watched stock index futures traders stare at the TICKS, mesmerized by a move from -300 TICKS to +200 TICKS, and think this was a positive thing for the markets. In reality, this type of move is not positive -- it's immaterial, and the information is useless in the stock index futures.

This brings us to the first rule I follow when watching the TICKS: In stock index futures any TICK reading that is below +400 or above -400 is noise and should be ignored.

I start paying attention to the TICKS on any stock index futures readings that are above +600 or below -600. These types of moves tell me that there is sustained buying or selling pressure hitting the stock index futures markets. This doesn't signal any actions on my part, but it does give me a heads-up. If the TICKS continue and hit +800 or -800, this does trigger specific action on my part, as only a sustained buy or sell program can move the TICKS to this level.

This brings us to my next rule in using the TICKS for day trading stock index futures: If I'm long intraday, my stop hasn't been hit, and the markets generate a -800 TICK reading, I will close out my position at the market. Conversely, if I'm short, the markets generate a TICK reading of +800, and my stop hasn't been hit, I will close out my position at the market.

Stock Index Futures Clear Signals

Readings this high are telling a stock index futures trader loud and clear that, on an intraday basis, he is either right or wrong depending on his stock index futures position. If I'm short, and the stock index futures market is telling me I'm wrong with a +800 TICK reading, I take the hint and close out my stock index futures trade. This also has the benefit of increasing a trader's risk/reward ratio, as it is possible in many instances to get out of stock index futures trades early that would otherwise have been stopped.

However, I want to make one thing perfectly clear before I move on. I never exit a stock index futures trade early just because "I think I'm wrong." I have learned the hard way over many years of doing this to stick to my original parameters -- unless I have designated a specific, measurable event that alerts me to get out of the trade early. A reading of +800 or -800 TICKS is one of these specific events. There is no emotion involved. There is no thinking. As a stock index futures trader, that's just the way I like it.

The next thing to be aware of in the stock index futures TICKS is if they hit +1000 or -1000. This is the most important reading of the day for two reasons: First, this usually represents the maximum amount of sustained buying or selling pressure the stock index futures market can handle in the near term. It's like a sprinter getting to the end of a 100-yard dash and having to stop and gasp for breath.

This brings me to the third rule I use with the stock index futures TICKS: If I am long and the stock index futures markets hit +1000 TICKS, I will use that as a signal to exit the remainder of my stock index futures position. If I am short and the markets hit -1000 TICKS, I will use that as a signal to exit the remainder of my stock index futures position.

Figure 1 is a snapshot of the stock index futures TICKS from March 29, 2005, showing how I have them set up on my TradeStation charts. I use a 5-minute chart, but the interval is not important; the key is that I want to be able to see a full stock index futures trading day's worth of data. (Note: all of the charts you will see in this article have a white background. This is for printing purposes. When I'm watching these on the screen, I set the background to black, and the chart colors are green on up moves and red on down moves.) In this chart we can see at point 1 and point 2 that there are horizontal lines placed at +1200, +1000, +800 and +600 TICKS, as well as at -1200, -1000, -800 and -600 TICKS.

These horizontal lines serve a very specific purpose, which brings me to my forth rule in using stock index futures TICKS: I set up audio alerts at all of the key tick levels. This way I don't have to stare at the chart, and I never miss a move.

Make It Fun

These audio alerts are a key part of my stock index futures trading plan. I can be on the phone, down the hall or in the bathroom, and I will hear them if the stock index futures TICKS make a move. Remember, at the 800 and 1000 levels, they are actionable items for me, and I don't want to miss them -- no matter what I'm doing. I spend a lot of time staring at computers, so I like to make these alerts halfway entertaining. When TICKS hit +1000, I hear Daffy Duck screaming, "I'm rich! I'm rich!" and when the TICKS hit -1000, I hear the wicked witch from the Wizard of Oz screaming, "I'm melting! I'm melting!" Visiting traders raise their eyebrows when these alerts first start to hit, but it gets their attention, which is the whole idea.

I want to point out that I specifically use a bar chart or candlestick chart for anything having to do with audio alerts. Another popular chart, the "line on close," also is good when watching the stock index futures TICKS, because it helps to show a trader when they are rolling over or "hooking." However, these types of stock index futures charts can, and do, miss many audio alerts because the line is literally created on the close of the bar and misses the high and low fluctuations, which is what sets off the audio alerts.

In Figure 1 we can see that at point 3 the stock index futures TICKS hit +800. On this day, I had a short in the mini-sized Dow with a 20-point stop. When the TICKS hit +800, I covered my short for a nine-point loss. When the TICKS hit +1000 TICKS 25 minutes later, I heard the audio alert for this level and set up a new short in the stock index futures YM. (This is a specific trade setup I follow that is covered in detail in my upcoming book, Mastering the Trade, to be released by McGraw-Hill in December.)

Between about 10:30 a.m. and 12:30 p.m. EST, nothing happened. The TICKS were twitching back and forth like a freshly caught tuna on a boat deck. Around 1:30 p.m., the action picked up enough to the point where the stock index futures TICKS registered a reading of -800, and they even hit -1000 later in the day. Let's take a look at this same chart with the actual market action overlaid on top of it. See Figure 2.

1. The stock index futures TICKS usually are quiet at the openof the stock index futures, and at point 1 we can see that the TICKS just flopped back and forth for the better part of an hour. The markets did a "whole lot of nothing" during this time.
2. By 10:25 a.m. EST, we get the first notable tick reading at +600, and this drives the markets higher with TICKS eventually hitting +1000. This is a specific signal to exit all longs.
3. The mini-sized Dow stock index futures hit 10,542 when the TICKS move over +1000, and this ends up being the dead high of the day.
4. I like to watch how the markets react when the TICKS start stair-stepping and making higher highs or higher lows. The TICKS shot up to +600 around noon, but the markets did not move higher. Yet when the TICKS started making lower lows, so did the market. This is key information. If high TICKS of above +600 can't move the markets higher, then that is a tip-off that the selling pressure predominates. In this type of environment, I ignore all long setups. This means I don't buy declines to pivots and I don't take a long squeeze on a 2-minute chart.
5. This series of lower lows in the TICKS leads to an eventual steep sell-off. The market generally works up to "abrupt" rallies or sell-offs, and the TICKS can clue a trader in to which way the "out-of-the-blue" move is likely to be.
6. Here we see the TICKS make higher highs, forming an uptrend.
7. Yet when the TICKS made higher highs, the YM made lower highs. This is a bearish divergence and a signal that the rally can be sold, as there isn't enough "juice" to get things rolling.

Staying on the Long Side

There are rare days where the stock index futures markets rocket higher and keep on going or gap down and keep on selling. On these days, consistent extreme TICK readings are generated, usually in the neighborhood of 1200 to 1400. These consistent high readings are rare, but when they do happen, I don't fight them. This brings me to my last rule regarding the stock index futures TICKS -- this is something I take into account after 10:30 a.m. EST and watch throughout the day: When the TICKS spend 90 percent of their time above zero with repeated extreme high tick readings, I ignore all day stock index futures trading short setups and focus on longs. When the TICKS spend 90 percent of their time below zero with repeated extreme low tick readings, I ignore all day trading long setups and focus on shorts.

The TICKS are a great way to see what is going on "underneath" the stock index futures price action. The charts can tell you if prices are going higher or lower, but they can't tell you if the buying or selling pressure is merely fleeting or unrelenting. Leave that job to the TICKS.

Find the Tree in the Forest

It also is easy to get overwhelmed by too much data, and the key for reading this data is to do it in such a way that your brain can take in the information as quickly and as efficiently as possible. I do this by forming a specific set of simple rules for all of the stock index futures internals I follow. It is important to realize that the markets spend the majority of the day consolidating and resting. Stock index futures traders who wait for a move and then have to chase it will always be at a disadvantage to stock index futures traders who get in before the move takes place.

The way to do this is to watch these internals and look for clues as to which way the stock index futures market pressure is leaning. If it is leaning lower, as shown by the TICKS, then focus on short setups and take them as they occur. Don't wait for the markets to drop and then chase it lower -- leave that job to the amateurs.

Trading isn't rocket science, but it isn't easy when stock index futures traders let their emotions dictate the outcome. The TICKS are what they are -- they are not emotional, and they show what is really happening in the markets. Let them be your guide as you navigate your way through the variety of trading setups available in stock index futures.