Getting short intraday

By Active Trader Staff
Many traders, especially new traders, like to think big — big trades, big moves, big profits (conveniently ignoring the likelihood of big losses). Besides the prudence of thinking smaller and more conservatively in general, looking at things on a smaller scale can open the door to low-impact trade ideas traders might otherwise overlook.

Although the word “scalp” typically brings to mind hyperkinetic intraday trading techniques, it can also refer to less-active strategies that aim to take less frequent and more modest bites out of price action. “Five-minute forex scalp” (Currency Trader magazine, July 2010) outlined an short-side intraday “scalp” setup in the Euro/U.S. dollar (EUR/USD) that centered around two consecutive strongly closing five-minute bars. The pattern originally included a third bar that closed lower (indicating weakness), but research showed that waiting for price to turn down harmed rather than helped: selling on the second strong bar a certain amount above the high of the first strong bar raised the average entry price and made the setup more successful over the 12-bar time window analyzed in the article.

Let’s see how this basic trade premise holds up in an entirely different market—the S&P 500 ETF (SPY).

The setup
The setup revolves around back-to-back five-minute bars that close in the upper 25 percent of their ranges. Just as important, however, is how much higher these bars must be than the bars that preceded them. Observation of several days worth of SPY data from June indicated a good starting point is to require the high of the second bar of this pair to be at least .05 above the previous bar’s high, and for the subsequent bar’s high to be at least .10 above that high. (All these parameters are representative: They are not the result of optimization of any kind, and are certainly worth experimenting with and modifying.)

Essentially, the setup is attempting to identify a 5- to 15-minute period of upward momentum that is excessive enough that we can expect the market to pull back. The bigger (.10) jump to the current bar means that, after two strongly closing bars and a .05 or larger high-to-high gain, SPY made another significant upthrust. As formulas, the setup rules are:

1. (close[1]-low[1])/(high[1]-low[1]) >= .75
2. (close[2]-low[2])/(high[2]-low[2]) >= .75
3. High[0] - High[1] >= 0.10
4. High[1]>High[2]+0.05

Where 0, 1, and 2 refer to the most recent bar, one bar ago, and two bars ago, respectively.
   
The red arrows in Figure 1 mark several setups that formed in SPY over the course of two days.



The hash marks to the left of the bars identify the price level that is .10 above the previous bar’s high, which is the prospective entry point for a short sale (or, alternately, an exit from a long trade). Some, but not all, of these setups offered favorable selling points.

The first signal (10:15 ET on July 6) is conspicuous because it triggered at virtually the high tick before an extended intraday sell-off. This behavior is out of the ordinary, however — the remaining signals are more typical. There are two things we can say about these setups: First, the subsequent downside movement was mostly limited and brief, occurring mostly in the first few bars. Second, the entry point was more often than not near the swing high of the move (i.e., there was little adverse price action before the market made its downside move), the second signal being an obvious exception — price moves higher for a few bars before turning lower.

Performing a little historical analysis will indicate how well these anecdotal observations mesh with reality.

For the complete article, see the September 2010 issue of Active Trader magazine. Click here to subscribe.



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