The Art Of Taking A Trading Position – A Complete Guide On How To Enter, Manage And Exit A Futures Position

This article on futures trading position is the opinion of Optimus Futures.

“Tell Me and I Will Forget; Show Me and I May Remember; Involve Me and I Will Understand.” Confucius (ca 450 BC)

This article is about the art of taking a trading position. The instruction here is limited in terms of its ability to “involve” you in the process, as the Confucius quote says above. The best it can do is to walk you through the process. This is just one way to approach taking a position. One way that it might work for certain traders.

Hopefully, it will be informative, covering all of the bases. Ultimately, you can take what you learn here and adapt it to your own trading approach. After all, successful trading is about finding an approach that comes from or resonates with you; and one that matches your knowledge, capabilities, and capital resources as well.

Futures Trading Position: January, Dow Jones Futures (YM)

Part 1: Trade Origination and Thought Process

CHECK THE FORMATION

On January 26,  you see a potential double top forming with a slight divergence in the relative strength index (RSI).

Should you take the trade based on these fundamental signals alone? Perhaps, but you don’t like to rely on technicals only. So, you do a bit more research. Before we get into that, let’s look at the last two bars, yesterday and today.

The first arrow shows a candle with strong rejection toward the upside and buying pressure followed by a doji signaling potential indecisiveness or hesitation.

Might there be enough momentum to break through resistance? Possibly. But considering that the short-term volatility is news-driven, let’s take a look at the bigger picture. Let’s start with the technicals.

CHECK OVERALL MARKET SENTIMENT

Here’s what you might use to “technically” gauge the overall market:

1. Regional Banks (KRE): shows sentiment regarding local banks, the lifeblood of the local economy.
2. Semiconductors (SMH): the chipmaker industry is an important leading indicator by virtue of the fact that its production schedule is at least a year ahead. If semiconductors ramp up production, it’s because the industry is expecting a bullish year in sales; the opposite reflects bearish sentiment.
3. Dow Jones Transportation Index (IYT): represents the transportation of goods across the country. If the business is going well, you’ll see this industry revving up its engines.
4. Biotech (IBB): represents high-risk speculation. There is no high-risk speculation when investors are pessimistic.
5. Retail (XRT): represents discretionary spending, which tends to pick up when investors feel they have extra money to spend.

Why is it that Retail (XRT) is rising while semiconductors (SMH), transportation (IYT), regional banks (KRE), and everything else is sinking?

Does this indicate the possibility that investors are getting ahead of themselves–as in “irrational exuberance”? This is a strong indicator, but it isn’t enough.

CHECK OVERALL NEWS SENTIMENT

CHECK FOR DIVERGENCES BETWEEN WALL STREET AND MAIN STREET

The market has been rallying, yet you suspect that the financial economy may be getting ahead of the “real” economy.

Think: production drives the economy; credit or financing doesn’t drive production. To date, Main Street is hurting due to the pandemic, yet Wall Street is rallying. What’s wrong with this picture?

Here’s another analogy for those who are getting it yet: if your credit card spending goes beyond your income, then you’re not financially healthy.

So what is going on with Main Street?

• Ray Dalio seems pretty bearish.
• 20% of all American renters are behind by an average of four months in their rent.
• Supply chains are still getting crushed, meaning consumer goods may end up skyrocketing–bearish for regular people like you and me.
• Big news broke that the ECB is doubling up efforts to scrutinize credit risks due to the pandemic. Thinking about our own situation, how stretched are our corporations considering the effects of the pandemic?
• The Federal Reserve is buying up Fannie Mae bonds–$700 Billion worth–to keep mortgage rates low (now negative) as many people elect not to buy news homes despite our “economic recovery.”
• The dollar is losing ground against other international currencies, like the Chinese yuan.

IS THE ECONOMIC PICTURE REALLY THAT BAD?

You understand that 20% of all dollars in existence were created in 2020. You check the M1 money supply in addition to doing further research to check that claim about 20% of all dollars. It’s accurate.

This does not look good. Let’s see how the dollar is faring in all of this.

No kidding. Investors are truly dumping the dollar. But of course, it’s because the Fed is taking a 2% “averaging” strategy, holding rates near zero possibly until 2023–a “pro-inflationary” position, making bond yields and savings rates undesirable. US saves are putting money in the markets; international investors are simply going elsewhere.

So, with the Dow and other indices rising, what does the unemployment (Main Street) picture look like?

As of December, 10.7 million people remain unemployed. This was caused by the Great Lockdown. But is it over? Not quite. We have several new COVID strains.

What’s the likelihood that more lockdowns may lie ahead due to the new strains of COVID-19? So, you check this site.

With all of this uncertainty, where is the economic recovery taking place? Perhaps you don’t see it happening any time soon. Might this double top lead to another correction or a bear market? It’s impossible to predict. But based on the odds derived from your research and bias, you decide it’s time to go short, and this double top formation provides the perfect opportunity.

MAKE A DECISION

On a larger scale, it looks like there may also be a Rounding Top which includes our shorter-term Double Top.

Let’s say that again: short-term we see the double bottom; longer-term, a potential rounding top.

Many bear markets are preceded by a Rounding Top. We’re not there yet, but you can see one forming in the next few weeks.

The next few days might see a short term incremental drop, so you have decided to swing trade it.

Part 2: Setting Up the Trade

Now, how do you set up a trading position? Let’s go back to the initial double top formation.

Top of the formation: [1] is the first top, and [2], the second top.

Bottom of the formation: [3] is support.

Let’s recall–how do we trade a double top?

1. Calculate the distance between the top and bottom of the entire formation.
2. Calculate 70% – 100% of that distance. I’ll choose 90%.
3. Subtract the result from the price level at the bottom of the formation

What’s the Margin of Error for this Trade?

Using your resources for calculating success and failure stats (every trader should have such a resource), the breakeven failure rate is 25%; the average decline is around 15%; the pullback rate is 64%, and the percentage of reaching a price target is at 64%.

These are the historical odds that you’re dealing with. Even though history doesn’t always repeat itself, these odds seem favorable enough to trade.

TRADING OBJECTIVE

Your trading objectives are:

1. To seek short-term profit from the potential swing down; and
2. If successful to hold one position to take advantage of a larger move down.

Short-Term  Entry and Exit Points:

• Entry: Place a sell stop order at 30455 two points below the bottom of the formation) for one contract
• Stop Loss: place a buy stop order at 31190 (two points above the top of the formation)
• Take Profit: Place a buy limit order at 29799

The result is +656 points:

Long-Term  Entry and Exit Points:

• Entry: Place a sell stop order at 30455 two points below the bottom of the formation) for one contract
• Stop Loss: place a buy stop order at 31190 (two points above the top of the formation)
• Take Profit: Manage the stops and move the targets as follows.

Here’s where you need to manage the trade, and here’s what you have decided to do.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. All examples are for illustration only. Trade at your own risk.

Part 3: Managing the Trade

Let’s suppose you’re bearish and expect the market to decline to even greater depths. That’s your fundamental bias. However, you want to keep your trading window closer to the near term. As a side note, if you want to take a much longer-term short trade, you can always buy an option put to minimize your risk to the cost of the premium rather than going short the market with an outright position.

So given your short-term time frame, you decide to look at the technicals, specifically Fibonacci retracements to see where market support levels may converge with either the 38.2% or 50% retracement.

The higher target seems more easily attainable. But given that the YM rallied strongly today, how might you manage your risk should your near-term bias end up wrong?

One practical way to do it would be to trail a stop right a few ticks above successive down sessions.

It takes a great deal of effort to push prices back above the high of a declining session or below the low of an advancing session. Both would constitute a breakout signaling potential reversal. So trailing stops at the opposite end of your direction can be a practical way to deploy a trailing stop strategy. It’s not a surefire way that guarantees success, but it’s probably the smartest way to do so if you need to trail your futures position. There are other ways to set up a stop-loss strategy. This strategy is just one of them. Most importantly, do what matches your own trading approach or risk preferences.

With regard to the stop-loss strategy above, it answers the question “What price levels need to be broken to move the stop?” The price level that’s broken is a breakout in the opposite direction. Now, should that reversal fail, you can always re-enter your original position.

Stop-loss Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

Part 4: Trading Exits

The answer to any trade exit should be this: the context was set up for a profit or loss, and the trade resulted in either one. If you’re a day trader, there are even more specific trading exit approaches to consider, depending on the shortness of your timeframe.

As you can see, the last candle in the futures position above is still active. That’s where the market is today, at the time of writing. It’s either going to fail or succeed. But it doesn’t matter, as the odds of the trade are reasonable and justifiable.

If this were a real trading scenario, maybe you wouldn’t have risked more than, say, 2% of your capital on this one trade. Risk management is an important part of your trading strategy. It’s just one of 14 skills and attributes that we touch upon in another piece that we recommend you read. For now, I’ll assume that you have one, as it extends beyond the scope of this article.

The Art of Taking a Trading Position Depends On Your Trading Personality

Everything mentioned above is just one way to approach the markets. Should everyone follow it? Probably not, as different traders may not agree with the entire methodology. Not everyone will agree with the technical approach or large-scale fundamental approach either. Some traders believe that technicals are more important than fundamentals, while some fundamentalists may believe that technicals are too unreliable. To each his or her own.

Most importantly, the chief aim of this article is to walk you through a potential trading process. Feel free to pick up any of the tips provided, or use the approach as guidance for constructing your own analytical and trading approach. Trading is an art, more so than a science. So keep creating and iterating. In time, you’ll evolve your own way to trade successfully.

Disclaimer: There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.

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Source: https://optimusfutures.com/tradeblog/archives/futures-trading-positions-guide/%20