Program Trading

Program Trading

There is a lot of talk in the news about program trading. But what part about program trading applies to your daily trading with ZoneTraderPro?  Program trading is defined as a computerized program to buy or sell a basket of at least 15 stocks. The trading that we will be talking about is not High Frequency Trading (HFT) where algorithms look to make fractions of a penny on thousands of trades.  The program trading we are interested in is Index Arbitrage and using the S&P E-Mini Premium.

Index arbitrage

Index arbitrage is buying something cheap and selling something else similar that is more expensive.  Futures move faster than the stocks that make up the S&P 500.  The futures have a Fair Value which is reset every day.  The S&P 500 futures will normally trade between the buy arbitrage and sell arbitrage during a normal day.  A small tight range around fair value is a normal liquid market.  A number of wide ranging bars reflect an illiquid market and a market reacting to news.

This picture reflects a good liquid market and a “normal” e-mini premium range.  There has not been index arbitrage program trading.

S&P 500 E-Mini Premium
S&P 500 E-Mini Premium

Buy and sell arbitrage occurs when the faster moving futures get in front of the physical stock prices usually due to a news event.  Price needs to exceed the arbitrage limits in order to pay for the cost of the trade and turn a profit.  In a selling arbitrage situation the futures climb very fast and there is more demand than there is supply.  Futures are then what is expensive and they are sold and the physical stock is then bought.  Typically the futures may fall back 4-5 ticks due to this selling.  The NYSE stock which is now inexpensive is bought, pulling up that index.  That is program trading that applies to ZoneTraderPro. How?

If you are in a short position when this occurs you are likely stopped out.  If you are not, it is a good reason to consider the risks in staying short.  When the futures spike outside of the arbitrage range, it is because somebody with a lot of money has just made a huge bet, usually because of breaking news.  These are traders that know what the news is.  Cable news is usually 15 seconds behind the news if it is a financial number that they expected a release on.  It will take minutes if it is a breaking news story, because they have to confirm the story.  If you are not already involved in the trade before the news broke, it is likely too late.

That is precisely what occurred today on 8/26/13. At around 1500 hours EST there was extremely tough talk by the Secretary of State about Syria.  The financial cable news networks did not start talking about this until about 1530 hours.  But somebody at the CME around 1510 hours realized that we are about to (possibly) start warming up the cruise missiles.

E-mini Premium for Breaking News
Increase in volatility in the E-mini Premium due to Breaking News

After 1515 hours the increase in volatility results in a decrease in the liquidity on the e-mini futures.  ZoneTraderPro defines this as illiquidity volatility.   This is an extremely important concept.  The more illiquid a market is, the fewer number of contracts are required to move price.  Logical computerized program trading has now been replaced by floor traders with information the general public does not have.

After the market found the initial bottom at 1526 hours, the ZoneTraderPro zones took over, even with the illiquidity.  A detailed examination of the chart will follow in the next post.

E-mini futures 8/26/13 during breaking news
E-mini futures 8/26/13 during breaking news


Day Trading Pattern – The Trend Trade

The Trend Day Trading Pattern

The trend day trading pattern occurs following an exhaustion trade.  The market must first form an exhaustion trade.  The exhaustion trade sometimes has additional risk if it is a test of a high or low. The trend trade is looking to take advantage of the new trend.  You may have not taken the exhaustion trade due to the risk, or exited the exhaustion trade for a profit.  The definition of the pattern is that after trading at the blue countertrend zone, the market then trades at intermediate support resistance.  This was the original description of the eSignal trend trade.  The difference between the Ninja version and the eSignal version is the additional filter of the exhaustion trade.  The “out of the box” trade will be a trend trade with all of the filters except the preceding exhaustion trade.

ZoneTraderPro Trend Trade
ZoneTraderPro Trend Trade

In this trade we use the tick filters again in the setup.  We have a lower low $TICK of -308 and a lower higher $TICK of 55 at the zone.  There was just 2 ticks of adverse excursion, and a total risk of 6 ticks.  Notice that the trade that followed was an out of the box trend trade that probably would have been passed on.  This was because as the price was approaching the zone, there tick filter was hit with a 311.  That is unfortunate, because the market had made a lower low of -451 going into the trade.

Bond Market with ZoneTraderPro
Bond Market with ZoneTraderPro

Notice how the above picture of the bond market is just as responsive to ZoneTraderPro.  The bonds were trading at intermediate support when the Trend Day Trading pattern formed.  The bonds fell which should be bullish for the ES.  It was not. The ES traded sideways at their intermediate support then fell to the target zone.  ZoneTraderPro painted the target 2 minutes before price actually traded at the price.

The ES out of the box trade then occurs as the bonds trade at countertrend support, and we get another 3 point trade.


Day Trading Pattern – The Reversal Trade

The Reversal Day Trading Pattern

As the name would suggest this trade is looking to take advantage of market reversals.  The reversal pattern will trade to a blue countertrend zone and then trade through the opposite intermediate zone, setting up the day trading pattern.  In the example below we first see the ZoneTraderPro Exhaustion day trading pattern.  When the market reaches the intermediate support zone, we see a $TICK filter dot indicating the sellers are coming in.  The low $TICK is almost 300 more than the previous low.  The market then trades 6 ticks through the green intermediate support zone.

Very Important – The adverse excursion of 6 ticks is calculated from the top of the support zone.  The opposite is true for a resistance zone.

The stop is a very small 4-5 ticks.  It is important to understand how this is calculated. On the Statistics page of the website there is a very important table.  MAE is the Maximum Adverse Excursion.  When the MAE is 4-5 the statistics indicate there is a 8.4% chance that the market will trade to where the blue line is drawn on the chart.  When there is a 6 tick adverse excursion the number is down to 3.6%.

ZoneTraderPro Statistics table
ZoneTraderPro Statistics table

This is what make the Reversal trade a ZoneTraderPro favorite.  This trade occurred at 1420 Hours EST, which is late in the day for the bond market.  The bond market has smaller moves in the afternoon, absent of news.  But exactly as the ES makes a reversal day trading pattern, the bond market is trading at blue countertrend support.

Bond market trading at support
Bond market trading at support

With the bond market trading at support, that would favor the short ES trade.  With all of the filters in place, this is a great trade with little risk.

Day Trading Pattern – Exhaustion

The Exhaustion Day Trading Pattern

The exhaustion day trading pattern is a topping pattern. The exhaustion pattern occurs when the markets reverses from a minor support resistance zone.  When price trades to the previous high/low the exhaustion arrow will signal a trade.  In the example below, you see an exhaustion trade which is a test of a high, followed by a trend trade.  This test of a high has a higher risk.

Exhaustion Trade Filters
Exhaustion Trade Filters

The reason that there is higher risk is that the market can trade to the blue countertrend zone as shown below.  This is an example of an exhaustion trade with a better risk reward ratio, with the risk being 5-6 ticks.

The risk on the 1st trade was much higher at around 9-10 ticks.  This is the only ZoneTraderPro pattern where the trading signal will move.  About 30% of the exhaustion day trading patterns are a test of a high.  The remaining 70% trade higher to run any stops that were placed just above the previous high.

What are some of the reasons that you would want to consider making the first trade with higher risk?  There are several reason why this trade works, and they all have to do with the ZoneTraderPro filters.

Exhaustion Trade Filters
Exhaustion Trade Filters

In looking at the above trade, notice that the background on the chart is red.  The red background signifies that the Euro futures are trading bearishly. The next filter is the tick filter.  Notice the red dot at the -406.  The red dot signifies that the $TICK is at least 100 greater than the previous low $TICK. The $TICK at the test of the high is 673 which is a lower $TICK high than the previous 833. So going into the trade there are more sellers and less buyers on the $TICK.  Lastly the Euro divergence indicator is marking on the chart.

Support Resistance – The Therory of ZoneTraderPro

Support Resistance Zones

ZoneTraderPro uses colored support resistance zones to define the patterns.  Every pattern is formed by a sequence of the support resistance zones, so the first thing we need to understand is the names of the zones.

In the picture below we see Intermediate Resistance in red and Countertrend Support in blue. Minor Resistance is in light red.Support and resistance zones

In the above picture we are in a bearish trend and we can see the pink strong trend zones below the countertrend zones.  We also see the pattern of the trend trade.  A trend trade follows an exhaustion trade and the pattern is that we first see an exhaustion trade, price then trades to the opposite blue countertrend zones, and then trades to the opposite intermediate zones.

Countertrend zones in blue can be both support and resistance

A blue Countertrend support resistance zone is how ZoneTraderPro defines a trend.

In the picture below we are in a bullish trend.  Countertrend resistance is again in blue, Intermediate Support is in dark green, minor support is in light green.  We again see a trend trade pattern after the exhaustion trade.

The order of the zones is simple

  1. Minor Support (light green) and minor resistance (light red)
  2. Intermediate Support (green) and Intermediate Resistance (red)
  3. Countertrend Support and Resistance (light blue)
  4. Strong Trend Support and Resistance (pink)

The name of the Countertrend zone comes from the eSignal version in which under most circumstances it was a trade. In the NinjaTrader version it is not a coded trade. Why?  The average countertrend trade makes about 6-8 ticks which is good number, if you get in at the bottom and out at the top.  Additionally as the name implies, you are trading against the trend.  The focus of the NinjaTrader version is trade quality, in which we are looking for 10-12 ticks or more.  There will be posts as an “out of the box” trade that I will take a countertrend trade from the blue zone.