The Perfect Day Trading Setup?

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Does the perfect day trading setup exist?

First of all, what does "perfect" mean?

The perfect day trading setup is NOT a trading strategy that never loses. Actually, that would be great, but it's a dream. It doesn't exist. When trading, losses are part of our business as traders.

So what IS the perfect day trading setup?

For me, it's a setup that...

  • ... is easy to execute,
  • ... does NOT require sophisticated charting software,
  • ... can be traded with ANY account size (small accounts and large accounts),
  • ... uses a small stop loss,
  • ... requires minimum time commitment,
  • ... has a high average profit per trade,
  • ... is easy to scale and trade with larger lot sizes as your account grows.

If you're definition of the perfect day trading setup is the same,
you should consider day trading spreads.

Let me explain...

Why Spreads?

Spread trading is great for conservative traders because spreads with correlated markets are relatively trades with much less risk. Instead of having complete market exposure by being long or short one market, an offsetting position is added, reducing the impact of market fluctuations. Brokers recognize this too, and will typically require much lower margin requirements when trading spreads in leveraged markets (like options and futures). This is a big advantage for traders with smaller accounts because it allows traders to hold positions overnight with relatively low margin requirements.

What Is A Spread?

Spread trading is the simultaneous buying and selling of the same, or two like markets. When trading correlated markets there is a tendency for these markets to move in the same manner, so a loss in one market will be offset by a gain in another. If the markets are in perfect “synch”, then there is a true hedge and any gain in one position will be offset by the loss in the other. In a perfect world, correlated markets exhibit similar moves and behavior, but we know that in reality this is rarely the case. It's these discrepancies that spread traders look to take advantage of.

Intramarket vs. Intermarket Spreads

Spreads are broken down into two categories: Intramarket & Intermarket. An intramarket spread is a spread that consists of a long and short position in the same market, but with different expirations (this would be the same as a calendar spread). This type of spread applies to options & futures trading and is a great way to capture moves when there is an expectation for a market to move and experience volatility in the near term.

As an example, if you are bullish gasoline heading into the summer months and driving season, you could buy gasoline futures with an expiration in the summer, and sell a contract with an expiration that is further out. If you are bullish heating oil going into the winter, you could initiate the same type of spread strategy.

Intermarket spreads consist of a long and short position in two like markets.

My Favorite Spread Trading Strategy

One of the easiest intermarket spreads to trade is the spread between the Russell 2000 and the Nasdaq 100. As you might imagine, these indices have a tendency to move together since they both represent baskets of U.S. Stocks. Although there is a strong correlation, there tends to be days when one market outpaces the other. You can identify times when one market is moving faster than the other by plotting the spread on a chart (showing the difference between both markets) and using technical analysis.

A great spread trading opportunity in the Nasdaq-Russell spread occurs with the overnight gap. If you're new to futures the Nasdaq symbol is NQ, the Russell is TF. To find trading opportunities, follow the steps below:

  1. Chart the NQ – TF spread on a 5 minute chart. Most major charting packages give you the ability to plot spreads and you'll need to see the difference (spread) between these two markets to make trading decisions.
  2. Take the previous day's U.S. Day Session closing price of the spread at 4:15pm ET. Compare this price to the current session's spread price at 9:35am ET, after the first completed 5 minute bar. The setup here is to trade in the direction of the gap. If there is a gap down, go short NQ, long TF. If there is a gap up, go long NQ, short TF.
  3. Once you're in a trade, always know when to get out! With this setup consider a $150 stop loss. Since the most movement and volume typically occurs in the first few hours of the U.S. trading session, you'll want to try to capture as much of this move as possible during this time. We've found that closing the trade at 11:30am ET is a great exit for this strategy. If you prefer, you might consider a $300 profit target. This is more conservative and will get you out of trades quicker, but you'll miss some of the bigger moves that can occur from time to time.

Entering after the first 5 minutes helps eliminate some of the noise you would experience otherwise near the open. If things turn around, you should be able to limit your risk to approximately $150 per contract. On the other hand, if the spread continues to widen you can hang onto the position throughout the morning session, capturing a pretty decent move between the two markets.

Perfect Day Trading Setup - NQ-TF Spread

 In the example above, we see yesterday's (August 20th, 2013) NQ – TF 5 minute spread chart .

Below is the NQ 5 minute chart:


And here's the TF 5 minute chart:


Since the spread showed a gap down between the 4:15pm close and 9:35am first bar completion, the goal would be to go short NQ and long TF.

Our positions at 9:35am ET:

SHORT NQ at 3075.0

LONG TF at 1013.6

During the session the spread moved against us $75, then continued to move lower throughout the session. At 11:30am ET we can close the spread by buying NQ and selling TF.

Our closed positions look like this:

SHORT NQ 3075.0, close at 3087.0 for a LOSS of $240

LONG TF at 1013.6, close at 1022.8 for a PROFIT of $920

Although we lost money on the NQ side of the trade, we have a total closed profit of $680 because of the profit in TF.

TF profit of $920 – NQ loss of $240 = $680

Even though both markets moved higher, the TF move was stronger and outpaced the move higher in NQ. This discrepancy led to a $680 profit during the first two hours of the trading session. If the spread went against us we would simply close the trade with a $150 loss and look for a new opportunity during the next trading session.

Getting Started

Just as with any strategy it's important to practice this method on a simulator before trading it live. Watching spreads and how a profit offsets a loss (and vice versa) can take a little getting used to, even though the entry is rather simple. The strategy above doesn't consider trade management or early exits, but at times you'll find that one side of the trade is moving so strong that you'd prefer to close one half of the trade (known as legging out), turning the spread into a directional trade.

Spread trading is a fascinating concept, and an effective way to trade markets with less market exposure and risk. With a little practice you'll probably discover that legging in and out of the spread will allow you to maximize your profit potential. Start with these simple rules, and with more experience see if charting reading and legging out can take your trading of the strategy to the next level.

Markus Heitkoetter


Have you used spreads with your trading?
What are YOUR experiences?

Please leave a comment below.


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