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greater chance for a profit (since traders live by volatility). But that also means that the fake-outs can be more dramatic, and the rally that you’ve been counting on can fizzle as quickly as it materialized. Still, the volatility of the Nasdaq market accounts for the general appeal of trading this market.

At TeachTrade.com we post intraday comments on stock index futures, following the movements of S&P futures and Nasdaq futures. Nasdaq 100 futures, based on the value of the underlying Nasdaq 100 index, are traded in the pit and electronically at the Chicago Mercantile Exchange. At TeachTrade, the Nasdaq futures market is monitored and analyzed by my partner, Brad Sullivan, a very gifted and experienced trader, and a team of junior traders who work with him.

A former stock trader, Brad uses certain key equities as indicators of what the Nasdaq is likely to do—and vice versa. His ability to read the market from a variety of perspectives is one of the hallmarks of his success. He also embodies the kind of discipline and focus that make for a successful trader. Brad is 100 percent a screen trader. Standing six-foot-six, he was an imposing figure during a brief stint in the trading pit where size does bring a certain advantage. If you are head and shoulders above the crowd—literally in Brad’s case—it’s easier to spot you when you’re looking to make a trade. But after a brief foray on the floor at the Merc, mainly to experience what that trading venue is like before the marketplace becomes increasingly electronic, Brad makes his living at the screen where he can more easily monitor multiple markets, guide and monitor the activity of the junior traders in the market, and post commentary intraday on the TeachTrade.com web site.

As Brad explains, to trade the Nasdaq futures, you must watch the action of the “big five”—the top five holdings in the Nasdaq 100, which at this writing are Microsoft, Intel, Qualcomm, Cisco, and Oracle. Together, these five stocks equate to more than 25 percent of the entire index’s capitalization. Put another way, what happens to these five stocks is going to have the most significant impact on the overall index. Therefore, it only stands to reason that you must understand and know the movements of at least these stocks on a daily basis.

Take one of Brad’s TeachTrade comments (posted live on the web

Figure 8.1 COMPX Historical Chart (Nasdaq Composite Index— Combine) (Source: www.interquote.com, DTN Financial Services)

people said, “This has to be the bottom,” in the first quarter of 2001, only to have the Nasdaq move even lower in April. That’s why—and especially in ultravolatile markets like the Nasdaq—it’s vital to keep in mind that every day, every trade has dynamics of its own.

As Brad noted in TeachTrade’s “Week in Review” for April 21, 2001, the performance of that Intel-Fed week was undeniable. The Nasdaq 100 was up 36 percent from its low earlier in the month, and the bellwether Semiconductor index (SOX) was up nearly 50 percent.

While speculative fever has not quite gripped the market, there has been a perception that the worst is behind us. And while that perception may be true and is something that we’ve been calling for over the past many weeks, something disturbing has emerged: that is the velocity of this upmove. . . . Certainly one has to wonder and be extremely con-

cerned about the phenomenon that is occurring in the Nasdaq. In spite of the massive decline in individual issues, the valuations have remained extremely high. . . . This leaves us to question how much more upside can there possibly be?

By the time this book comes out, the April move will be part of history, and who knows what market moves will have taken place. We won’t venture to make any predictions here, but one thing is certain if you look at the pattern of the past. The Nasdaq, in particular, remains a volatile, trigger-happy market that moves on some earnings reports and warnings, shrugs others off, and has an emotional quality that can seesaw from euphoria to dire pessimism.

If you’re going to trade the Nasdaq or Nasdaq stocks, you can’t trade in a vacuum. All market forces exert an influence to some varying degree, and possibly in contrary ways. On April 17, for example, Cisco cast a short-term pall on the market, which later shrugged off that news and then skyrocketed on Intel. That’s why you must use an integrated approach to trade setup and execution.

STOCKS TO WATCH

When it comes to trading Nasdaq futures, one of the most commonly asked questions is, What stocks are we watching? The answer is, It depends on the day. As outlined earlier in examples, if one of the major stocks—such as Cisco, Intel, or Microsoft—is in the news, it will exert at least a psychological influence on the market, either positive or negative. For follow-through, however, it’s important to see what other stocks in that particular sector (biotech, semiconductor, networking, etc.) are also affected. In other words, if a semiconductor stock is impacted by worries about future revenue and earnings growth, is it a company-specific concern or a symptom of the state of the industry?

Looking beyond just an individual stock to what’s happening sectorwide is vitally important in a market such as the Nasdaq, which is so dominated by technology. So when you’re using stocks to trade an

index, one of the keys is to study these equities in much the same way you would the index. In particular, you need to watch the intraday support and resistance levels for these key equities. If one or more of these benchmark equities breaks through critical support to the downside or rallies through key resistance to the upside, you can expect some impact on the index overall. Again, remember that the largest stocks in the index exert the most influence. So when they are impacted, the tremor is felt throughout the index.

There are other benchmarks that act as proxies for the overall behavior of the Nasdaq index. Among them are:

•Semiconductor index (SOX): Traded on the Philadelphia Stock Exchange, this price-weighted index is composed of 16 U.S. companies primarily involved in the design, distribution, manufacture, and sale of semiconductors. The index was set to an initial value of 200 on December 1, 1993, and was split two-for-one on July 24, 1995, according to the exchange.

•PHLX/TheStreet.com Internet Sector (DOT): Also traded on the Philadelphia Stock Exchange, this is an equal-dollar-weighted index composed of 24 leading companies involved in Internet commerce, service, and software. The DOT was set to an initial value of 200 on September 30, 1998.

•Nasdaq Biotechnology index (IXBT). This index contains companies primarily engaged in using biomedical research. Established on November 1, 1993, the Biotech index began trading with a base of 200.

•Amex Networking index (NWX). This index of networking stocks, the largest of which at this writing is Cisco, trades on the American Stock Exchange.

In addition, many Nasdaq players watch—and trade—the QQQs, a tracking stock based on the Nasdaq 100 index. The QQQs are used by both individual and institutional investors to participate in the Nasdaq, but in the form of a tracking stock that seeks to follow the perfor-

mance of the Nasdaq 100 but at a fraction of the value—(about one- fortieth)—of the underlying index.

In addition to these subindexes, there are individual equities that bear watching. As discussed earlier, there are the big five of Microsoft, Intel, Qualcomm, Cisco, and Oracle. While we keep a sharp eye on these issues, we also closely watch what we call our “second tier.” Currently, they include Juniper Networks (JNPR), Ciena Corporation (CIEN), Applied Materials (AMAT), Veritas Software (VRTS), and Checkpoint Software (CHKP).

The movements of the major stocks and the second-tier stocks are like navigation points for charting the probable next direction (or at least giving hints about it) of the broader Nasdaq market. Let’s take an example from some of TeachTrade’s commentary archives. On February 13, 2001, amid pronounced market weakness, Brad noted intraday, “Now the [second] tiers are just giving back their session [gains]. . . . In addition, the SOX continues to struggle. More importantly, we are now nearing our critical support zone, below which new contract lows are the target.” Again, dissecting this comment, the downturn in second-tier stocks and a stall in the SOX signaled trouble ahead for the Nasdaq. At the end of the trading day, the SOX ended the day off 12.40 or 1.9 percent, and the second-tier stocks also settled downward. Nasdaq futures traded down 75.50 points at 2226.

And there are times when Brad will watch a particular technical stock—even though it may not be in the Nasdaq—because its earnings outlook or comments by an analyst on that stock have broader implications for technology stocks in general. For example, EMC Corporation (EMC), a data storage company that trades on the New York Stock Exchange, was on the radar screen on April 11, 2001, when the Nasdaq was under pressure. As Brad wrote in intraday commentary:

What is most important in here is the erosion of confidence. . . .

EMC provided the best example of this. While not in the NDX, the analogy is certainly applicable. EMC announced it will miss earnings expectations by 0.02. Instead of selling off, the stock opened unscathed and traded up to 36—nearly $2 higher on the session. But

soon the frenzy failed and we went lower. The stock is now on the lows at 32, off 2.34—an apt proxy for the NDM [Nasdaq futures, June contract symbol M].

So how do you know what to watch? If you try to keep track of everything, you’ll soon be lost in a sea of information that you’re too overloaded to process. Rather, you need to be selectively focused on your radar screen on those stocks and subindexes that have an influence or act as a proxy (meaning what happens to them is an indicator of what’s going to happen in the broader market) for the Nasdaq. Here are some suggestions of what a Nasdaq futures trader should be tracking daily and intraday.

•Keep the top five stocks on your screen. Watch for activity at support and resistance levels, retracements, and so forth in these stocks. Keep an ear tuned to the financial news for announcements or comments regarding these stocks. If one of the big five is suddenly upgraded or downgraded by an analyst, or makes a comment about earnings, you can expect the impact to be felt in the Nasdaq 100.

•Watch the second-tier stocks. While their weighting in the Nasdaq 100 is not as large as the big five, they do cast their share of influence over the market. It’s particularly important to watch the second tier when the market is discounting (meaning ignoring) the movement in the big five. For example, if one of the big five releases earnings that miss estimates, but that shortfall had already been factored in by the market, then the actual news will have little impact on the trade. Rather, the real sentiment indicator would shift to the second tiers.

•Be on the alert for news in other technology stocks, even if they aren’t Nasdaq issues. What happens to IBM has a broader scope of influence than just the S&P 500. IBM is a technology stock, of course, and if news on IBM has ramifications for the technology sector, look for a ripple to go through the Nasdaq.

•Given the dominance of technology on the Nasdaq, watch for movements in the subindexes, such as the SOX (Semiconductors) and DOT (Internet), mentioned earlier in this chapter. The SOX is often a proxy for the Nasdaq. Many times, if we see a rally in the SOX, we can expect the Nasdaq to turn around, and when the SOX breaks Nasdaq is soon to follow.

•If you’re trading Nasdaq stocks, your radar screen will look much the same. You’ll be tracking the movements of the Nasdaq 100 futures and the subindexes. In addition, keep an eye on similar sectors. For example, if you’re trading a networking stock, look at other companies in that sector. If a rally or a sell-off in one stock is not company-specific but rather sector-related, you will want to know that as soon as possible.

•Read the headlines. There are many online news sources that you can scroll through during the day. If you can configure your screen to have scrolling headlines, then do so. Keep the financial news on the television during your trading session. Or go to one of the many online news sites (see Resources) for updates on the market and individual issues.

STOCK WATCHING—HOW IT WORKS

It’s important to note that we spend as much time analyzing the top 30 stocks in the Nasdaq 100 as we do the index futures themselves. What we’re looking for is a significant movement in one or more of these key stocks as an indication of what might happen in the broader index.

For example, on April 16, 2001, Microsoft closed above its 200day moving average. (That date was also two days before the Federal Reserve’s surprise 50-basis-point rate cut.) Microsoft’s crossing of the 200-day moving average was in itself a significant move, given the pressure that this stock and other technology issues had been under. But what could it mean? The important thing is to analyze this kind of information and use it within the proper framework. What the

(or lack of volume) in Nasdaq futures pit trading—and this makes for a unique market to say the least.

Given these dynamics when it comes to trading the Nasdaq, you must consider your use of stops. As I’ve said previously in the book, but it bears repeating, never trade without stops. However, there are times of extreme or abnormal volatility when stops should be widened to account for the fact that a market could go against you momentarily and then reverse and go in your direction before you have time to react. If your stops aren’t wide enough to accommodate these gyrations, you could get stopped out too soon and miss an opportunity to trade.

Because of the Nasdaq’s generally volatile nature, Nasdaq futures require traders to use wider stops than they normally would. Our professional traders, for example, use fairly wide stops as a rule in Nasdaq futures. In general, you might consider stops that take into account a 1.25 percent to 3 percent move. But remember, when you widen your stops to that degree you have effectively increased your risk. You are saying that you won’t exit an unprofitable trade unless it makes a substantially larger adverse move. The only way to balance that increase in risk is to cut down your trade size, thus reducing the capital you expose on each trade. By cutting your position size, you can keep your overall risk/reward ratio in balance.

Another thing to keep in mind when trading Nasdaq futures (as opposed to Nasdaq stocks in general) is liquidity. Traders looking to play this market have to understand that there is a general lack of liquidity in Nasdaq futures, which have average daily volume of some 20,000 contracts per session. Add to that relative lack of liquidity the volatility of the index. The stocks in the Nasdaq index include some of the largest-capitalization companies in the country. These issues move quickly, especially compared with their New York Stock Exchange counterparts. One reason is because the Nasdaq is a dealer-based market, while the NYSE is a specialist system aimed at keeping a smooth and orderly market. Another is that the majority of the momentum day traders—those who trade stocks based on momentum to the upside or to the downside—trade Nasdaq stocks. Nasdaq stocks also have the