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advantage of access provided by electronic communications networks (ECNs), and faster access can increase the volatility.

What that means for the Nasdaq trader is that because this pittraded futures contract is comparatively illiquid you can end up with a wide bid-ask spread. It’s not unusual to call the trading floor for a quote and find that the market is 500 “pit points” wide (or 5.00 on your screen), meaning it’s 1980 bid and 1985 offered. If you’re trading 10 contracts, that’s a $5,000-wide bid-ask spread—which is another reason why you can’t trade with your stops too close.

There’s another phenomenon that we see in volatile markets such as the Nasdaq. It can show up in virtually any traded market, whether a stock or a stock index, particular when conditions are volatile and movements are fast. This is the “air ball.”

Once again, the sports analogy: In basketball, when a player shoots for the hoop but misses—no backboard, no rim, no net—it’s called an air ball. The minute the ball leaves a player’s hands until it hits the floor it doesn’t touch anything but air.

This kind of action can happen frequently in the Nasdaq, where an “air ball” can cover as many as 20 handles and sometimes 30 han- dles—or even more. What happens then is there is nothing between one price and another but “air”—or more precisely, massive acceleration to the upside or the downside.

For example, on February 13, 2001, Nasdaq was trading at 2312 before a final-hour sell-off that took us down to 2212.

Another day from our trade archives was Thursday, September 21, 2000. In the last half-hour of trading, the Nasdaq rose from 3768 to 3810—or 42.00 points or 42 “handles”—all in seven minutes. Six minutes later, Nasdaq futures were back down to 3769—a drop of 41 handles—and closed at 3765, three points below where they took off. Let’s take a closer look at this action: at 2:48 P.M. Central time, Nasdaq futures went from 3780 to 3795 in one minute. That’s an air ball. Then at 2:51 P.M., it went from 3799 to 3810—11 handles—in another minute, and another air ball. On the downside, in six minutes, Nasdaq dropped all the way back to 3775—or 35 handles.

What causes “air balls”? Perhaps there is speculation about an event or a rumor that circulates that sends a shiver of panic through

the market. Short positions are dumped. Long positions are exited quickly. Whatever the reason, it’s apparent that air balls—sudden, rapid, and sometimes unexplained events—are going to happen, especially in a dramatically volatile market like the Nasdaq.

EXTENSIONS

Another feature of a volatile market such as the Nasdaq is “extensions,” which are simply percentage changes from various moving averages (see Chapter 3). For example, let’s say the 20-day moving average in the Nasdaq is at 2500. If the current price is 2650, that would be a 6 percent upside extension. Plotting these extensions on a graph, you can analyze these correlations, to see when—and where— the market is abnormally extended. (Think of a kid on a swing at the playground. That swing can go out and up just so far before it begins to swing back. And it can swing back just so far before it moves forward again.)

Typically what we find is that a bounce or a reversal is more likely to happen when the Nasdaq trades at more than a 12 percent extension from the 20-day moving average. But in recent history, given the dramatic moves in the Nasdaq, we have seen some monumental extensions. For example, at the highs in March 2000 the Nasdaq Composite was about 58 percent above its 200-day moving average, an abnormally wide extension to the upside. The biggest reading on the downside was at the lows of 2001 when the index was 63 percent below its 200-day moving average.

Once you know that, how do you use this information? For one thing, it helps to determine what is likely to happen next. Trading, in many ways, involves finding when the odds of something happening are high, which increases the probability of success for a trade. For example, let’s say that the Nasdaq is extended at a very wide percentage (compared with recent activity) from the 20-day moving average. At that point, the odds are slim that you’d get much more of a long position. (Conversely, if the Nasdaq is extended by a very wide percentage below the 20-day moving average, you’d expect that virtually all

of the downside potential has been exhausted.) The strategy at that point would be to look for the best place to cover a position and exit. You probably wouldn’t jump on the opposite side, however. For one thing, there is still a chance that the market could extend further to the upside or downside—although the odds of a continued significant move are slim. Rather, you’d wait and look for the market to reverse, the next day or the day after that, to take advantage of the extended conditions—either overbought or oversold.

MARKET DYNAMICS

For the sake of those trading the Nasdaq, we would be remiss if we didn’t discuss the dynamics of the futures market—both the Nasdaq major contract that trades in the pit at the Merc, and the scaled-down Nasdaq 100 e-mini, which trades electronically. The Nasdaq major contract does not trade that often in the pit. Liquidity there is comparatively light. In the Nasdaq e-mini, however, there are far more price changes. What this means for you, the individual trader, is that in the Nasdaq e-mini, orders, cancels, fills, and reversals can all be done in seconds. But in the pit, these actions can take 10 or 20 seconds—or maybe even minutes.

As a result, quotes and trades in the pit often are playing catch-up with the e-mini. This sets up an arbitrage opportunity between the Nasdaq major and the Nasdaq e-mini for serious, professional players. Granted, to do this you must have a Globex machine (see Chapter 2), the electronic terminal from the Chicago Mercantile Exchange, to trade directly. And you must have someone in the pit trading the Nasdaq major. This kind of setup allows professionals to trade off the price differentials in the e-mini, which tends to react faster to changes in the underlying stocks, and the major.

One other word on liquidity: When you are trading individual Nasdaq shares, make sure there is enough volume and liquidity in the issues you choose. In the beginning, stick with the household names, when you can be assured of strong volume that will make for a fairly orderly trade (even in volatile conditions). Don’t try to trade—particu-

larly on a day-trading basis—low-volume stocks. The participation may not be there to make for predictable movement. And when a comparatively large buy or sell order comes in, the stock may overreact to the point of severely undermining your position.

Meanwhile, there is also an interesting dynamic between the Nasdaq and the S&P, which sets up an intriguing interplay between the two markets. As we’ve seen—especially in 1999, 2000, and thus far in 2001— there are times when one index will dominate, leading the other upward or downward. At TeachTrade.com we are always watching to see if one of the three major indexes is dominating, if one is dragging down the rest, or if all three are moving in concert one way or the other. We often note that for a rally to be sustainable, it needs the three major indexes— Nasdaq, Dow, and S&P—to be moving together to the upside.

When there is a convergence among the indexes, that convergence often is a function of money flow. Often we’ve seen in first-quarter 2001 and thus far in second-quarter 2001 money flow into and out of techs. On days that the Nasdaq has rallied, we’ve seen bargain hunters buying Nasdaq tech issues at fire sale prices, often at the expense of the blue-chip and household names of the Dow. Certainly during the “tech wreck,” we saw money flow out of techs and into the safe, more value-oriented Dow stocks. Watching the sectors you can see which stocks are in or out of favor at the moment.

Of course, both the S&P and the Nasdaq are reacting to the price movements of the stocks in their relative cash indexes. But the technology-dominated Nasdaq is the quicker of the two to move and react.

For these reasons, Nasdaq traders need to be acutely aware of the type of market they’re in. There are times when volatility is high, and traders need to adjust both their strategies and their executions. At other times, volatility contracts and the market is thin, making for an unproductive and fruitless trade. The important thing is to listen to what the market is telling you, instead of to what the pundits are saying it should do. In the first quarter of 2001, while many of the general investing population were looking for (and hoping and praying for) a bottom, traders got caught looking for a breakout that never happened. Time and time again, we saw the market able to rally only from the

lows. At the highs, the trade just died. What did that tell us? The market was tentative as it moved higher, and interest evaporated at the highs. The wishful thinkers could postulate all they wanted. The market had the voice of authority, and it was saying, loudly and clearly, that it was not time for the breakout—yet.

As of this writing, the market pundits are more positive. Commerce Department data that shows growth in the economy—with the gross domestic product (GDP) for the first quarter gaining 2 percent instead of an expected 0.9 percent—has been touted as evidence that the economy is okay and recession is not a concern. (At TeachTrade, we cautioned that this is an economic indicator in the rearview mirror and is not a forward projection of growth.) This underscores the need to trade the market as it’s presented to you. Don’t trade on expectations, or hopes and wishes. You may want a rally, but unless that materializes in the market and is sustained, you can’t play the breakout. You may think the market will pull back significantly, but if volatility declines and Nasdaq is stuck in a tight range you have to trade it as such.

That’s why, in any trade but especially in the Nasdaq, you must put emotion and expectation aside. Analyze the market that you’re trading; watch the charts and the other indicators. And remember, the Nasdaq is a different kind of animal: fast and unpredictable. Unless you can be quick to analyze moves as they’re happening, this is not the market for you. But if you like volatility, then you may have found your trading home.

to work with and learn from some of the best traders imaginable who took the time to train me and explain how things work. I’ve tried to extend that legacy by training young traders who had the dedication, discipline, and drive. In these chapters, I’ve tried to give you what I believe are the essential lessons of day trading.

If you take away one thing from this book, let it be the realization that there is no one surefire indicator, or never-fail system. Trading is a process that begins and ends with you: your technical analysis, your discipline, your trade execution, your commitment. All that adds up to how you do on your inevitable learning curve.

As we wrap up The Day Trader’s Course, I want to address some of the questions and topics that I’m frequently asked at seminars or in reader e-mails. Chances are these are some of the questions you may also have.

“HOME RUN TRADES”

Many young traders hope for the “big win,” the kind of trade that gives them a big profit and bragging rights to a great story after the market closes. They are hungry to take those 20 handles in S&P futures or that 15-point move in a stock. They want this so bad they can taste it. The problem is, in their quest for the big one they may be missing a lot of little ones along the way. Or, worse still, they may try to trade the smaller moves as if they were the big break.

To use yet another sports analogy, you can’t swing for the fences every time you’re at bat. (Keep in mind that the same year that Babe Ruth led the National League in home runs he also led the League in strikeouts.) Rather, you take your pitch, swing as hard as you can, and run as many bases as you can without getting out. In trading, you devise your trading plan every day, you wait for the setup, and then make your trade. You stay with that trade according to the parameters of your plan. You get in and out of the trade based on the price points identified by your technical analysis.

As a beginning trader, in particular, your goal is to make several

well-executed trades. The net result of small profits and even smaller losses is a profit. You may not have “the story” to tell at the bar about the five-figure trade you pulled off. But if you stick with your plan, with well-executed trades and discipline above all else, there is little chance that your buddies will be telling a story about you and your five-figure loss that wiped you out of the market.

Yes, I’ve made some big trades. But over my 20 years in this profession, I’ve been more “tortoise” than I’ve been “hare.” Slow and steady—methodical and deliberate—does win the proverbial race. The hare that wants to dash toward the big profits will run out of breath—and capital—too quickly.

EXITING TOO SOON

Many beginning traders complain that they get out of a trade “too soon” and, in hindsight, they see the profit they “could have made.” Hindsight, as they say, is always 20–20. But when you’re in the thick of things, it may be hard to see clearly. First of all, you should know your exit point and your stop-loss level before you execute your trade. You get in at A, your target is B, and you set your maximum loss at C. Then you execute the trade.

If it turns out that B was only the middle of the move and the market eventually went to D, then you should examine your setup again in the light of your technical analysis. It could be that you missed the trading signal that indicated a bigger move. Or the market may have surprised you. In either case, keep in mind two things:

1.Trade according to your plan. If your analysis indicates a price at which to exit and the market keeps going after you do so, then congratulate yourself for sticking with your plan. If you think the market has a chance to make a run beyond your initial target, you may want to scale out of the position. Get out of, say, half your position at the first price target, and then scale out of the rest at other price targets.

2.Nobody ever went broke taking a profit. Better to sell too soon than to hang on too long and turn a winner into a loser.

HANGING ON TOO LONG

For every trader who has the problem of “exiting too soon” there appears to be an equal number who “hang on too long.” These traders are so worried they’ll miss something that they don’t take the profits that they have in their hands. Once again, it goes back to the trading plan. Pinpoint your entry, exit, and stop points and stick with them. You may determine—based on technical indicators and market behav- ior—that the market could make an extended move in your direction. If that’s the case, then reduce your position (taking a profit) at the first target and exit the rest at successive targets. If you scale out of a position, however, remember to move your stop to the first profit target. That way, if the market turns against you, the stop will be at your original target.

When you trade, keep in mind the story of the goose that laid the golden egg. The goose laid only one golden egg per day. Eager to get more all at once, the farmer killed the goose and looked inside. No more golden eggs; just a bloody mess. If a well-executed trade yielded a profit, that’s great. But don’t hang on to squeeze more of a profit out. If you do, you could end up like that farmer—or the goose.

PRICE TARGETS

Do support and resistance levels become targets for the trade? The answer is yes . . . and no. Remember Chapters 3 and 4 in which we put the first indicators on the chart. When you have a trend line above the market (resistance) and a trend line below the market (support) you have determined the expected boundaries for that market. The only time the market would extend beyond these levels is if it were breaking out in one direction or the other.

Thus, support and resistance act as the initial parameters to define

the trade. Beyond the first levels above and below the market, there will be other resistance and support levels. For example (taking an excerpt from our Morning Meeting of May 3, 2001), we identified a support zone between 1262.50 and 1257. Below 1257, we saw another support level at 1248. On the resistance side, we targeted 1264 to 1265 and then 1271. S&Ps opened at 1262 and made a high at 1262.50 (at the end of our support zone) before trading lower to around the 1248 level. Our resistance levels of 1264 to 1265 and 1271 weren’t touched. At midday, they continued to define the expected upper parameters of the move. At the same time, it’s easy to see that the support levels outlined earlier did act as targets.

You may find that the support and resistance areas that you identify in your technical research are similar to others that you read about in market commentary, such as on TeachTrade.com. Some of this is obvious. If 1270 is a double top, then much of the market focus is going to be on that level. Other aspects are more subtle, such as retracements of particular moves or the observation of two-sided trades (with buyers and sellers both active).

Most importantly, understand that there is really nothing magical about support and resistance areas. They are guides to help you plot your course of trading. The market may reach them; it may not. But knowing where these parameters are will help you to determine where you want to enter and exit your trades.

Identifying the significant support and resistance areas will help you to plot your trade; then, depending on your trading style and time frame, you will trade between those price targets.

S&P FUTURES TRADING

I’m often asked why I trade mostly S&P futures instead of day trading stocks. When it comes to stocks, I make some short-term trades (based on technical analysis) as well as longer-term investments. But I make my living trading S&Ps. Your choice of what you trade is like many life choices. You end up being affiliated with what’s familiar to you, and what suits your nature and your personality.