Sunday, October 11, 2009

Passing the Plate: An Experienced Prop Firm Trader Shares His Setup

This post goes back to a September trade in AIG (see chart above). Credit belongs to Adam, a successful prop trader who I have had the pleasure of knowing for a while now. Adam's firm, T3 Capital, maintains a website that you might want to check out. It features a number of learning services, including a virtual trading floor.

Monday, September 21st offered a great trade in AIG for Adam. Here is his detailed explanation of the trade:

"For the past few months, the market's strength has been obvious. I think the one thing that sets this rally apart from other rallies is the fact that it is not just the market as a whole that has been rallying. On days where the broader market seems to be taking a breather or even pulling in some, there have been stand out "daily plays" on the long side that have been going up a significant percentage every day. I felt that AIG was a fitting stock because it is mainstream and has had a ton of volume since reverse splitting. There had been a tremendous amount of momentum in this name.

When looking for stocks to get involved with intraday, traders must do their homework by first looking at daily charts to see which stocks are "in play", then breaking them down to the relevant time frames which they typically trade. My time frame (along with other traders in our firm) are the 5-minute intraday, 15-minute intraday, and the daily time frame. I tend to use ranges anywhere from 5 days to 3 months to 1 year, just so I can have price points to use as reference for most recent levels to watch for breakouts. I also think it is important for a trader to know a stock's 52-week high.

August 5th was a signficant day for AIG. It put in a tremendous wide-range bar on monster volume. It had almost a 10-dollar range; if a trader didn't capitalize on it this day, it was important to put it on the radar for the following few days or even weeks. This type of day is a sign to an intraday trader that there is money to be made in this stock over the next few weeks. Sure enough, the stock continued to climb higher. Every pullback was small and every rally was strong, with volume on the up days far greater than volume on the down days.

That brings me to my trade. After having a big run into the end of August, AIG came in and settled into a tight range for the month of September. On the prior Monday, it put in a significant green bar with volume. Its range contracted every day of that week, with volume drying up each day. On Friday, September 18th the stock showed a little life, but then came in at the close.

So the first level a trader should look for the stock to break would be 40.80, which was Friday's high. The market gapped down on Monday morning and AIG gapped down as well, but went green within the first five minutes of the day. The stock was displaying relative strength immediately. Once the stock went from red to green, a trader could have made a case to buy it then. But if you are more technical, you could have put a buy stop above 40.80, gotten filled, and within the same five minute bar had a 2 dollar profit.

This trade worked, but I am a bit longer term than that and like to build into a position. Already at this time of day AIG was coming up on my filter with larger than average volume, so I knew this stock was going to be one to watch today. Recently, when AIG has had "special days", the range on the stock has been exceptional, so the fact that it sprinted up so fast in the morning should have been a hint that it could be one of those special days for the stock.

The market proceeded to break lower at 9:55 AM and AIG barely came in. To me, this was an entry point for a few reasons: The market sold off hard, but the stock was showing positive divergence, great relative strength, and big volume for that time of day. It was also holding its breakout level from the last five days, which was 41.30. This was a well-calculated risk/reward entry point. After the selling stopped and the market began to uptick again, AIG rallied from 42 to 45 in three five-minute bars. Again, if you are an active daytrader/scalper, a three dollar move in this short period of time is tremendous. And remember: this was all happening within the first 30 minutes of the open with the market still sitting in the lower end of its range for the morning!

At this point on the daily chart, AIG was now at its highest point for the month of September and was on pace to put in its biggest volume day for the month as well. Traders at our firm wanted to see the stock consolidate its gains and base out for hopefully another move in the afternoon, which is exactly what we got. If you look at 15-minute candlesticks, AIG's range contracted significantly after the big move in the first 45 minutes of the day. Before 1:00 PM, its range started to expand and it began to inch up to the morning highs of 45 again. It consolidated there for about 30 minutes and pushed through to new highs. This was a fresh buy signal for traders in our firm. Thas all happened with the S&P futures not really doing much on the day or even at the time. They weren't near the highs they had made around 11:30 AM, yet AIG had broken out to new highs.

Technically, the stock traded great in the afternoon. A trader could have put a stop in at $45 after it broke higher on the day and would have risked 60 cents to make a few dollars. There was really no reason to get out of this trade in the afternoon, other than to book profits. The stock got a few cents shy of $50 before pulling back, but still finishing great. This also qualified as an overnight position for traders at our firm."

I want to thank Adam for taking the time to detail one of his trades. Note how he integrated a wide array of information in generating and managing the trade, including price levels from recent and longer time frames, volume, and relative strength. Observe also how he waited for the stock to show its strength before making his moves. Hats off for a good trade and--better yet--an inside look at how a pro trades.