A great way to reduce our basis is by scalping around our core positions. This is done by trading in and out of a position intraday. We often use this strategy to take advantage of what the market is giving us on any given day.
Today, Tom Sosnoff and Tony Battista discuss all of their best practices when scalping futures. The guys explain their do's and don't's around scalping and how you can use it to lower your cost basis!
Tony Battista: Thomas, we're back my friend. Best practices. Scalping.
Tom Sosnoff: Yeah and I'm excited about this one because I wrote it up with a team because it's a lot of the things that you guys have asked me to do.
Tony Battista: Fozia said, she didn't say follow Slim. She said listen to Slim.
Tom Sosnoff: What's the difference?
Tony Battista: I don't know.
Tom Sosnoff: What's the difference?
Tony Battista: I don't know. I just don't want her mad at me.
Tom Sosnoff: Huh?
Tony Battista: I just don't want her mad at me.
Tom Sosnoff: Okay. You're such a whus! Whatever! Scalping. You ready? Let's have some fun with this! So, let's talk about in-house parameters for intraday trading. When I say in-house parameters, that means me and Tony. We're your in-house parameters.
Tony Battista: That's correct. And your barometers and everything else.
Tom Sosnoff: And for intraday trading that's just another term for scalping. I've never liked the term day-trading because I've been, I guess I've been what people call, I guess when we got off the floor we heard the term day-trader for the first time and I didn't even know that I was considered a day-trader.
Tony Battista: Right.
Tom Sosnoff: Do you know what I mean? So I had only heard two terms: scalping and intraday spreading, intraday trading, whatever it is. So these are kind of mine and Tony's parameters for what we do during the day and part of it, most of it is about engagement but I clearly - I fully expect to make money. At the end of the year, I think that thirty years of doing this is worth a lot of money and at the end of the year, it usually is! So that's part of what I do. Let me walk you through this.
Tony Battista: Okay.
Tom Sosnoff: So first of all, just some background. First, you have to be permissioned for all products because if you're not, then just . . . If you're not permissioned for all products, you're not the level where you should be doing this yet.
Tony Battista: Sure.
Tom Sosnoff: It doesn't make any sense. In other words, if you're going to be good at something, you have to be able to use all of the tools, products at your disposal. If you don't, you're not ready. That's all. It doesn't mean you won't be but you're not ready. You must be familiar with all the products, their tick sizes, and their risks. That doesn't mean seven thousand products you have to understand. But the biggest, most liquid projects, you have to be familiar with what's out there so you can easily make a change for example, from NASDAQ futures to Russell futures and know what you're doing. Or from a hundred shares of … let's just say a hundred shares of UAL to the equivalent of a hundred thousand dollars’ worth of Spot4X, if that's what it takes.
You just have to understand the very basics. You must be familiar with the corresponding options, ETFs, and pairs. So for example, if I suggested we're going to trade the SMP500, you must be familiar with the spider options, the ES options, any other ETF that you would consider correlated and then anything that we can pair off that with that's reasonably liquid.
So again, it's not knowing every one of seven or eight thousand products out there. It's just . . . it's a reasonably . . . it's an acceptable understanding of enough stuff that's out there.
Page number two. The correlation know-how is also important. So just like this morning when somebody said to me, What's the deal with notes and NASDAQ? You know, understanding that the correlation between implied volatility and notional value is how we figure it out, that's a very basic because I'm not looking for you to be able to explain all of the fundamentals and everything about each contract. I just kind of want to know the simple overview. How is that correlated?
You must have the ability to multi-task when you're trading which means you have to have the ability to make different trades simultaneously. And remember, this is about scalping. This is not about investing or trading. You asked questions about scalping, I'm giving you these.
You have to have the ability to multi-task which means trade multiple products at once. I do the show and trade multiple products.
Tony Battista: Oops! Sorry, sorry, sorry. I didn't finish.
Tom Sosnoff: You must have the capital so this is very difficult to do when you have limited capital or you have regulatory limitations. So for example, if you're under the pattern day trade rule, you're only allowed when it comes to stocks and options, you're only allowed to trade three times in and out in a four day period.
Tony Battista: Or, is it four times in a five day period? I can't remember right now.
Tom Sosnoff: It's either three times in a four day period or four times in a five day period but that's in and out of the same underline the same day. In futures markets, those don't apply. If you're doing in today, out tomorrow, that's different too. I caution you. You have to have the capital to be able to do this so it's not for everybody. Then finally …
Tony Battista: Execute four or more trades in five business days. [crosstalk 05:13]
Tom Sosnoff: Those trades are in and out of the same underline. And then it's the max use of capital has to be between ten and twenty percent. So in other words, even if you have let's say twenty-five thousand or fifty thousand you can't really go much over using more than five thousand on a twenty-five thousand dollar account or let's just say ten thousand on a fifty thousand dollar account because that would be committing too much of your capital.
Tony Battista: Sure.
Tom Sosnoff: You have to have the capital to do it and then the max use of that capital has to be between ten and twenty percent. I will review these one more second. You must understand the liquidity and the leverage of the most active instruments. So knowing the difference between for example, trading bonds and notes, bonds being two times the size of notes. Knowing the difference between SMPs and NASDAQ or SMPs and natural gas, you must understand the liquidity and the leverage of the most active instruments.
You must also have an advanced understanding of the implied volatility, both individual and broad market because if you don't know broad market volatility, and you don't know individual volatility you're doing yourself a disservice. You can't set up expectations.
Tony Battista: Sure.
Tom Sosnoff: It's going to a game without knowing what the weather is going to be so you don't have the right clothes, whatever it is. You must be an active trader to begin with because otherwise, you will not understand the concept of staying small. Let me review these before I go to the next page because that's when we get into the heavy stuff. So again, these are mine and Tony's in-house parameters. We don't usually do this but I don't think anybody has ever written a good book on this or really laid this out and I think this is it.
These are for intraday trading. We call it scalping. I don't even know if that's politically correct anymore but in-house parameters for intraday trading. Again, you must be permissioned for all products. It's critical. You must be familiar with all products that you are going to trade, tick sizes, and risks. You must be familiar with the corresponding options, ETFs, and pairs. We call this a combination of market awareness and market preparedness.
Next thing is, you have to understand correlation. You see, you need some correlation know-how. Not asking you to be a pair’s expert or basis trading [inaudible 07:38] but you have to have correlation know-how. You have to have the ability to multi-task. If you are a very one-dimensional trader, which is not bad, okay. You just can't do this. It's too hard. You have to have the ability to trade multiple things simultaneously.
Tony Battista: Some things are not for everybody, right?
Tom Sosnoff: You have to have the capital to scalp or to daytrade and you have to have the max, meaning you have to have a certain amount of capital because the max use of that capital has to be enough to trade with which should be ten to twenty percent of what you have.
Then on the last page, you must understand liquidity and leverage of the most active instruments. This is something that most people take for granted and it shouldn't be. Very hard. You must have advanced understanding of implied volatility both for the individual underline that you want to trade and for the broad market because otherwise, there's no context. You must be an active trader to begin with or you will never understand the concept of small.
Now, we get into the heavy stuff which is you have to be able to approximate the daily range of assumptions based on current, active at the [crosstalk 08:41]. You must be able to approximate daily range assumptions, that's price range assumptions, based on current, active, at the money, implied volatility. The biggest contract out there is the SMP500 and if you look at the VIX right now, you're talking about, let's ballpark it and say it's a 1550 VIX. So based on a 1550 VIX, we know and based on the twenty dollar stock price, we know that the expected move is probably in the SMPs, around fifteen dollars. We've got a ten dollar move so far. If you're looking for price extreme . . .
Tony Battista: There's a sixteen dollar top to bottom move [crosstalk 09:21]
Tom Sosnoff: Which is kind of the expected top to bottom range. All that does is, it set you up for reasonable expectations based on where we are right now versus what we should expect to make. Meaning if I sold something, and I was up six dollars, that would probably be as sweet of a percentage that we're going to take out of this market for this particular day.
So again, you must be able to approximate daily range assumptions based on current, active, implied volatility. That means you have to know where the stuff is traded. If you're going to trade nat gas, you have to know where UNG is trading. If you're going to trade oil, you have to know where USO is trading. These are all implied volatility wise. So we're not talking about IVR at this time. We're just talking about implied volatility. Give yourself a certain range.
Tony Battista: Sure.
Tom Sosnoff: Then you want to be able to of course, understand IVR so that we just know to what extreme we are. You must be able to assess price extremes, because it's the next question, at both ends of the range per opening criteria. So before the market opens in the morning, you've got to be able to understand what is a price extreme today, or what may be considered a price extreme today. If the expected move is fifteen or sixteen points and we go thirty points, I think that's a little bit of a price extreme.
Tony Battista: Sure. Sure.
Tom Sosnoff: If we're at forty points, that's a price extreme. It's outside of what was normally expected. If we go six points, you have to be careful because you want to enter at either intermediate price extremes or at important price extremes. Two different things and it comes with experience.
You must recognize that two-way trade is difficult. One of the things you almost never see Tony and I do is play both sides of the market. People that say you can do that, God bless them. I have never seen anybody do it.
Tony Battista: Right. Or do it successfully. Correct.
Tom Sosnoff: I've seen Slim in different roles throughout his career, buy the bids, sell the offer. You know, just trade back and forth a two-sided market. I think it's extremely difficult. I think even he would tell you that it's extremely difficult. I think if you watch like those [Paul Jones 11:27] videos, back in the 1980's and stuff there was a lot . . . the markets were a lot looser. There was far less efficiency. They were a lot looser. There was an opportunity to play potentially different forms of arbetraj based on the technology you had. That doesn't exist today. There is no two-sided trade. You can't bet the house and the bank. It just doesn't work. So you essentially have to pick a side and that's going to be your side.
Tony Battista: Go one more?
Tom Sosnoff: Yeah.
You must be comfortable with a rinse and repeat mentality. This is really important. So in other words, you make a trade and it's a winning trade, then you get right back out there. Not necessarily every trade. Not necessarily everyday but you must be comfortable. There's no such thing as Hey, I'm one and done.
Tony Battista: That's right.
Tom Sosnoff: You have to have that I don't care. I'll just get right back in. I'll just do it again. I don't care. I'll keep doing it until it doesn't work. So we have that rinse and repeat mentality.
You must set reasonable profit targets for yourself. This is what, if you've watched us over the course of the year, we've shown you every single scalp that we've done in 2014 and there's been thousands of them. I think we've had some really bad trades this year and we've had some amazing scalping this year. Part of it is we've gotten our mechanics in much better order than ever and our success rate on the scalping has been remarkable this year. Part of it is just using a set of mathematical mechanics that we never did before. One of the things we've done is we set reasonable profit targets based on current, at the money, implied volatility.
So we're not looking for fifty percent or a hundred percent or whatever it's supposed to be of implied volatility. We're setting reasonable targets intraday at twenty, twenty-five, thirty, thirty-five percent of whatever the expected move is which is still a big number. We're not talking about ticks. We're talking about pretty significant pointage and it's been quite interesting. So we're setting profit targets at twenty-five, thirty, and thirty-five percent of intraday projected ranges.
You must recognize when you are in the wrong product. Notice how I didn't say you must recognize when you're wrong because it is very hard to recognize when you're wrong. I mean as much as we love to say oh I'm wrong so I recognize, that's really hard to do. I think you have to recognize when you're in the wrong product and when the move has exceeded your expectations. So what you do then is you just back off. You just take a step back and you go okay, I'm going to wait a little bit.
So again, I went through this fast. I'll do this again because there's . . . Tony Battista: There's a lot of take-aways in there. Tom Sosnoff: Oh my God! There is a lot of take-aways. But let's focus this. You must be able to . . . is this my . . . Tony Battista: Slide three. Tom Sosnoff: So, you must be able to approximate daily range assumptions and everybody needs to do this because you cannot effectively trade if you don't understand kind of what's expected of this underline. You can't sit there and say, Oh I expect this thing to move six dollars today. It hasn't moved six dollars in two years. Okay, it doesn't happen. You must be able to assess price extremes, which are extremely difficult to assess. Price extremes are totally subjective. Tony Battista: Of course. After the fact, you can come up with the price extreme, for sure. Tom Sosnoff: Recognizing that two-way trade is difficult is something really hard for most, especially new traders because I've seen a million people teach classes on daytrading. You just buy them here and you sell them here. You go short here, you go long here. Not even possible. No good trader has ever done that in the history of trading. It never happens. You'd be the first. You must be comfortable continuing to repeat yourself. Sold them here earlier, sold them here again, sold them here again, sold them here again. You must set reasonable profit targets at twenty-five, thirty, and thirty-five percent of max profit and you must recognize, hey, I'm just in the wrong product. I can't do any right in this product. Tony Battista: That's not like yesterday when we were trading NEM and you thought you were looking at G&G. That's not being in the wrong product, right? Tom Sosnoff: No. That's not being in the wrong product. That is something completely different, thank you. That was user error. But you should save your jokes for HBO. Tony Battista: HBO wants me? Vanna! Pack your bags! We're leaving! We'll be back in ninety seconds. We got a booster [inaudible 15:55] Tastytrade live.