Trading Education: Part 3

Tactics and hedging longer term swing plays

This post will be short and sweet, and hopefully extremely helpful to your execution in trading. Execution is where the money is actually made, there are many people who are very good with general direction in the market who fail to make any money because they fail at execution.

This post is written in the present day, using real price action from the last month, September-October 2023. If you are reading this in the future, you can apply it to any scenario, the price action is very common and similar to what you will see in most rallies.

So you start with a selloff, like we had late September stemming from the dot plot surprise and hawkish FOMC. We sell for a solid two weeks, and say you do your market analysis and figure you want to buy the dip eventually for a retest of 4500 SPX. You also decide that 4200 SPX is a good spot to buy. So now you know you are targeting a roughly 300 point swing in SPX. Knowing that, I would begin with realistic expectations in terms for looking for a precise entry. A precise entry for me in this scenario would be, no pun intended, a 50 point MAE or so. Looking for a 300 pt swing long with a 5 or 10 point stop is just not realistic. I see this alot on Twitter, this circle jerk over 1-3 points MAE and I think it’s pretty naive and shortsighted.

You can focus and design your trading around having low MAE, but you likely miss out on alot of very lucrative trades in the long run. If you are willing to get a bit “sloppier” with your entries, you can hit more trades and although suffer more drawdown in your P/L in the short term, in the long term you end up with more gains.

So in swing trading, especially in my own style, I have found it’s better to enter too early than too late, and enter at “too high” of a price rather than too low. Because if your entry is too low, you dont get filled at all.

I found these meme really funny but accurate. Once you become experienced enough trading and managing risk, the goal is to take more risks. The market only moves so much a certain week, month, year. So you ideally want to take more managed risks with a positive expectancy because it just means more opportunities to make money. If you miss out on a giant swing trade like the one in March, that’s a massive loss both literally and figuratively. You can’t exactly 10x your size and look to make it back because you risk getting blown up. So I want to make sure when these big swings are on the cusp of being realized, I dont miss out on getting my piece of the pie because I got too stingy with my entry. Especially on the SPX, everyone is watching a few of the same major levels and alot of people are thinking the same as you. More often than not the ideal entry just never materializes, and the front runners got their piece of the pie and the 0 MAE folks have their thumbs up their asses and have to resort to posting about how bearish the macro is Twitter but secretly wishing they got the chance to go long.

Recently, I saw many on Twitter looking to enter long on an undershoot of 4200DMA. They are still looking, hoping, wishing for that entry. They left 200 points on the table. Even if we gapped down tomorrow to 4150 SPX, and they got their perfect entry, nothing has changed. They still missed out on that 200 pt rally.

For me, my goal is very simple, to make as much money as I can. Not to have the sexiest picture perfect 0 MAE trades, I dont mind taking heat because I can manage my risk, and I can overlook my unrealized P/L because I know its the realized that really matters.

I think pyramiding swing longs when buying the dip in a downtrend makes sense here. If your ultimate target is 4200 SPX, you can enter in 20% of your trade allocation at a front run target like 4240 SPX. Then 60% at your target. Then 20% dry powder for an overshoot of your target. Those are rough numbers but you get the idea.

Now fast forward say you got your ideal long entry at 4210 SPX like we did this past September (4250 ESZ 2023). Now what? For starters you need to take profit at reasonable targets because the first thing to consider is that you are wrong in your trade thesis. The SPX might not rally to your target at all and you are dead wrong. It’s possible and we must plan for it. So you want to take off a good portion of your longs at 100-150 points I would say. Like this past month 4410-4430 was a good spot for taking profit as this was the gap from the post FOMC gap down so a logical spot for shorts to defend their positions.

In this scenario, rough targets and TP for me would be something like this. 50% off of my position at 4420, 25% off at 4500, 25% off at either all time highs, or a time-based stop. Let’s say I think Santa may come this year, so I want to hold my longs until after the Santa Rally has arrived. This way you have runners on in case a right tail scenario materializes, you can capture a massive winner that makes your entire year.

It’s big winners that move your equity curve ultimately, and big losers. If you develop your risk management to curtail small losers before they become big ones, then the only thing materially shifting your equity curve should be big winners. If you hit just a couple of those a year, you could smash the benchmark SPY in the long run. Thats the goal.

So in the scenario that you are dead wrong, if you took 50% of your profits at 4420, and the other half got stopped out at break even, oh well. You still made some good money but not the ideal scenario.

Now assuming you were indeed right, and SPX trades to 4650 by the EOY, that’s quite a large winner. If you are still holding that half position here’s how I would play it. When encountering short term resistance like 4420, you remain in your longs which would be calls or call spreads with a 3-6 month expiration. You can short against these levels with ES futures and look to monetize on 20-50 points retracements. These resistance levels can and do often reject multiple times, offering 100+pts each go around. You can then bank those and add to your longs if you desire and have the conviction. This can also reduce your cost basis for all intents and purposes. So although you bought 4200 SPX, by the time you reach the EOY your cost basis could essentially be 4100 or 4000 SPX if you are experienced at hedging.

Another way to play this with options is selling calls against your larger position. Say I am long SPX 4600 Jan 19/24 for 100 contracts. You can sell the SPX November expiration calls against that larger position at resistance points. This varies on your broker, but you should utilize your margin accounts for this. If you hold some T-bills like me, you can us those as collateral in addition to your SPX contracts and short a decent size. Even if you sold 10, 20, or 50 compared to your 100 long contracts that offers quite a reduction in your cost basis. You can buy back your short calls once the levels reject, or you can also hold and let them expire. You can enter and exit this trade multiple times.

The idea is to never just write out theta checks every day, or be blindly 100% long and just white knuckle your trade. You can be long and short at the same time, tactically.

For me the ideal execution of the trade would be something like this. We are long 4200 SPX, targeting say 4650 by EOY. I am long January 19 2024 calls, and I am short the November monthly expiry at various lower strikes.

In a separate account I am selling ES futures against my longs at key resistance points, and looking to monetize rather quickly, for 20-50 pt moves at a time. I usually dont play a level more than twice, as it starts to become more risky.

Overall, using these tactics can dramatically increase your profits during these longer time frame swing plays. You can reduce your cost basis, add more to your conviction swings, or just take more profits. Last but not least you can nail more swings, be more sloppy with your entries, front run more levels because you are playing both sides of the price action. I would rather take 50MAE on a trade rather than not get filled any day of the week. Especially in the ES, where major levels get front run all the time, and stop runs during hours of thinner liquidity happen frequently.

Hope this helps.