10/20/2017 FRIDAY : Hot Topic

Time of Day and Target Size

Adjusting target size with hours-to-trade

Trader B joins a trading room where a star trader (Trader Ace) is calling out trades. Trader B shadow trades Ace and gets exactly the same entries but elects smaller targets than Ace because he finds that he has not developed the mental fortitude to stay in a trade for as long as Ace can. He discovers that while he has more winners than Trader Ace he still ends up losing money over time. Why does one do better than the other? Let's take a look at these two traders side-by-side and assume that they are trading the E-mini S&P500 (the ES). We specifically exclude the size that these traders are trading and deal with that in the Size of Position article. We also exclude the concept of scaling out of trades because that complicates this example and taking partial profits should not affect the results of this experiment.

Trader Ace Trader B
Target 12 points 2 points
Stop Loss 2 points 2 points
% winners 20% 40%
Expected Points per 5 trades 4 points (12 x 1 - 2 x 4) -2 points (2 x 2 - 2 x 3)

The example is simple and illustrates the point. The smaller targets that Trader B gets are not achieved often enough to provide him with a profit over the long term. For whatever reason, Trader Ace has never traded using the target that Trader B is using and so finds it difficult to understand why Trader B can't make a profit with his entry calls.

Now Trader Ace doesn't just call out trades. He also teaches his methodology and helps all the traders in his room learn how to find entries. Because Trader Ace trades the E-mini S&P500 and the average daily range on this symbol is about 11 points it is very difficult for him to get his target and he usually only gets it on trend days and only when he enters early in the day. He knows that the more time there is available after his entry the larger the market move can be and so the higher the chance for him to achieve his target. He's learned this over the years because his target has always been 12 points and so has adjusted his strategies and time of day entries to make himself profitable over the long run. It doesn't matter that he gets stopped out 4 time before he hits his target because the profit from 1 trade that hits the target easily covers his previous losses and gives him an almost 1 point per trade average profit. Trader Ace has learned never to enter a trade after 11:30am and if he's not in a position before then be packs his hammock and umbrella and heads to the beach.

The missing clue that Trader B needs from the profit puzzle is the Time of Day entry that best suits his target. While Trader Ace is at the beach Trader B starts to apply the strategy to trades in the afternoon. Trader B notices that if he takes all of the entry signals after 11:30am as well, his win percentage jumps to 80% giving him exactly the same expected points per 5 trades as Trader Ace. He also notices that none of the post 11:30am trades ever go to the 12 point target that Trader Ace was looking for and in fact after he has taken his 2 points of profit they frequently turn around and would hit the 2 point stop loss area that Trader Ace uses.

This story is hypothetical but was written in response to an observation made in a trading room. The star trader in that room is usually the only trader in the room to take any of the entered trades to a 10-point-buck. One of the reasons that this is the case is because of the number of contracts traded and the scaling of contracts at different profit targets. Another reason is because of the different styles and targets used by members of the room. It was noted that the lead trader would rarely open positions on certain strategies later in the day and that is what inspired this article. If he adjusts his targets to smaller and more achievable sizes later in the day and became more of a scalper could he become more profitable?