Book Reviews, Trading

Book Review of The Very Latest E-Mini Trading by Michael Gutmann

The full title of this book is “The VERY Latest E-mini Trading: Using Market Anticipation to Trade Electronic Futures” by Michael J. Gutmann (Former Intel Engineer), published in 2009.

This book is one-of-a-kind. This is the first book that I’ve read that actually goes into a lot of details as to the setups, tools used, and how everything fits together. Most books that write about setups typically leave out a lot of details, talk in broad general terms, lack other components necessary for a complete system, have setups that are too simplistic, comes through as marketing fodder, etc. Gutmann’s book comes through as an honest, solid attempt to explain how he trades, what he looks at, how he arrived at his current system, and contains numerous examples to reinforce his concepts.

The only part that I think can be better is with the trade management section. While Gutmann presented various 1-tier, 2-tier, 3-tier strategies, it is unclear what are the actual levels being used for the stop loss, profit targets, etc. in the final implementation, and that is a key component for a successful system. In addition, Gutmann showed that a 2-tier strategy is better than a 1-tier strategy, and a 3-tier strategy is better than both the 2-tier and 1-tier strategies. However, that is based on assuming what I think are pretty high probabilities of hitting profit targets. Regardless, I presume that those assumptions are consistent with Gutmann’s actual experience which I think are pretty impressive.

My main takeaway from this book is actually not on the setups or tools used, but rather one of Gutmann’s conclusions that struck me: that we should recognize and accept that we cannot control our own actions to perform flawless execution, and hence should seek to find the proper tools to plug this flaw. In a way, the statistic that more than 90% of traders lose in the trading game is evidence of the difficulty in controlling one’s psychology and emotions for proper execution. Yes, it is possible to succeed without any automation or computer algorithms, and less than 10% indeed succeeded, but that is through a combination of natural make up, hard work, adequate capitalization, significant time spent, and even factors such as having a supportive family. It may be an easier route to implement technology to help overcome our human weakness.

In conclusion, I think this is a great book on day trading futures, especially the E-minis which are the focus on this book. While the cumulative tick indicator may not work on other futures markets, many of the other tools such as market profile, significant levels, etc. are definitely relevant for other markets as well. I also admire Gutmann on his willingness to share details of his trading system to benefit other traders.

How Gutmann Arrived at Trading E-Minis

  • Stocks: Stocks need to be traded on the same side as the market, then might as well just focus on the market.
  • Stock options: Was selling covered puts and call spreads (i.e. covered short strangles). Would do quite well for several months in a row, then have a mini blow-up which would wipe out months of profitable income.
  • Stock index options: Did the same as with stock options, but using SPX options on the CBOE. SPX seldom experiences sudden gaps like a stock.
  • Futures: Intra-day trading profits for  futures and futures options are taxed as capital gains with a 60/40 long-term/short-term capital gains ratio, as opposed to being taxed as ordinary income for short-term stock profits.
  • Futures options: CME offers options on SP and ES futures. CME offered more aggressive margin requirements, so did the same short strangle strategy, but still experienced months of profitability followed by a mini blow-up when the market became volatile.

Tools Used in the E-Mini Trading System

  • Market Profile
    • Day type
      • Trend day
      • Non-trend day: Side-ways, directionless with small price range.
      • Normal day: Market moves to a new price level, and stays at the new level.
      • Neutral day: Side-ways with large price range testing both extremes.
      • Double distribution day: Market spends significant time at two different price levels (imagine two mountains in the market profile diagram)
    • Initial Balance (IB)
      • First hour price range.
      • IB High (IBH) and IB Low (IBL) are the first hour’s high and low prices. IB Range Extension (IB RE) = breakouts / breakdowns.
      • IB range can be compared with average IB range of the last 100 trading days to determine whether it is narrow or wide.
      • Wide IBs means more likely to be a sideways market for the day. Narrow IBs means more likely for a breakout.
    • Point of Control (POC): Day’s mode price (most volume)
    • Value Area (VA): One standard deviation around the POC, contains ~70% of the volume. Enclosed by Value Area High (VAH) and Value Area Low (VAL)
  • Market internal data
    • NYSE TICK measures the number of stocks that have traded up minus the number of stocks that have traded down. Typical range is -1000 to 1000.
    • Cumulative Ticks (CTs) computes an accumulation of 1-minute sampled NYSE TICK. The TICK value used is the average of the high, low and close vlaues of a 1-minute TICK chart.
    • Compare each day’s CT at any point in time with 9 horizontal lines drawn on chart
      • 50-day average CT level at 3pm for a bullish day (bullish day is when CT finishes above zero)
      • 50-day average CT level at 1.30pm for a bullish day
      • 50-day average CT level at 12nn for a bullish day
      • 50-day average CT level at 10.30am for a bullish day (after 1st hour)
      • Zero line for the CT chart
      • 50-day average CT level at 10.30am for a bearish day (bearish day is when CT finishes below zero)
      • 50-day average CT level at 12nn for a bearish day
      • 50-day average CT level at 1.30pm for a bearish day
      • 50-day average CT level at 3pm for a bearish day
    • Equivocal CTs = CTs neutral to slightly bearish = neither bulls nor bears in control = look to fade
    • Unequivocal CTs = One side in control, usually a trend day = look to follow trend on retracement
    • If CTs are not reaching their time-of-day pivots, then they are considered Equivocal
  • Price levels
    • PDH / PDL / PDC = Previous Day’s High / Low / Close
    • Pivot = (PDH + PDL + PDC) / 3
    • Open = Today’s Opening Price
    • R1 = (2 * Pivot) – PDL
    • S1 = (2 * Privot) – PDH
    • R2 = (Pivot – S1) + R1
    • S2 = Pivot – (R1 – S1)
    • IB = First hour’s trading range
    • IBH / IBL = IB High / Low
    • DPH / DPL = Day’s Previous High / Low
    • Local price maximums / minimums / extrema
    • BN = Big Number
    • Order of importance
      • DPH, DPL, local extrema
      • IB, IBH, IBL
      • PDH, PDL
      • Pivot, Open
      • R1, S1
      • R2, S2
    • For the ES, market will often test BN price levels using ~2 points of price discovery (i.e. cross BNs by  ~2 points before reversing).
  • Price extension and retracement
    • Price extension = Fading the market
      • Use oscillators and moving average indicators to determine price extension (i.e. overbought / oversold)
      • Use a MACD(12, 26, 9) on a 233-tick ES chart, with +1 and -1 (i.e. 1 ES point) as the overbought / oversold watermark.
      • Use MACD-Price Divergence to indicate possible price extension exhaustion.
        • Buy: MACD moving upward from Oversold while price is not making new lows
        • Sell: MACD is moving downward from Overbought while price is not making new highs
      • Take note of CTs-Price divergence. The discrepancy cannot continue for long.
    • Price retracement = Joining the trend
      • Retracement to a relative price level (e.g. Fibonacci)
      • Retracement to an absolute price level (e.g. significant price level)
      • Retracement to a local price level (e.g. 20-period EMA on a 233-tick chart)
  • Time-of-day patterns
    • 9.30am: Opening gap trades, or inter-market divergence trades consistent with CTs.
    • 10.00am: Market can reverse. 10am economic reports can create pivot.
    • 10.30am: Trades based on Initial Balance. Reversal from IB extrema or IB RE.
    • 11.30am: Start of lunch-time chop.
    • 1.00pm: Lunch-time over. Rallies often begin between 12.30 and 1.30pm.
    • 1.30pm: If rally does not commence shortly after 1.30pm, it can be a sign of selling ahead.
    • 3.00pm: Sudden reversals may occur. Price level reversals may occur at 3.30pm on rally exhaustion.
    • 3.45pm: No new trades opened. Erratic behavior possible.
  • Inter-market analysis
    • TF leads ES
    • NQ leads YM
    • If a market is divergent compared to the other three, look for it to ‘conform’ when the direction of the market for the day supports it (e.g. overly bullish market coming down on a weak day).
  • Multi-frame charting
    • Daily charts of ES, TF, YM, NQ
    • Daily ES Market Profile
    • 3-minute E-mini 4-Plex to detect inter-market divergence setups
    • 1-minute NYSE CTs
    • 3-minute ES to detect intermediate day-trends. MACD(12, 26, 9) with intermediate overbought/oversold (1.5) and extreme overbought/oversold (3.0) levels, and 20-EMA for local retracement levels.
    • 233-tick E-mini 4-Plex for actual trades. MACD(12, 26, 9) with overbought/oversold levels (ES: 1, TF: 0.7, NQ: 1.67, YM: 10) and 20-EMA for local retracement levels.

Trade Setups

Key Elements

  • Day type
  • Price levels
  • Technicals
  • Time-of-day patterns

Trend Trades

  • Initial Balance Range Extension (IB RE)
    • Setup
      • Narrow IB
      • Unequivocal CTs
    • Entries
      • Stop market order for the initial extension breakout.
      • Resting limit order on retracement to the IB extrema (usually 2-3 ticks away).
      • Resting limit order on retracement to a 20-EMA using a 3-min chart.
  • Afternoon Rallies [top 3 trades]
    • Setup
      • Support prior to 1.30pm
      • Unequivocal CTs
    • Entries
      • Retracement to 20-EMA on 3-min or 233-tick chart
      • Bottom of a consolidation zone on the 3-min or 233-tick chart.

Reversal Trades

  • Initial Balance Reversal (IB Reversal)
    • Setup
      • Wide IB
      • Equivocal CTs
      • IBH / IBL corrsepond to key levels (e.g. PDH / PDL, R1 / S1, R2 / S2)
    • Entries
      • Limit order at IBL + offset (for long), IBH – offset (for short). Offset is 2-3 ticks.
  • Price Level Reversal [top 3 trades]
    • Setup
      • Equivocal CTs
      • Significant price levels coinciding (e.g. IB extrema with PDH /  PDL or other significant levels)
      • Support from other areas: e.g. MACD overbought for a short.
    • Entries
      • Resting limit order at the significant price level, or 2-3 ticks above that for long entries, or 2-3 ticks below that for short entries.
      • After the price level is touched, limit order placed at the 20-EMA retracement of a 233-tick chart.
  • MACD-Price Divergence [top 3 trades]
    • Setup
      • MACD is more pertinent in non-trending markets (e.g. CTs are equivocal), or in trending markets when the MACD is in opposite direction of the trend (e.g. MACD is at overbought level when CTs are unequivocally bearish).
      • MACD(12, 26, 9) on 233-tick charts with OB/OS levels (ES: 1, TF: 0.7, NQ: 1.67, YM: 10). For ES 3-min chart, use 1.5/3.0 for aggressive/conservative OB/OS levels.
      • Divergence observed between MACD and price (i.e. bullish when MACD making higher lows but price lows unchanged, or bearish when MACD making lower highs but price highs unchanged).
    • Entries
      • Enter (in the direction of the MACD movement) when divergence is first noticed, with a limit order close to the market.
      • After the divergence is well-defined, enter on a retracement to the 20-EMA of the 233-tick chart.

Inter-Market Divergence Trades

  • Setup
    • TF leads ES, NQ leads YM.
    • If the Day-Type is bullish and the leader is rallying while the follower is in a consolidation, then a long position in the follower is considered.
  • Entries
    • Enter immediately when the divergence is detected with a limit order close to the market.
    • To not chase the market, can also enter on retracement to a 20-EMA on a 233 tick chart.

Trade Management

  • I am convinced that the only way to establish winning runners is with automation. Essentially, we can’t expect to overcome the overwhelming desire to book profits without help.
  • I remember one evening an instructor spoke to me about golden retrievers. She said, no matter how well trained, if off the leash and a small animal runs in front of your dog, he’s going to chase it.
  • We can talk all we want about the importance of trading with the trend and achieving winning runners, but it seems that without some external automatic mechanism as a guide (our leash?), we just can’t not take certain profits. Perhaps what’s important is to recognize this fact and then find the right tools to deal with it.
  • The 10-min ATR of ES is 4 points. When a trade is entered, it should on average move 2 points in either direction  value in 10 minutes. Hence experienced traders typically use at least a 2 point (8 ticks) stop loss.
  • Use a 3-tiered strategy
    • 1st contract: SL 10 ticks, PT 4 ticks
    • 2nd contract: SL 10 ticks, PT 6 ticks
    • 3rd contract: SL 10 ticks, no PT for runner
    • When PT1 is hit, 1st contract is exited, SL moves to original entry price.
    • When PT2 is hit, 2nd contract is exited, Invivo.Stops are used to trail the 3rd contract.
  • Gutmann showed using a directed graph that a 2-tiered strategy is better than an unscaled strategy assuming that the probability of hitting PT1 is 70-80%, and the probability of hitting PT2 is 50-90% (conditional on PT1 being hit). He showed that a 3-tiered strategy is better than a 1-tier and 2-tier strategy using 70% for PT1, 67% for PT2 and 33% for runner.
  • A 1-tiered strategy is more suited for rotational markets (Equivocal CTs). A 3-tiered strategy is more suited for trending market (Unequivocal CTs).

Other Important Points

  • Minimum winning percentage
    • Automated strategies need to deliver a 60% winning percentage to be psychologically viable on an on-going basis.
  • Key of day trading
    • To win at day-trading, one has to anticipate the market.
  • Anticipation creates positive psychology
    • Entering with limit orders demands forethought and setup discipline. The trader, even when confronted with a failure, knows that he or she executed a well-defined setup. This creates a positive trade psychology.
  • Third-Time-Up Rule
    • When a new level is reached and price reversed, that is the 1st time the level is “hit”.
    • When the level is re-tested and there is no follow-through, the price level holds for the 2nd time.
    • On the 3rd re-test, the market will often breakout.
    • Hence reversal trades need to be made on the 1st or 2nd time up to a target price level.
    • If the 3rd re-test still fails, we expect the market will sell down.
  • Do not sell afternoon rallies early
    • Only short an afternoon rally in the last hour or last half hour after the rally exhaustion is identified and CTs become Equivocal.



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