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Trading Psychology Futures trading strategy Trading Education S&P 500 Futures Swing Trading

Why #ES Traders Should Consider Diversifying with Swing Trades

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Many day traders who see success in their first few years become obsessed. They wake up hours before the open to prep for the trading session and remain on their screens hours after the close to study for the following day. As they build their wealth, start a family, and their need to trade every session for a paycheck diminishes, they search for ways to reduce their daily screen time, and swing trading is usually the first option.

Aside from “growing out” of day trading, plenty of traders realize that it doesn’t suit their temperament to day trade full-time, and opt to become swing traders, reducing their need to trade every day.

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From a mechanical point of view, the change from an intraday to an interday (daily+) time frame is simple: you widen your stops and targets and hold your trades longer. However, most of us aren’t fully quantitative traders. So many qualitative factors are involved in creating our trading signals, and those qualitative factors shift once you switch from an intraday to an interday time frame. 

Day traders are used to obsessing over precise execution, buy/sell programs, and HFT, ensuring they're flat into the close, reducing the noise in price action, etc. Most of these things dramatically wane in importance as soon as you begin holding overnight positions. 

Long-Term Volatility Is On The Decline

"Day traders are slaves to volatility."

 - Anton Kreil

For the better part of two decades, we've seen the overall level of volatility in the S&P 500 decline. This is probably due to several factors, like historically low-interest rates, which begets money flow into risk-on assets like equity markets, as well as a more efficient market due to the advancing automation of trading and investing. 

Of course, with the recent market sell-off, there's a good chance that the publishing of this article will mark the reversal of the trend in volatility. Because that’s just how these things work, right?

Here are two graphs to illustrate this. While there are spikes throughout, focus on the overall trend: downward.

Average Daily Range

12 month vix daily average

12-month moving average of the VIX

Markets move in cycles, and volatility has returned in a big way recently, which is creating more and more opportunities for day traders.

I estimate that the cumulative returns of day traders mirror that of the volatility of their market of choice. In the case of /ES, the futures market most favored by day traders, I think it makes sense to mix in some swing trades across a more diverse array of futures markets to smooth out your returns during those dead months. 

Not only can mixing up your time frames add to your bottom line, but it can curb the urge to take marginal trades when it feels like there are few opportunities in the market at the time.

Swing Trading vs. Day Trading: Ranges

Any trader worth their salt knows that the open and closing half-hours are responsible for the majority of a session’s daily range. 

As a day trader, unless you’re buying the opening print and selling the closing print, you’re realizing a fraction of the daily range. On a swing trade that you hold for several days, you’re exposed to several opens and closes within one trade. 

Let’s compare both the average true range and the bar chart structure of a daily chart versus a 5-minute chart on /ES:


ESH Daily Chart


ES 5 min Chart

The most recent action on the 5-minute is price action from a -3.6 sigma day in /ES, which indicates an unusually high level of volatility, so the ATR on the chart is skewed to the upside.

Still, the ATR on the daily chart is roughly 7.5 times that of the 5-minute chart. The paradox here is that swing trading with the daily chart actually requires less time than trading on the 5-minute chart, because of the necessary babysitting in day trading.

Trading Costs Are Lower for Swing Traders

There are high costs of day trading compared to that of swing trading. This is because the trading costs account for a much more significant fraction of your profits. 

Day traders typically have to pay the spread unless they place passive orders, in which their fill-rate will be lower, with many of them being “toxic” fills, where the market moves against your order as it fills.

Paying the spread in a futures market is more dire than that of equity markets, which usually have penny-wide spreads, even on a $1000 stock. 

For instance, the tick size in /ES is $0.25. If you apply a 4,000-period moving average (roughly 15 trading days in the futures market) to a 14-period ATR of a 5-minute /ES chart, the average ATR is about $2.12. So, as a very rough guestimate, let’s assume that we can, on balance, expect about $2.12 to be the average ATR of a 5-minute chart. That’s only 8.5 ticks. 

If you’re a scalper, a strategy employed by numerous /ES traders, your typical profit target will be somewhere between three and five ticks. By crossing the spread, you’re surrendering between 20% and 33% of your expected value. Is your strategy robust enough to pay the spread consistently? Is your execution fast enough to have fill priority over HFTs with hundreds of millions in execution-related infrastructure?

With that said, most futures day traders aren’t scalpers, and the impact of paying the spread will reduce as you hold your trades longer. Here’s a chart I made that looks at the bid/ask spread as a percentage of the ATR on popular day trading time frames. 

Bid-Ask spread percentage

Then there is, of course, slippage and commissions to worry about as well. These costs compound as you trade on shorter time frames. You’ll be making more round trips and paying more commissions, and experiencing more slippage because your competition will typically be much better at execution than you.

Final Thoughts

I don't mean to trash talk on day trading at all. Intraday trading enables an excellent trader to quickly realize their expected value because of how many trades you can make in a short period, as opposed to something slower like swing trading. The overall variance of your returns is lower, you avoid overnight risk, benefit more from trend days, have lower margin requirements, can exhibit more control over your trades, and a multitude of other benefits. 

However, if nothing else, I think adding in some selective swing setups to your trade book can benefit your mindset considerably. If you know you have profitable swing trades working for you, and you see green in your P&L daily, that can reduce the feeling that you ‘need’ to trade every day, even if the setup isn’t there. Our brains have a comical way of working against us in this way, convincing us that a marginal trade is a home run, that a range day is turning into a trend day, etc. 

If low risk market participation sounds good to you, then take a look at Topstep's Swing Trading Combine!


Posted by Pat Crawley on March 04, 2020
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