Welcome back to part 3 of my month long Futures Trading Bootcamp.

If you haven’t already, you can read week 1 and week 2, and start building your DOM trading skills.

In the previous two weeks, our goal has been to adjust our eyes to the DOM and to start being able to spot areas where there is buying and selling going on.

We covered some interesting concepts that centered largely on the idea of volume being traded at each price level.

This week we will be continuing with our exercises and building on what we have learnt.

This week our focus is on correlations.

Hopefully it shouldn’t come as a surprise to you that different markets are related to one another.

Sometimes those relationships are obvious, sometimes they are not so obvious.

A good example might be relationship between stocks and bonds.

Conventional wisdom would suggest that when stocks go up bonds go down – or vice versa. Bonds represent safety – stocks represent risk. However while this relationship has held true for a number of years, in recent times we’ve seen bond prices trade upward along with stock prices and that historical relationship has become distorted.

Another example of a related or correlated market is a currency and equity index. For example the Australian stock market should have a strong level of correlation between itself and its currency. Drivers of the economy will have an impact on both stocks and the currency.

However correlations are not always forever and they’re certainly not always perfect.

But the good news for us is that they don’t have to be.

So how does this help us with our DOM trading? Well we can use correlations to help improve our entries and exits, which is ultimately our goal.

Exercise

This week your task is to look for a market that is correlated to the one you have been trading. If you’ve been trading the US 10-year note (ZN) then your task is easy. You can see very clearly that there is a very strong correlation between the ZN,  ZB and ZT. All the bond futures in reality.

You can continue with last weeks exercise – spoting buying and selling areas where there are high volume profile ledges and levels – however now I want you to add in the correlated market as a pseudo indicator.

I want you to look how all two or three markets are trading, in terms of where they are in relation to the high and low of the day.

For example, let’s say you spot a volume profile ledge in the ZN toward the bottom of the days range. You also see that there is buying going on and 3-4 times the size of the bid has traded at the price.

However when you look at the ZB you see that in fact it has broken through the low of day and is trading toward the very bottom of its range.

Now because these markets are correlated we can assume that the fact that the correlated market is pointing in one direction and we are looking to trade in another might cause an issue.

For the point of the exercise I want you to observe what happens when the correlated market is headed in the same direction as your potential trade vs when it’s headed in the opposite direction.

It’s important at this point to not try and read the DOM on the correlated market. It’s hard enough getting used to reading one DOM, let alone multiple. All I want you to do is to use the correlated market/s as an indicator. Think about it like a clock. Is it pointing up or is it pointing down?

How does that impact my trade?

Now it’s also important to keep trading a lot. Keep taking all trades where there is a significant volume profile level and size printing at the bid or offer. The goal is to give you as many opportunities to trade as possible and the more the better. Don’t worry about being right during the exercises.

What we are doing with this weeks exercise is just building on that.

You are just making mental notes this week about how the correlated market – or it’s current direction – impacts our main market.

It’s like our own special indicator.

Things to note about correlated markets

Unfortunately correlations aren’t always there and are not always perfect – but they sure do help.

If you’re trading the bonds then there is a pretty good chance the correlations will be there and will be strong. You’ll see the same thing with the Bund/Bobl/Schatz on Eurex.

If you’re trading equities look at the EuroStoxx/ Dax.

In the US test out the ES/YM.

Try the Aussie SPI/AUD.

Find one that is correlated and have it there as an indicator and watch how it impacts your chosen market.

As always if you need to clarify the exercise a bit more please feel free to leave a comment and I’ll be more than happy to help.

I’m back with week 2 of my month long Futures Trading Bootcamp.

You can find my week 1 post here.

Hopefully you’ve been able to start conditioning your eyes and you are starting to see the way in which orders are executed using the orderbook. It’s not an easy process as I’ve said before and the learning curve is steep. However the rewards will certainly be there if you can stick it out.

So now onto this weeks exercise and it’s one that builds on last week.

I want to again take you back to thinking about what a large trader might do when they execute an order. Theoretically, we said that if you had a large number of contracts to execute you’d likely do it slowly and try to disguise what you were doing.

So what if there was another tool we could use to identify a place where there is likely to be a large amount of buying and selling going on.

Enter our next tool – Volume Profile.

Week 2

Now if you look on our DOM in the image we can see the volume profile on the very right had side. It is showing the cumulative contracts that have traded in that session. Last week we were mostly focused on the contracts that had just been trading recently. Volume profile is really just the total of all those trades.

So why is that useful to us? Well it’s really showing us where there has been a large amount of buying and selling that have been going on at a given level. And if there has been a lot of volume at a given price level previously, then there is a fair chance that there will be more action next time around when we get back to that level.

But how do we identify the levels of interest?

I like to look for what I call a volume profile ledge.

It’s a ledge in the sense that there is a significant difference between two price levels. So at one level (tick) below, there is perhaps only a small amount of contracts that have traded and at the level above or below (depending on the direction) there are a lot.

You can see the volume profile either as a number on the DOM, or you can actually bring it up on a chart. For the point of this article I’ll show you on a chart so it is a bit clearer. Note there is also a mini histogram you can bring up on the XTrader DOM too.

As you can see, on the chart there is a significant difference between the number of contracts traded at 5429 and 5428. Now the actual number of contracts aren’t all that important. What is important is that there is a significant difference between the two levels.

So imagine once again what has been going on here.

What we are seeing is that every time price has traded back down to these levels, a buyer has stepped in and started buying.

Does that sound like a familiar concept?

To me that is the definition of support. However I would suggest that this is a far more accurate idea of what support is than simply drawing lines on charts.

So how can we use this support level – our volume profile ledge – to help improve our DOM trading?

Well we can incorporate our ability to spot the buying and selling that we learnt last week, with these significant volume profile levels.

Exercise

Watch the DOM in the opening 2 hours of trading on your chosen market as you did in week 1.

As the session progresses, the volume profile areas will slowly start to develop.

Look for price levels that have significantly higher volume. Ideally there would be a ledge in place, but if not focus on the high volume levels. When price starts trading at these high volume levels and there is 3-4 times the size of the bid or offer trading (as we did in week 1), enter a limit order and try and get filled.

Hold the trade until it goes in your favour and exit when 3-4 times the size of the bid or offer trade in the opposite direction.

If the trade goes against you by 3-4 ticks exit and look for the next trade.

Bonus Points

As you become more comfortable identifying the high volume areas start making a note of how price begins to react in specific areas.

What happens when the volume ledge is close to the high or the low of the day? What happens when it’s a long way away?

What happens if there is a volume ledge but price has been trading in a very small range compared to a wide range?

What happens when price trades at the highest volume level – also know as the high volume node?

What happens when price meets a volume ledge early in the session compared to later?

These are questions that you can start to ask yourself and will be important going forward. You’ll quickly start seeing patterns so I suggest you start making a few notes in a notebook or with Word. This will be helpful in week 4.

As ever please leave a comment if I haven’t been clear enough with what you need to do and I’m more than happy to help.

I’ll be back soon with the next exercise which will again build on this one.

Good luck.

I’ve had a number of subscribers recently ask me if they could get some more information about how to pick entry points.

To me that’s what DOM trading is all about. When using the DOM to locate entry points you can often times get fills without the market even ticking against you. So how do you do this?

Well the first thing you need to do, is go through the process of being able to actually read the DOM. And it’s not easy.

The first time you open it up is very likely going to be overwhelming. I remember when I first started using the DOM, I couldn’t actually stare at it for more than 30 minutes as I simply couldn’t concentrate. It takes time to firstly condition your eyes to what you’re seeing then secondly to actually be able to identify the points at which buying and selling are taking place.

I would say at a minimum it’s going to take you a month of staring at the DOM to build up that mental conditioning.

So what I’m going to do today is prepare a month long bootcamp to get you up to speed with your DOM reading.

Week 1

This is the time to get your eyes used to reading the DOM. There are the bids on the left and offers on the right. However what we are more interested in is the column on the far right that shows all the contracts that are trading at either the bid or the offer.

Imagine for a moment that you want to buy 500 contracts. Do you just hit the orderbook with a market order? Probably not. Similarly would you just plonk those 500 contracts on the bid – again probably not.

Realistically you’d work the order slowly – attempting to disguise what you were doing in an effort to get the best price you can.

So knowing that, consider that as a futures trader it is in fact your job to discover all the signs that someone with a lot of contracts is trying to either buy or sell. And that’s effectively your edge as a short term trader.

Exercise

For this exercise I want to you to study the cumulative contracts that are being traded at each price level. They are the ones that are showing up on the very far right column in our image.

When you see three or four times the size of the bid or offer trading at that price – enter an order.

For example:

Let’s say we have 21 contracts on the bid like in the image.

If 80+ new contracts trade at the bid price (5493) and there remains contracts on the bid – then that’s telling you that someone is there trying to buy at that price.

Place a limit order and try to get it filled – on the demo only of course.

See if you can make 1-2 ticks profit.

If it goes against you by a tick or two just exit and wait until the next setup.

These targets are based on slower moving, ‘thicker’, type markets. You can make up your own profit targets for more active markets. The aim is not to make money, just to look for buying and selling. The more trades you enter the better. Don’t worry about being right or wrong. That’s one of the most important habits you need to break.

Try and do this for the first two hours each day on the open of your favourite market.

If you don’t have a preferred market to trade then I suggest the ZN – 10-year US Treasury Note. Aim to watch this market from 8am-10am.

If you can’t get through the entire two hours – don’t worry. When I started I was struggling to watch it for even 30 minutes.

Tools

You really need to be using a DOM that shows the cumulative contracts that trade at each price level. In the image you’re seeing Xtrader by TT. You can also consider Qtrader from CQG, or Jigsaw Trading which is an add on for Ninja Trader. You can get a free demo of Xtrader from a number of brokers and that’s the best way to start that doesn’t cost you anything.

Next Time

I’ll be back with week 2 of our Futures Trading Bootcamp, which will be another exercise that builds on this one.

If I haven’t been very clear about the exercise or you need some help getting up and running please leave a comment below or email me.

Good Luck

Short term trading is all about identifying areas where there is a buyer or a seller. That’s what moves markets.

In trading we all love charts. There’s something inherently satisfying about drawing patterns on charts, whether that’s a trendline or a moving average or whatever.

As a short term trader I always felt that following chart patterns was a great way to miss the move. A good example of that is candlestick patterns.

They look great but in reality the bulk of the move has already happened. Take a hammer trading pattern for example. On a chart it might look something like this.

Conventional wisdom suggest that you should buy at the close of the hammer or the open of the next bar. Note the above chart is daily but just imagine that it’s a one minute chart.

Looking at the chart the reality is that the buyer was active right down the bottom of the candle. If you’re using this pattern as an entry you are getting in right at the point when you should be exiting the trade.

If you were using the orderbook, you would have seen that there was a buyer right down at the bottom (the wick if you like) who wanted to buy and buy right now!

Effectively you’re risking a lot less to ride the potential wave of buying, by using the DOM for your entries.

So next time you see a pattern like this on a short term chart – think to yourself that you’ve most likely missed the move already.