Subscriber Q&A - principles of tactical swing trading

A reader asked the following question in the paid subscriber chat:

I am very impressed by how you manage to successfully trade in and out in all this market chaos. However I was wondering whether trading in this very short term tactical style one could miss “the big one”. Let’s say one day the market has a gigantic gap up or down because overnight half the Gulfs oil infrastructure was destroyed or a peace deal was reached and you were flat or had the wrong position. Do you see this as a risk? And if you had high conviction in predicting the war’s ultimately outcome would you consider switching to a less short term framework by just holding on to your position?

This is a good question and a useful way to introduce a few trading principles that have improved my performance and reduced pnl volatility over time.

There was once a time when I would trade by taking the view that outcome “X” would happen and result in a market going from 100 to 120 (as an example), so I’d have to stay long from 100 to 120. The problem was that sometimes the probability of outcome X was a coin flip, and half the time I’d get stopped out. If outcome X did happen and the market went from 100 to 115 and then back to 105, I’d end up staying in the trade too long and giving back a lot of my profits. This approach of trying to anticipate what the market would do instead of reacting to it got me into a lot of trouble.

The approach of reacting to the market rather than anticipating results in better expected outcomes. Let’s say I waited for outcome X to happen and the market immediately gapped to 105. If I still believe the market should be at 120 in that scenario, I would buy at 105 and stay long to 120 or until my trailing stop gets hit. I would miss out on the first 5 points of pnl, but a profitable outcome is more certain.

Principle #1 - spend more time reacting, less time anticipating. This means waiting until an outcome is determined to trade, rather than having a position waiting for an outcome to happen.

Accepting this principle means accepting that you will miss parts of some moves even when your underlying view is right. Sometimes the market never gives you an attractive entry to join a trend. Sometimes you simply miss the boat, and forcing a trade after the move has already happened only digs a deeper mental and financial hole. In those situations I remind myself of the following:

Principle #2 - Another trade is always around the corner. Do not chase trades out of FOMO; other opportunities will appear.

Markets spend roughly two thirds of the time in choppy, range-bound conditions and only about one third in trending phases. It is almost always easier to make money riding a strong trend than trying to extract small gains from a range. I would much rather take profits from a move that covers a lot of ground in a short time and then step aside, instead of sitting in a position for months to earn the same dollars. For example, my current long in WTI oil is about 12 dollars in the money after less than a week of holding it (with the usual caveat that I may still give some of it back). In calmer markets, a 12 dollar move in oil would take weeks, and capturing it would be a home run.

Principle #3 - Look for environments with volatility and clear trends that allow you to make meaningful pnl in a short period.

It is also important to distinguish between a trader and an investor. Investors work with longer horizons because their thesis takes time to play out. Their entries and exits will never be perfect, and they have to sit through both trending and range-bound markets. You need to be very clear which role you are playing. The worst outcome is letting a swing trade turn into a long term “investment” simply because you refused to cut losses.

I followed these principles when developing my S&P futures trading strategy. The goal of the strategy is to risk less than 1% in price to make 2-5% on each trade. I use defined stops and trail them aggressively to protect profits. Because of these parameters, the strategy naturally has a shorter time horizon of 1-3 days. In environments like this, when I am more active on the short side, I have to be quicker to cover because squeezes can be brutal. If that means I miss a large move up or down on a big headline, so be it. My objective is not to catch every large swing, but to run a process with positive expectancy per trade and a smooth pnl curve that avoids large drawdowns.

Since the war began, my journal shows I have taken about 200 points out of ES through active trading. If I had simply sold ES on day one of the war and held the short, I would be up about 300 points, but with a much more volatile pnl path. That 300 point figure also assumes perfect hindsight, while the 200 points come from real trades and realized gains.

This short-term tactical trading strategy is well-suited for S&P futures as the market is more prone to mean reversion than others. When I trade other markets, I usually trade with wider parameters that allow for longer holding periods. In gold, for example, I would risk 100-150 points to make 300-500. In today’s oil market I would risk $3-5 to make $10 or more.