The Forgotten Edge: Scalping MES

Graybox Trading

Sep 06

Recently, due to external obligations, I have not had time to do the proper prep work that I require of myself to trade seriously. Even without proper prep work, the e-micros allow me to control my risk and experiment with scalping techniques.

As such, I have been scalping with what one might consider more of a market making or liquidity provision style. Read on to learn the methodology.

As for the process, I use my specialized order flow and tape reading software, AlphaReveal OrderFlowDashPro to read the tape and to get a feel for the market.

While there are many order flow tools now on the market with similar features, it is not hyperbole when I note that it would be impossible for me to read tape with some of the other order flow tools on the market because of key oversights the developers made. This is the difference in software made by someone actually trying to do something vs. fill up a bucket feature list.

AlphaReveal OrderFlowDashPro

In addition tape reading, I run specialized algorithms developed for my BeyondBots. Because with this trading style, I am often just flipping orders, at times I have questioned the importance of having the algos but every time, my experience has taught me that they really make the difference.

In order to better understand the trading method, it helps to understand there are a few different aspects that are required to work in harmony:

  1. The Alpha Signal. This is fully algorithmic signal generated over accumulated data. It is purely algorithmic and expected to have an edge. Without the alpha signal, I am more likely to churn or just run up commissions. I trade around the alpha signal.
  2. A boundary/stop loss/risk limit that I define. This is the max risk I will take on any trade.
  3. A maximum number of units I will trade at any time. I allow myself to selectively average down or up within my boundary.
  4. My real-time tape read and software. It is required with this methodology to be able to read the real-time changes in the market.
  5. Tactics/The Game. Playing the right game is important to win. The game changes depending on the conditions.
  6. Volume is critical for this game. It doesn’t work well when there isn’t enough volume.

I am working limit orders with this method about 70% to 85% of the time. The game is to either flip the spread as many times as possible or to work a scalp into higher R trades.

In flip the spread game, I am typically targeting only 1 to 2 ticks. Most importantly, I am never targeting the real trade on the first contract. I am aware of the real trade and working off in front of it, effectively arbitraging or facilitating trade.

I use my tape read to predict the market moment-to-moment while leaning/working off the alpha signal, as my bias, to try to setup a higher R trade.

Sometimes, I am able to flip the spread enough times that I generate more from arbitraging the signal then I get from the signal. Other times, I am able to get into a trade that starts going my favor and ride it for a high R trade. In those situations, I will often move my stop loss to break even and sometimes average up, not down, into the trade.

Other times, the market will move against me, and I will very carefully average down into the trade within my boundary zone. It can be viewed as either just new scalps to capture the spread but also has the advantage of improving my cost basis, tick by tick. However, it is important to be able to recognize real-time conditions that favor taking a small stop loss.

This is why I call it the game. There are many games one can play with the foundation of the alpha signal and the boundary.

The spread is the built-in edge that makes this method more consistent then trying to capture the alpha signal outright. It allows me to use my ability to read the tape with the alpha-signal together.

On the other hand, I think it is difficult to truly know whether or not one has an edge trading an advanced method like this, even with a relatively large number of trades, because of all of the following:

  1. Most scalps will start with a negative skew, having a larger risk then reward. The objective is to work into some higher R trades too.
  2. Trading profitability is highly dependent on whether or not one gets filled. In any given day, there will be a lot of no fills. As well, there will be “save” fills that have unknown probability. The very uncertain qualities of limit order fills are highly undesirable for someone who wants to know whether or not a method will work tomorrow.
  3. Commissions can eat into a significant portion of profits. If this is a staple method, a trader trading this way will need to get rock commissions. That’s another reason the alpha signal is important because it can sharply reduce the amount of scalps required to hit some profit objective.
  4. A strong tape read and proper order flow software is required. My ability to read tape is critical for this method because it allows me to predict the market in ways that are distinct from the alpha signal. It is a highly developed and discretionary skill. The upside is I can use a highly developed skill while the downside is that it is another non quantified aspect of the strategy.
  5. Micro-structure can change significantly. For high R style scalping, the volatility needs to be elevated. Lower volatility environments have two challenges, the lower volume means reduced potential to flip, perhaps more difficulty getting filled, and reduced ability to pull of high R trades which means more negative skew.

While I am not sure whether or not this specific methodology will become a staple, I do like that this methodology does allow me to quickly get into the market with a minimal risk, makes use of my tape reading, and benefits from a real edge. The relative profits that can accumulate in relation to the risk can be surprising.

My insights from trading this spark creative ideas for further research and exploration.

About the Author

The author is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact the author at curtis@beyondbacktesting.com.

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