» Context and Trading Blog for Trading Success: Ray Barros

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One of the reasons I prefer discretionary to mechanical trading is due to the fact that the latter fails to take context into consideration - at least this is true for all the mechanical plans I have seen. By discretionary trading I mean, trading with rules that contain this one: ‘I can choose not to follow my rules‘ (??!!).

What this does is to allow me to use my intuition when I feel it’s appropriate to do so and is most useful when my trading is in the flow stage.

The price action of the S&P in the past few days provides a wonderful example of what I mean by ‘context’ and ‘intuition’.

In the video starting the current series, I warned that the new reaction lows on May 15 with below average normalised volume and below average Delta selling volume augured a rally. The next morning the market opened up with an open-gap of at least 1/2 ATR and ATR; so, I applied the ‘open-gap’ 60-minutes rule (see end of blog) and covered the shorts I instituted at 888.75.

By day’s end, however, despite the above average true range day, the volume was almost the same as that of May 15. (See Figure 1 & Figure 2). For this reason, I reinstated the shorts.

However, later analysis showed that the buying Delta that predominated was slightly above average (Figure 3). This suggested that on May 19, we’d see new highs but given the condition of the market (stalling and overextended), I surmised that May19 should produce a smallish range day. I said this in the most current video. So, it proved.

Yesterday the market again opened up with an ‘open-gap’ of at least 1/2 ATR. I did not even think of applying the 60-minutes rule until a mentor student e-mailed and asked that question. That failure to consider a favourite setup was my intuition in play - it automatically discounted the rule’s application in the context.

Examining the context of May 18 and yesterday is instructive:

May 18’s ‘gap-open’ came on the heels of a lack of follow-through selling volume after a breach of a 1-day swing low and after 6 days down.
On May 18, the first two 30-minutes bars showed below average volume - one of the two volume patterns for trend days.
Yesterday’s ‘open-gap’ occurred after a large day up which produced below average volume in a situation where the 18-day swing momentum (price/time) was the second largest in my data base; and, where the volume pattern, since April 21, was showing a possible buying climax. The first two 30-minutes bars showed above average volume but covered only around 50% of the normal day’s range. With that sort of volume, I’d have expected at least 70% and preferably more. This argued against the occurrence of a trend day.
In short while May 18 held out a high probability for rally, yesterday’s context held out a low probability. My intuition took in the data and arrived at the same conclusion.

So, as a discretionary trader, I chose not to apply the ‘60-minutes’ open-gap setup. And in that decision lies the crucial difference between a mechanical and discretionary trading style.

‘60-MINUTEs OPEN-GAP RULE’

If the market’s open is at least 1/2 an ATR beyond yesterday’s close, we look to fade the open if:

After 60-minutes, the market has failed to close at least 50% of the open-gap.

The assumption is: if the market does this, we expect the gap to remain unfilled and for the day to be a trend day in the direction of the gap; we also expect the close to be in the extreme 25% of the day’s true range i.e. in an up day at the top 25% of the day’s TRUE RANGE.

If at least 50% of the ‘open-gap’ is closed in the first 60-minutes, the assumption is the market will close the gap some time during the day.

If at the end of 60-minutes, the market is trading at the extreme of the day’s range (not true range) in the direction against the gap (i.e. in the direction of filling the gap) and 50% is unfilled, then I wait another 30-minutes to see if at least 50% of the open-gap will fill.

I’ll leave it to you to create ways to make use of this proven idea.