Scenario Creation for Discretionary Traders

Last night’s price action provides some great lessons:

  1. On a trade-by-trade basis, the market can and will do anything.
  2. Our plan provides high probability, low risk trades over a large sample size.
  3. The better plans provide roadmaps of what should happen if the trades are working out. By the same token, they tell us when the trades will probably not work out.

To see how this operated last night, let’s first review a short history of the ES did since the March 14 low at 1258.

  1. The March 14 low provided an Spring Buy signal that projected a target to at least the Primary Sell Zone 1382 to 1396. Following a Spring, I expect the high of the Primary Sell Zone to be breached i.e. I expected the market to move above 1396.
  2. Since the 18-day swing (monthly trend, my trading timeframe) had given a confirmed Upthrust Change in Trend Pattern, I expected the market to hold below 1406 or if 1406 was breached not to accept above it.
  3. Why 1406? The 1364 to 1406 was the Primary Buy Zone of the 18-d swing. Acceptance above 1406 would project a move to 1577 to 1564. Such a move would negate the current bear scenario.
  4. The market appeared to be fitting the scenario in (2) until April1 when we had a huge day up that was followed by a 4-days of sideways low-range activity. On the 4th day we pushed into the Primary Sell Zone 1396 to 1382 and closed below 1382.
  5. This suggested we would not see a push above 1396.
  6. The market then broke. In the process we formed a Failed Auction (see ). This suggested we would at least retest the Primary Buy Zone 1258 to 1276. HOWEVER
  7. Yesterday we saw a number of signs that throw doubt on the 18-d Bearish Scenario. This doubt comes into play if we breach 1396 before we accept below 1308 (bottom of the Value Area.). The signs of strength were:
  • The Market broke to the Point of Control 1328 and bounced. In the process it accepted above strong intra-day resistance at 1353 to 1354.
  • A breach of 1396 before we accept below 1308 is very bullish; it projects a move to at least 1416 (Figure 2). Since this is above 1406, we can say that if yesterday’s price action is confirmed by a breach of 1396 before acceptance below 1308, the market is expected to go to 1577 to 1564 – in turn this would invalidate the current Bear stance.

One lesson that I learnt from Pete was to form scenarios of how the market should behave if my view was correct (e.g. the April 1 short). Over time, by doing this, I learnt to ‘see’ what the market could look like if I was incorrect. Last night was a good example of both. But this lesson was not the only benefit delivered by last night’s price action.
In addition to the above, last night’s price action afforded a number of lessons:

  • The failure to cover the open-gap was a sign of strength.
  • However the resulting move up until around 3:00 PM EST exhibited a weak structure in terms of volume and price range. Sometimes when the gap is not covered, that sort of price action indicates a breakdown after 3:00 am. EST.
  • Once the market began moving up, around 3:00 PM EST, the Market Delta showed exhibited 1-timeframe volume profiles: these exhibit volume profiles that discourage contra-direction trades.

What happend to my shorts of April 1? I covered them at 1355.25 for a small profit. But I did not exit well the next trade so well.

Normally I don’t trade the middle of congestion; but last night when the market gave an Upthrust Sell on 15-minute chart (and given the lack of volume and interest to head North at the time), I sold small size at 1357 with an intention of exiting at 1360.75 if the market showed signs of heading North at 3:00 PM EST.

I also placed a stop at 1367.75 – the price beyond which I was not prepared to accept any further losses for this trade, in this context.

When the market broke to the upside, I kept missing the exit price by a point or half-point. I did recognize the move as one- timeframe and usually I just exit at market. But last night, I kept trying a limit order. I eventually got stopped out. The difference between early exit and my stop out price was probably three to five points – nevertheless I rated the exit as a poor one and gave myself a rating of 1.5 for the trade (1.5 entry; 0 for exit). In today’s journal, I reasoned that I was rusty given that I had not traded for over 14-days. The remedy to this is greater time spent in pre-visualization.

So you see, last night held many lessons.

Figure 1 as the Market Profile Zones.

Figure 2 shows the retracement equivalent to the Market Profile Zones – the Primary Zones line up but not the top and bottom of Value. In the event of a conflict, I use the Profile Zones. Note that the 66.67 level (1353) coincided with intra-day resistance even though the top of value via the Profile is 1370.


Figure 1 Market Profile


Figure 2 Retracements and Projections

The Failed Auction Revsited

I thought a great place to start the blog after Mumbai would be the ES. I have two issues on the line:

  1. My comments on the the Failed Auction at 1372. (
  2. My comments that tonight’s CPI will exceed expectations (

Let’s take a step back and review the longer term price action. Figure 1 shows the 12-m swing (Yearly Trend). We have a potential Upthurst Change in Trend Pattern that needs a bearish monthly bar to complete the signal – we’ve had a close below the Primary Sell Zone but the rejection lows to date mean the change in trend pattern is incomplete until the market negates them. A monthly close at or below 1270 would do that.


Figure 1 12-M S&P

Figure 2 shows the 18-day and 5-day swing (monthly and weekly trends). At ‘C’, we had a 5-day Upthrust Change in Trend pattern that projected an 18-day line turn up to at least the Primary Sell Zone and more probably a move above 1395(basis cash). The market reached the Primary Sell Zone and turned down.


Figure 2 18-d and 5-d

The Failed Auction at 1372 (basis June) expired yesterday – recall that Market Profile Theory suggests we ought to see a Failed Auction’s price within 5-trading days. The fact that we did not, suggests that the market has more downside.

The dual failure – the failure to move above 1400 and the ‘Failed, Failed Auction’ – suggests to me that we’ll close below 1270 in April.

Figure 3 shows the 80-minute ES M8 chart. Note that the average volume for down moves in this last swing has been around 250,000.00; however the average move up’s volume has been about 163,000. This suggests the up moves have been short covering rallies. If this proves correct, I’d expect any rally to be held by 1354 (basis June).


Figure 3 80-minute ES

For tonight, if I am right about the CPI, then we should have a new directional move down to the minimum target: the Primary Buy Zone 1274 to 1256 (basis Cash). If I am wrong, and the market comes in within expectations, I’d be looking at the day structure to see if I can add to my shorts – but given we are in the middle of congestion, it is unlikely that I will. Finally if the CPI comes in lower than expected, I’ll drop my stops down to breakeven less brokerage and slippage.

Potential and Capability

Back in Singapore after the Mumbai trip.

A short entry tonight; I’ll reply to all the comments tomorrow. Tonight, I’d like to comment on a question that was asked of the panel (see Figure 1): Can anyone be a trader?

One of the panel replied in the negative. The panelist argued that not everyone has the temprement to become a trader. I disagree. I think the answer confused potential with capability.

I believe that everyone has the potential to be a trader -just as everyone has the potential to be a marathan runner, golfer, tennis player etc. However not everyone is willing to put in the hours, application and money to achieve the measure of success they want. But that doesn’t mean that they don’t have the potential to achieve their desire if they are willing to pay the price. Of course, not everyone can be a Buffett or Sekoyta. But that doesn’t mean that they cannot be profitable – IF they are willing to pay the price and do whatever is necessary to succeed.


Figure 1 Mumbai Panel

Hi from Mumbai

Hi All

My apologies for missing the blog on Friday – Internet woes. The blog will be back to normal on Wednesday.

An episode in Mumbai serves as the basis for this blog.

  • The first was the comment by a local educator that in ‘day-trading, stops are for losers’. Hmm…I could see what he was getting at but I think that the advice is poor advice for the newbie.

In my approach to the markets, I ALWAYS have a hard-stop in the market. It can be a long way away from the current levels and is placed at a level beyond which I am not prepared to lose any more money. In addition to the hard stop, I have time and structural stops. Over 90% of my trades, I exit a position before the hard stop is hit.

That being the case, why do I say that the advice is poor? Because the newbie faces two problems:

  1. Most newbies are unable to execute mental stops and mental exit strategies.
  2. If the market suddenly moves dramatically against the position, newbies freeze.

Hence, my objection to the advice.

Test Open in the ES

Ryan asked whether the opening on April 8 was a test-open. In my view it was not.

A test-open is second only to the drive-open in terms of exhibiting conviction. In the case of the test-open, the market is unable to find activity in one direction, reverses and finds activity in the other direction. There are a number of indicators I use to help me assess if an open is a test-open.

  1. How far did the market move in the non-dominant direction? Ideally, it should move 33% (or less. I prefer to see no more than 25%) of the ATR.
  2. In the AB period, I want to see at least 40% ATR in the dominant direction. The reason is, a test-open usually is a sign of a rotational market. If the AB period produces less than 40% ATR, it is unlikely that the Initial Balance will achieve an IB with at least 50% ATR i.e. by the end of the ‘C’ period. The smallest IB range for a rotational day is the Normal Variation Day (about 40% to 50% ATR)
  3. Finally, in the AB period, I want to see a Delta difference of at least 10k.

Armed with the above, let’s examine the open of April 8 & 9

April 8: The current ATR is 27 points +12/-6. So the minimum 60-minute range would be 10.5 points ([27-6]/2).

  1. The market moved 1 point down and then rallied: Pass
  2. The 60-minute range was 1370 – 1263.5 = 6.5: Failed
  3. The 60 minute Delta was +427: Failed

April 9:

  1. The market rallied 0.50 points and then dropped: Passed
  2. The 60-minute range was 1370.5 – 1361.5 = 9: Marginal pass (greater than 40%, but less than 50%).
  3. The 60-minute Delta was 13171 – 2816 = 10, 355: Passed

On the balance of probabilities, I leaned to April 9 being a test-open and April 8 being ‘wishy-washy’ i.e. one that would mark non-trend day.

Figure 1 shows the Delta for April 8 and Figure 2 the Delta for April 9.


FIGURE Delta April 8


Figure 2 Delta April 9

Failed Auctions – A Behavioural Parameter of the Market Profile

Before I begin tonight’s blog, some news: until Wednesday April 16, my blog may be a little late and a little light. I am speaking in Mumbai ( see and I am not sure what the Internet connections will be like. The mobile phones (cell phones) connections are not that great.

As Figure 1 shows, last night we saw a Failed Auction in the ES Traditional Profile. What’s a Failed Auction? It’s a single print at one end of the profile occurring after the Initial Balance that is followed by a Range Extension at the opposite end. Last night we saw the Failed Auction in the ‘E’ period and the Range Extension in the ‘J’.

A Failed Auction says that we’ll revisit that price (1372) within 5 trading days.


Figure 1 Failed Auction

In the current context, the more interesting thing about the Failed Auction is it normally marks the start of a new IPM in a direction opposite to the Auction – should we fail to see the Failed Auction price in the 5 trading days. In this case, unless we see 1372 by next Tuesday, we are likely to be seeing or will see the start of the 1270 retest.

The Failed Auction becomes a great assessment tool. If the market breaks down now and moves at least 2 ATRs away from 1272 by end of trading Friday, we have a reliable indication that the 1270 retest is underway.

The key is to get set before the breakdown. In this regard, what is tonight’s profile telling us?

Tonight we have a possible test-open. This suggests rotation with a possible range of 22 points. If 1270.5 holds, we can expect to see 1248.5. I am bearish the market and will be looking to see 1269 to 1268 if I see the right volume configuration in Market Delta.


Figure 2 Market Profile April 9

The Paradigm of Success

Nowadays, there is a tendency among trading coaches to diminish areas outside the province of their expertise: those who specialize in psychology will claim this is the most important; those that deal with money management stress its critical role; others focus on the having of a written plan with an edge.

One reason I like Dr. Brett Steenbarger’s material is he stresses that often traders fail because they lack a coherent plan or because they fail to keep metrics of their results (TraderFeed) – and his area of expertise is psychology.

It seems to me that newbies fail to appreciate the nuances of the relationship between psychology, money management and trading plan. In this post, I am seeking to approach the subject from a different angle to describe the essential connections between the three.

Figure 1 is the Paradigm of Success.


FIGURE 1 Paradigm of Success

Success starts with the centre and the centre gives birth to the rectangle and the circle. The more we radiate away from the centre, the greater importance the factor plays in our trading success; at the same time, the closer we get to the centre, the more primary a role the factor plays.

On this view, the written trading plan plays the foundational role to our success. Unless it has an edge and unless it provides us with robust (i.e. repeatable over instruments and market conditions) entry & exit signals, psychology and money management have no role to play.

The plan gives birth to Risk Management: money management and trade management. Money management decided such issues as risk per trade, position size, portfolio risk, when to make our profits available for trading and when to reduce our capital because of losses. Trade management protects our open profits while allowing room for the market to fluctuate as it moves in our favour. I have suggested that the primary tool of trade management is the initial risk.

Risk management depends on our analysing the metrics of our trading plan. For example, knowing the plan’s Maximum Adverse Excursion; knowing the plan’s Maximum Favourable Excursion; knowing the plan’s Expectancy Return. Once the plan produces the data, Risk Management takes over to balance the maximization of profitability with minimizing Risk of Ruin. You can have the best trading plan in the world but it takes one breach of our risk management to send us bankrupt.

The circle surrounding the Plan and Risk Management is Winning Psychology. In my view, the chief function of Winning Psychology is the consistent execution of our trading plan and our Risk Management. A secondary role is to learn from our successes and failures. No matter how much of an edge our trading plan has and no matter how effectively our risk management rules optimize profitability, unless we execute both consistently they will be unable to produce their promised results.

Why 95% of Traders Lose and What You Must Do

I have just finished Noble Derakoln’s “Winning the Trading Game, Why 95% of Traders LOSE etc”.

I like it in parts – the best was the section describing the path losing traders follow. I’ll start this series by setting the stage using Derakoln’s description (page 70).

Beginning with Happiness: For some reason, most newbie traders I have met start off with a series of winning trades – certainly this was my experience. Nothing feels better! Put a position on and whamo! Profits by the bucket load! Why didn’t I discover this sooner? I must be the world’s greatest trader!

Next Comes Greed: Now we start to overtrade and start to create fantasies of untold wealth. Then, sooner or later, the deck of cards come crashing down. Somehow we get into a trade that was way too big; somehow we failed to take profits (“not worth my while”); or somehow, we failed to exit at breakeven (I knew I should have got out when I had the chance). Now we are praying: “Dear God, please let me just breakeven – I’ll even accept a small loss!

Followed by Fear: Now we really start to fret. We look for news, magazine items, books anything and everything that will provide some solace to the deepening horror of imagined greater losses to come. By imagining future losses, we find the current loss easier to bear. It allows us to ignore the reality of the meaning of the actual losses. We can pretend that soon, very soon, the market will go in our favour and then the pain will stop. But as the losses mount, panic finally sets in and eventually either we run out of margin funds or the pain of losing is so great that we exit.

Which Leads to Sorrow: The loss was an aberration – ‘the method was good, I only have to find a way to avoid losing trades!” “After all ..the market just turned around. It was a shakeout, I just didn’t have the courage of my convictions (my stop was too close)” etc. All I need do is study and find a solution to the pesky problem of losses.

Frustration: The problem is no matter how much we study, the problem of losses remain. We find that in just one trade, we lose months of profits; worse still, we lose all our capital in just one trade. And, we find that this loss of all our capital happens more than once. “It’s not our fault. I returned 1000% my original capital in just one month! I must be a good trader! It’s all the broker’s fault – it’s Ray’s fault (he’s hiding his good stuff) – it’s the market’s fault; it keeps finding Black Swan aberrations! etc etc.

Defeat: We come to feel that we’ll never be winners. The seminar we attended (book we read) was a load of xxxxx. ‘The author makes all his money teaching (writing) – no wonder he said it would take 3 years to be successful’. Then a new ‘get, rich, system (software)’ flyer arrives and the cycle starts again.

Until I read the pages in Drakoln’s book, I couldn’t understand why I had been unable (at least to the extent that I wanted to) to have newbies accept that success comes from:

Winning Psychology (60%) x Effective Money Management (30%) x Written Plan with an Edge = Success

Even though the multiplication sign between each factor meant that we need all three to succeed, most newbies I struck at Expos, ATIC (see etc failed to break the Drakolyn’s cycle.

Today, I realized that I needed to present the material differently. So folks, wait for it! Tomorrow, I’ll introduce the Paradigm of Success.

More of the Same?

The Non-Farm Payrolls just came out. The unemployment numbers came out at the higher end of expectations. So far price reaction from the markets has been muted: Gold is down a little, Crude up slightly, US$ down slightly, ES up slightly – more of the same.

But folks, if I am right, a bombshell is around the corner. On April 16, the CPI numbers come out.

It has been 8 months since the FED publicly started massive increases in the money supply. As a general rule, it takes around 9 months for the economy to start showing the effects of a loosening of the purse strings. I may be a month early, but the easing of the money supply has been so massive that the CPI increasing a month before ‘normal’ would not surprise me.

If the CPI does come out much greater than expected, what is that going to mean for the markets I trade? I expect:

  • The US$ to move up and therefore
  • Gold and Crude to drop. I also expect
  • The Grains to drop and
  • The stock market to tumble.

Interestingly, while I was watching the Cash Flow program on CNBC today, Illian Mihav, professor of economics at INSEAD, made an interesting observation: he said that the FED number 2, Rick Michigan has been, in effect, previewing FED policy in his speeches. And, his latest speech at the end of March was on the dangers of inflation. Hmm, does the FED know something we have yet to discover?

And, if the inflation numbers are going to start rising, what are the chances that the FED will continue to raise rates?In Aussie terms, ‘buckley’s’ (i.e. NIL).

Well, OK, I suppose there is some chance; but I certainly would not take the odds to a continuing rate decrease or other form of stimulus once the inflation numbers start to rise. Perhaps then we’ll break out of the market ranges we have been in.

ES Trend Day Pre-Conditions

I was looking for a way to round off the current series when Ms Ana Wang, student and friend, referred me to the latest blog by Dr. Steenbarger ( He wrote on the characteristics he looks for in trend days. I thought: ‘Great topic to round off the series!’ Thanks Brett.

Since my approach to day trading relies heavily on the Market Profile, my tendency is to automatically assess: is today likely to be a rotational or one time-frame market? For one-timeframe markets (trend days), I first look at the context to see if the context supports a possible trend day.

Generally, I perform context analysis on the cash S&P because I find it a more reliable analysis.


Figure 1 S&P Cash

Figure 1 shows the three contextual conditions that pointed to a possible trend day on April 1.

  1. The buy signal generated by the 5-d Spring Change in Trend Pattern that projects a target to at least 1396.
  2. The failure of the market to follow through on the downside volume generated on March 28 2008,
  3. The market holding the bottom of the value area on March 31st i.e. there was no acceptance below 1313.

The next condition is the open of today relative to yesterday’s value area. If the market opens above yesterday’s value area, then we are more likely to have a trend day.

The third condition which helps identify a trend day before it occurs is the narrow range day – what Tony Crable called an NR4 (i.e. a day where the range is the smallest of ‘x’ days. NR4 means the narrowest of the last 4 days. It is of additional significance if the day is an inside day – INR4). I look for at least an NR4. The greater the number of days, the more likely a trend day can develop.

I also look at O’Connors Historical Volatility Ratio (HVR). If the HVR (5 and 100) touches 0.5 or less, then the probability of a trend day occurring rises. (

Figure 2 shows the HVR and NR4


Figure 2 HVR & NR4

Finally if there is an open gap of at least 0.40% (rounded to first decimal place), I utilize the ‘open-gap’ behavioural parameter: this states that if there is an open-gap of at least 0.4% and the market fails to close at least 50% of the gap in the first 60-minute of trading, a breakout of the 60-minute range in the direction will probably signal the start of a trend day.

The above conditions prepare us for a trend day. Let’s turn to managing the trend day once it has started.

Yesterday’s blog (ES Managing Trades on a Slow Trend Day) showed how to manage a slow trend day. The other types of trend day are double distribution trend day and the Steidlmayer Bull or Bear Pattern. The first type starts with a rotation and generally does not develop where there is gap-open and the market moves in the direction of the gap. It tends to occur where the market moves contra the gap-open and/or where the market opens or near the previous day’s close.

Figure 3 shows this. We see the market closing at 1374.4 (N) and the market opening at around 1375 to 1377 (blue arrow). The market rotated until the J period. At J, it tried to break out and failed. This started a double distribution trend day down.


Figure 3 Double Distribution Trend Day

Once the vertical move begins, we can manage the trend day in the same way as the Slow Trend Day. This trade management method will stop you out once rotation begin so you won’t capture the part of the move that closes at the extreme of the day. But, it’s a simple management method and it will capture the directional portion of the move.

The final type is not a traditional Market Profile pattern. I derive it from Pete’s evolution of the traditional Market Profile and it is probably the most common of the three occurring today.

Generally the rotational aspect of the pattern sets up the day before. Today the market opens and starts the directional move which continues until the last hour of so of the day – at that time, rotation begins. Managing this trend day in the way we discussed yesterday, will achieve great results. Figure 4 is an example of the Steidlmayer Distribution down trend day.


Figure 4 Steidlmayer Distribution Trend Day