Feed Fish or Teach to Fish?

Once a month I check the analytics for this site. The last time I checked on January 22, we had hit an all time high for visitors. But since then, the numbers have been moving directionally down in a big way!

I couldn’t understand why until I checked the topics. I found that the peak was hit when I was writing on the S&P, basically I was ‘tipping’ the market. Once the series ended, the numbers started to drop and picked up only when I started writing “S&P Intraday”.

So it seems that the majority want a tipping sheet.

Sorry folks, that’s not the reason I write. My outcome is to provide a resource to improve trading results. I don’t see tipping doing that. In fact, in its success, tipping sows the seeds of trader destruction. The reason is tipping focuses on the plan and ignores risk management and winning psychology – elements that are so necessary for investing/trading success. Now I may end up tipping when seeking to illustrate an idea but in that case, the tipping is incidental to the main purpose which is to share my ideas.

I could tell you countless horror stories about the ills of tipping. One will have to suffice.

The latest occurred about two years ago when I was asked to mentor a group of pit traders. The Singapore Exchange had made it clear that the pits would close. This group of very successful order-fillers and a few friends formed a group to trade from their former employer’s home.

Initially they found it tough going but then they came across a spread ‘tipper’ who appeared to ‘be the goods’. He racked up four out of four winners! I am told the room was abuzz with excitement – “the good time would roll again; perhaps bigger and better than ever!” We are talking 6-figure numbers here so you can understand the euphoria. The feeling was: “If only we had really loaded up!”

The next recommendation, they did exactly that. This time the trade hit the stop loss and instead of exiting they added to the losing position. I am told that the market went in their favour after that, so they added even more positions. Well, you can guess the sorry end. By the end of this trade, the group lost all of the profits and some had to quit trading altogether.

Success is a function of having a positive expectancy: (avg%win x win rate) – (avg%loss x loss rate) where:

  • avg%win = (profitable results (on a one contract basis)/price initiating the trade)/all winning trades
  • win rate = winning trades/all trades.
  • avg%loss = (losing results (on a one contract basis)/price initiating the trade)/all losing trades
  • loss rate = losing trades/all trades.

By normalizing the result as % of the price initiating a trade, we are able to compare across results, setups, traders etc i.e. by any metric benchmark you’d like to use.

The positive expectancy is a function of a written plan with an edge x effective money management x winning psychology. A trader with a plan but without the other two skills will not survive unless he quits as soon as he hits a hot streak – and that is unlikely. Can you imagine what my room would have said if I had told them to quit after the third win? What would they have said after the fourth? They may have listened after the fifth trade but by then it would have been too late.

Hence the emphasis on this blog is to provide information that will be of long-term benefit to the readers rather than focus on producing short-term gains. And speaking of results….

Results of last night’s trade: I sold S&P March 1321 and covered 1323.5. There was volume at 1321 but after the market poked below 1321, volume dried up, suggesting a rally was to come. I did not go long because my trading timeframe trend is down and I am looking for spots to add to my shorts.

Why Won’t the Market Reach My Sell Zones?

Raymond of raymond9@gmail.com posed this question:

Ray I am reading your blog and having hard time understanding IPM. Looking at current S&P as end of last Friday feb 8, i understand the trend is down and will break the last low at 1272. Question is: I want to short but I am waiting it at least going up to 1355 or even higher to hit the first fibonacci fan which is around 1367. I often found myself wrong in this waiting game cause a lot of time it run down without hitting my target first. I want to understand how do you think to play this short?”

I am happy to answer Raymond’s queries because I thought the questions had relevance to readers.

IPM

It’s not easy to understand the concept of an IPM unless you have grounding in Market Profile. In the USA, I have been recommended to two instructors:

  1. Tom Alexander of Alexander Trading, http://www.alexandertrading.com/home/
  2. Jim Dalton: http://www.marketsinprofile.com/

There is no one I would recommend in the East.

Essentially an IPM is a vertical move; in a vertical IPM, you have a series of bars moving up with no or very little overlapping higher lows and higher highs.

ZONES

Your question on where to enter raises the question of time frames. This first question I’d have you ask is: what timeframe are you trading? Once you answer this question, you need to assess the structure of that timeframe and where you are in the timeframe’s trading cycle.

  • In this context, by structure, I mean this: is the market moving in directionally (trending) or is it rotational (sideways)? Each structure has its own zones (retracement tools).
  • By trading cycle I mean the cycle Tubbs wrote about in the 1900s. It is a cycle with four phases:
  1. accumulation
  2. markup and pause
  3. distribution
  4. markdown and pause

So armed with that, let’s look at the current S&P cash. For the purposes of this exercise, we’ll assume we are trading the 5-d (weekly trend). The 18-d (monthly trend) and 13-w (quarterly trend) will be the first (18d) and second higher (13-w) timeframes.

Figure 1 shows the 13-w: The market broke a prior 13-w low formed on Aug 17; so whatever you have on the 13-w, you don’t have an uptrend but it could be doing a number of things:

  1. The market may have completed a distribution phase and is now in the beginning of a mark down (directional) phase;
  2. Or it may be forming a sideways market, 1576 to 1270.
  3. If it is forming a directional move, it’s not clear if the directional move is giving way to a rotational phase.
  4. Whatever it may be forming, the up and down bars of the past two weeks suggest that the next price move will most likely be a retest of the Primary Buy Zone (1286 to 1270). The Primary Buy Zone is created by the high of the recent rally and low to date (1395.38 to 1270.05).

Acceptance above the Maximum Extension of 1421.24 would suggest a retest of the boundaries of the Primary Buy Zone (1576 to 1550) bounded by the 1576.09 high and 1370.6 low.

So the first area of 13-w resistance is the Maximum Extension to the lower boundary of the Primary Sell Zone (1421 to 1380) (the area marked by a magenta rectangle in Figure 1).

Note that this area overlaps the Primary Buy Zone (formed by the 1576 high to 1370 low, red lines in Figure 1). In such a case, I treat the Primary Buy Zone as the more important i.e. acceptance above the end of the Primary Buy Zone (1396) suggests the market is moving to the Primary Sell Zone (1576 to 1550). So your ultimate stop level for shorts on the 5-d is above 1396. The sell zone thus runs from 1380 to 1396.

[I have used the retracement levels as substitute for Market Profile zones for the sake of simplicity. I prefer the Market Profile zones where available but for the purposes of this blog to use them would be an unnecessary complication. The retracement levels are an acceptable substitute. (For those that must know, the Market Profile Buy Zone runs from 1370 to 1417. So, my stops would be above 1417 basis cash)].

02-11-2008-13-w.jpg

FIGURE 1 13-w

Figure 2 shows the 18-d which may be moving into pause or accumulation mode. The market stopped at 50% of the IPM 18-d range from 1523 to 1270. Market Profile says once development starts, if a bear profile is to develop, we can expect the market not to accept above 50% of the IPM. Thus we ought not to accept above 1396 to 1397

So now you have the zone ‘1396 to 1397’ within the 1380 to 1396 zone as a sell zone.

02-11-2008-18-d.jpg

FIGURE 2 18-d

Let’s now turn to the 5-d, Figure 3. The 5-d is in a directional mode down (IPM) with a pause. The pause may result in a continuation of the IPM or it may start a rotational move. If it rotates back up, the first area of resistance is 50% of the IPM. This comes in at 1356.

02-11-2008-05-d.jpg

FIGURE 3 5-d

Figure 4 shows the combined 30 minute profile from the M period on Feb 2. This shows that from zones derived from previous profiles, we have major resistance 1356 to 1359. This area is derived from Volume profiles within the price action since the 1370 low on August 17.

02-11-2008-mktpro.jpg

FIGURE 4 Market Profile

My plan for today:

  1. Define the type of day.
  • If rotational, classify the type of day (traditional Market Profile);
  • then ask: what should be the high and low?
  • Does the projected high ‘fit’ the 1353 (lowered from 1356) to 1360 (lifted from 1359) zone – stops above 1367?
  • If it does not ‘fit’, I’d look at the next zone being ‘1394 to 1400’ with stops above 1418.

2. If the day is directional, what will indicate this?

  • Friday’s inside day and today acceptance below Friday’s low 1323.5, say 1321.5 (10% of Friday’s range less 1321.5), will suggest a directional move.

In this situation, I’d sell the break with a stop above Friday’s high 1345.5 (say 1347.75).

That is an example of my model. I define the nature and structure of current market conditions and then look for a zone, employing a top down approach.

Based on that model, let me answer your question this way. I can think of two reasons why you aren’t reaching your zone:

  1. You may be mixing timeframes – selecting price zones beyond your trading timeframe; and/or
  2. Your zone tools may be inappropriate for the current market structure e.g. applying rotational zones to a directional market etc.

SP Intraday 4

In this post, I’ll conclude the series on the Market Profile analysis.

Yesterday I wrote in relation to the Directional move from the ‘E’ period on Feb 6:

  1. “Is the move from ‘E’ the start of a new Initial Price Movement down or part of a rotational process?
  2. If a new Initial Price Movement, are we likely to have continuation of the directional move or the start of development?
  3. What is the significance of a ‘Neutral Day closing in the lower quadrant’? (See Mind Over Markets by Jim Dalton)”

Let’s take the (3) first. A Neutral Day closing in the lower quadrant implies continuation in the direction of the gap. Usually we can expect enough follow through the next day, so that by the end of the Initial Balance, the worst result would be a breakeven trade. (This is not quite what Pete Steidlmayer meant by ‘free exposure’ trade but I found it occurs often enough to be a high probability occurrence).

Let’s now turn to (1) and (2). All prices unless otherwise stated are basis March. Here’s how I saw the market:

  • I could not tell from the price action if the price movement from the “E’ period was part a new IPM or part of the rotational process.
  • If it was a new IPM, then continuation was highly likely since we had not achieved mean -1 standard deviation for the IPM. In addition we had the Neutral Day close to lean against. So my strategy in the first 60 minutes was to go short and monitor the break of the opening low. If the break signaled continuation, I’d stay in, otherwise I’d exit immediately.
  • If it was part of the rotational process, then the high of the rotation was limited by the 50% retracement – calculated from the high of the IPM 1386 to the low at 1325.
  • Consequently if I wanted to initiate new shorts, the stop loss for the new shorts was known.

In the “A” period, the market tried to rally and failed. It then went on to break to new lows. However after the break, there was no volume coming through. This signaled to me that price action at “E” Feb 6 and following was part of rotation. I had sold at 1321 as the market went to break the opening price and covered when the market began moving up, losing 2 points. At the end of the ‘B” period yesterday, we had:

  • The possibility of a bullish profile. If the 50% level 1328 could hold, then we could expect a move greater than a normal day’s range (30 mean + 15). With a low at 1317, this projected a target to 1347 to 1362. You will recall from the charts of SP3 that we had resistance zones around 1356 to 1357.
  • But if ‘C’ did not extend the ‘B’ range, the ‘test’ opening (See Mind Over Markets by Jim Dalton), suggested a rotational day. In that case the projected high was 1317.5 + 30 to -15 = 1347 to 1332. Again we had resistance zones between 1347.5 to 1346.5.

Figure 1 shows us the Market Profile chart as at the ‘B’ period.

02-06-2008-daily-mkt-pro-b.jpg

FIGURE 1 Market Profile ‘B’

The market went on to form a rotational day. Figure 2 shows the situation as at end of trading on Feb 7.

Looking at the larger picture: The S&P has had an IPM starting at 1386 and ending at 1325. Rotation has formed between 1317.5 and 1347.5. The move back to yesterday completed the minimum price action required for development. But, I’m inclined to the view that we’ll see a move to the Primary Sell Zone at 1348.5 to 1344. 5 before the downtrend resumes.

02-06-2008-daily-mkt-pro-m.jpg

FIGURE 2 Market Profile Feb 7

If we break above 1348.5, and we have acceptance above 1355.75, Market Profile suggests a move back to the start of the IPM. If this occurs, it would throw doubt on my view that we’ll retest 1286 to 1270 (basis cash) before any potential upmove.

Figure 3 shows the 30 minute picture as at end of trading Feb 7.

02-06-2008-30-min-2-sd-retracements.jpg

FIGURE 3 30-min Feb 7

SP Intraday 3

In SP Intraday 2, I said that there were major differences between the gap on Tuesday and the potential gap yesterday (potential at time of writing).

If we put aside the size of the gap, the differences I spoke of were structural. In order to explain these differences, I need to give you some background to ‘the Steidlmayer Distribution’. This is now also called the Market Profile. Initially Peter called it the Steidlmayer Distribution to distinguish it from the traditional Market Profile. The major difference between the two is this:

In the Steidlmayer Distribution, there are no fixed time frames and time periods in which a distribution occurs. In the traditional Market Profile, we use 30 minutes time periods to form a profile for one day’s trading.

A Steidlmayer Distribution has four parts:

1) It begins with a directional move which I call an Initial Price Movement (IPM). Think of this series of directional bars with few or no overlapping ranges and retracements.

2) Development (rotation) begins and with it, the formation of the Point of Control (the mode of the forming Profile i.e. the line containing the greatest volume) determines if the Profile will be a sideways market, a bullish profile or bearish profile.

(NOTE: For the Point of Control to play a part, development must first begin. In an Initial Price Movement, the Point of Control will tend to lag the directional move).

A sideways market takes the form of a bell curve with its Point of Control in the 60% to 45% area of the IPM’s range. A bull profile (looks like a ‘p’) has the Point of Control in the top 1/3 (or higher) of the IPM range; the bear profile (looks like a ‘b’) has the Point of Control in the bottom 1/3 (or lower) of the IPM range.

Think of this as a pause which may turn into the next phase.

3) Development forms and with it the first standard deviation forms. Pete called this Value Area.

Think of this a sideways market.

4) Development completes and usually from the Point of Control of the completed distribution, a new IPM forms that either moves in the original direction or accepts above 50% of the IPM range. If the latter occurs, the IPM will go on to form either a larger sideways market or the start of a new directional trend.

Think of this as the breakout following a sideways market.

Of course the market need not complete the four steps or may stay in any one phase longer than normal. In doing so, the market provides information on the strength or weakness of the market.

Now let’s turn to the gaps.

On Monday, the market had returned to my preferred zone to stop the rally and had formed a balanced day. The next day the market gapped on the open and formed a directional day down.

Pete Steidlmayer used to say: “Trend days are not good continuation days unless they mark the beginning of a move”.

Let’s look at this idea from the stance of the four stages. If the trend day marks the completion of an Initial Price Movement, then the likelihood is the next phase will be the development phase. If the trend day marks an uncompleted Initial Price Movement, we are likely to have continued directional moves.

  • Q: How do we tell whether the Initial Price Movement is likely to have ended?
  • A: By keeping stats on the Initial Price Movements’ duration in the various time frames.

At the conclusion of trading on Tuesday, the Initial Price Movement that had begun on Monday’s close had travelled just under mean +2 stdevs. This made the commencement of development likely. For this reason I took the view that yesterday, we were likely to have a rotational day.

Figure 1 shows a combined profile from the 3:30 to 4:00 PM Feb 4 to 4:00 PM Feb 5. At this stage the Point of Control is 1358 (just below the 50% of the IPM – the white rectangle). There is no development as yet. This can be seen from the even distribution of the volume. BTW, the various lines on the profile represent my resistance zones.

02-05-2008-distributional-pattern.jpg

FIGURE 1 Market Profile Wednesday Morning

And so it turned out (got lucky). The market formed a rotational day until the ‘E’ period when it rallied to the first resistance and then started down.

In my view, the new Initial Price Movement came in early and yesterday was a ‘Neutral Day closing in the lower quadrant’ (traditional Market Profile). What this means for today, I’ll complete tomorrow. But the questions to ask are:

  • Is the move from ‘E’ the start of a new Initial Price Movement down or part of a rotational process?
  • If a new Initial Price Movement, are we likely to have continuation of the directional move or the start of development?
  • What is the significance of a ‘Neutral Day closing in the lower quadrant’? (See Mind Over Markets by Jim Dalton)

Figure 2 shows the Split profile as at end of trading Feb 5. Figure 3 shows the Neutral Day.

02-05-2008-distributional-pattern-2.jpg

FIGURE 2 Split Profile

02-05-2008-neutral-day.jpg

FIGURE 3 Neutral Day

SP Intraday 2

A follow-up to my earlier post.

I said earlier that where there is a gap (I meant open-close gap) of 4% to 8% I expect a trend day if at least 50% of the gap is not closed in the first hour. However, as with all of my ideas, this behavioural parameter (set-up) is driven by context.

Early indications are we’ll have an open-gap of about 4% today – and this brings me to the reason for this entry.

For reasons I’ll explain tomorrow, whether or not the gap closes today, I’ll be looking for a rotational market. In turn this means that I’ll be less aggressive, looking to initiate shorts at my resistance levels.

In the meantime, you may want to consider: what is it about today that is different to yesterday?

S&P Intraday

In the S&P series (S&P I to VII), I showed my thought processes for end of day analysis. In today’s blog I want to do the same for intraday data.

I generally do not day trade. Even when I do, like my trading on February 05, it’s within the context of improving my entry price. My intraday entries rely more on Market Profile, Market Delta and the normalized volume provided by MarketVolume (www.marketvolume.com) than on the Barros Swing and Ray Wave. (I do use the Barros Swing and Ray Wave to provide context rather than as entry tools).

I looked upon the bars of February 3 and 4 in the same light as that of the bar of January 30th but with an important difference. Both sets of bars showed the market moving into balance; but whereas the bar of January 30 was still showing above average range, the bars of February 3 and 4 were showing normal ranges (mean range of 20 +/- 10 [10 = 1 stdev]). Figure 1 shows a comparison of the days.

02-06-2008-01-18d-sp.jpg

FIGURE 1 Comparison Jan 30 & Feb 3, 4 (cash)

What I wanted to see was some follow through on February 5th: ideally a poke above the Feb 3 high, followed by a sell-off. Instead the market gapped on the ISM figure.

I like gaps of between 4% and 8% because they give me a behavioural parameter to lean against. (A behavioural pattern is a pattern with an edge). If the market fails to close at least 51% or more of the gap by the end of the first hour, then we are likely to see a trend day (a directional move) in the direction of the gap for the rest of the day.

Figure 2 shows the Market Profile with splits for each 30 minute distribution to show the volume distribution.

If I suspect a trend day, I use the split to warn me of a possible bottom. To understand how the warning sounds, you need to know that when Pete Steidlmayer developed his Steidlmayer Distribution (the modern Market Profile), he postulated only 3 shapes:

  1. The sideways (Bell curve)
  2. The Bullish (Positive skew – like a ‘p’)
  3. The Bearish (Negative skew – like a ‘b’)

Pete also taught that:

  • As a rule, markets went from Bull to Sideways to Bear and not straight from Bull to Bear.
  • Down trend days tend to close in the bottom 25% of their day’s range (top 25% for up days)

My reasoning is this: for a trend day to turn, we will see a sideways volume configuration ahead of or at the same time as the bottom. This gives me time to exit should the market structure be changing before the close.

With a trend day, my strategy is to define the type of trend day (double distribution: where the market forms a small range in the first few hours, breaks out and then forms another range) or slow trend day (each break of the extreme is followed by a retracement).

Each type of trend day has different strategies but in each case, I trade more aggressively than normal. For the double distribution I look to get set above the value area for shorts and I place the entire position (the sizes for the position trade as well as the ones for the day trades) on the rotation.

For a slow trend day, I place the position size first. I then place the day-trade sizes as the market retraces after making to new lows. In each case, the stop for the day trade is placed above the start of the previous distribution down.

Let me now walk you through Figure 2.

I placed my position size on the retracement at the ‘E’ period after the break to new lows during the ‘D’ period. This break and rally suggested a slow trend day. When the market rallied during ‘F’, I sold 1/2 my day trade size. The Volume Profile for the “C”/”G” distribution is a bearish one; so I am looking to continue selling.

In “H” we break to new lows. I sell the rally at ‘J’ (1/4 size) with stops above the high of ‘C’. I move my stop for all day trade positions to above ‘H’ when the market breaks to new lows in ‘I’. When the market rallies during the ‘K’ period and the range extension forms a low extreme, I sell the remaining 1/4 day trade size. At the end of ‘K’, my stop on the full day trading position is above ‘H’.

At the end of ‘K’, the volume profile has formed a sideways pattern. Since I expected the market to close near its lows and I had support at 1340. I determined that if the market broke below 1342, I would exit. When the market broke at ‘L’, I exited all day trading positions at 1341.5.

The result of the day trades has been to reduce the risk on my position size.

02-05-2008-esh8-mkt-profile.jpg

FIGURE 2 Market Profile (ESH8)

Pete used to say that traders reversed the natural order:

  • On trend days when they ought to be aggressive, traders tend to sit back and admire their great trade location. At the end of the day, they can rightly boast that they sold near the high of the day, and bought near the low (on a down day). In fact they failed to take advantage of the opportunity presented by the market.
  • On rotational days, traders tend to trade fast and furious and generally in the middle of rotation, the second worst trade location. At the end of the day, the result is usually not commensurate with the risk and the effort.

If we learn to reverse these tendencies and apply the correct strategy in the appropriate context, our bottom line will be much improved.

The Art Of Position Sizing

Today I want to talk about a subject that normally causes participants to doze – it’s a very unsexy subject. Unsexy but very important. So bear with me.

There are two issues I have with many commercial position sizing software:

  1. The software allows only testing on an instrument by instrument basis.
  2. It reports only on dollar results

There is no problem with testing on an instrument by instrument basis if you are trading one instrument. But if you are trading a basket of instruments, then serious problems rear their heads.

One of the main issues lies in the fact, that unless you can test on a portfolio basis, you cannot assess the damage a drawdown will do to the portfolio. For example, in a diversified portfolio, a drawdown in one instrument may be saved by a profitable run in another. Or, if all instruments suffer a drawdown simultaneously, then their drawdown would have a much greater impact on capital.

The commercial package I like best is the successor to Trading Recipes: Mechanica Standard Edition

http://www.mechanicasoftware.com/products.htm

I don’t own a copy (I had my own program written) but I have seen it work and I am impressed with it.

The second issue arises because all dollar results are treated equally. But in the real world of trading, this is clearly not the case. The volatility of the market plays an important role in assessing the reasonableness of the return. For example, a risk of $1000 would be very different in an instrument that has an Average True Range of $3000 to one that has an Average True Range of $200.

The Expectancy Formula I quoted in previous blogs is not the one I use for this reason. The formula quoted has been:

(Avg$Win x Win Rate) – (Avg $Loss x Loss Rate) = Exepectancy

I prefer to normalize the result by dividing the result on a one contract basis by the initiating price. Let’s say I bought gold at US$850 and sold it at US$930. The Initiating Price % result would be:

((930-850)/850)x 100 = 9.4%

What I am doing is substituting the $ expectancy with a % of initiating price then translating that to dollars.

For example, let’s say my long-term expectancy is 10%. I enter the ES tonight at 1377. My expectancy for the trade would 1377 x .10 = 137 points x 50 x number of contracts. If I were trading gold and my entry is 890, my expectancy would be 890 x .10 = 89 x 100 x number of contracts.

I find using the % of initiating trade price a more accurate way of assessing expectancy than dollar values.

So then, the Expectancy Formula I use is:

((AvgWin%IPrice x WinRate) – (AvgLoss%IPrice x Loss Rate)) = % Expectancy

Intergrity, Honesty, Responsibility

The successful traders/investors I have met in my travels all share these three qualities: Integrity, honesty, responsibility. In this blog, I’ll first explain what I mean by the terms and then proceed to give examples on how their lack stops us from achieving our dreams.

  • Integrity: I see three levels of integrity. The first is keeping promises to others; the second is living our lives in alignment with our professed values and beliefs (we ‘walk our talk’); and the third is keeping promises to ourselves. (Landmark Forum)
  • Honesty: The refusal to pretend that facts are other than as they are (Ayn Rand: the refusal to fake reality)
  • Responsibility: The ability to personally respond (Fritz Perls). We are accountable for the responses we have to life’s situations. For example: we are not responsible for an accident caused by the negligence of another party but we are responsible for the way we respond to the consequences of the accident.

In my role as mentor, I see a wide diversity of personalities. Yet despite variances in human nature, those who succeeded all evidenced the three traits. Those who ultimately fail – those that surrender without completing the course – are the ones who never acquire one or all of them.

For example: I have one student who has the ability to be making money now. Yet, he is merely breaking even. Given the time and effort put in, the breakeven result would be, for another, an excellent result. But in his case, given his talent and feel for the market, the results could be much better.

When we examine the metrics, the reason for the mediocre results is clear: he takes profits much smaller than his losses. The cause for this is not hard to find: he trades two timeframes – FX for swing trades, ES for day trades. Whenever the market moves rapidly in his favour in the swing trade, he grabs the money rationalizing that he may as well put some money in his pocket. He figures that should the market correct, he can reinstate the position.

You can imagine the result. The very best trades do not retrace and as a result the profits he took and what he ought to have taken are wide apart.

To deny the facts, he focuses on the occasions that the early grab gave a better result. What he ought to be doing is focusing on the whole spectrum of trades. He chooses not to on the basis that ‘things are different now’.

Because, because ……we can rationalize away just about anything.

Actually in his case, I am optimistic that he’ll see the light. He is bright, intelligent and has a great feel for the market. I think it is only a question of time before the penny drops. The fact that he is breaking even rather than losing is testimony to his ability.

Another student may not share the same result. In this case, the program has always been a struggle. The student has been seeking success for over 5 years after leaving his job as a bank dealer. Having him change his ways has been a hard- fought victory, won inch by inch. We are now at the stage where he has to write out his trading plan.

Normally writing out the trading rules, takes no more than a month; some do it in a week. In his case, we have been at it for 3 months and there is still no plan in sight. I understand the source of the barrier. As long as the plan is not written down, failure to achieve his goals can be laid at the feet of ‘something out there’: it’s the market’s fault, I am having girl-friend problems, it’s Ray’s fault, he ……

Once the plan is down in black and white, then he perceives that long-term success rests squarely on his shoulders. And right now, he is playing the avoidance game.

How do we tell if we lack integrity, honesty and responsibility? It’s a question of self-awareness of the consequences of our actions. Dr. George Lianos once said to me: “If you repeat a behaviour, then no matter how valid the reasons for each individual occurrence, focus on the fact that you are repeating the behaviour – that is the reality”. Once we identify the behaviour, then we act to change it.

The Nature of Price Action

It’s important that we remember that the charts and studies we use are representation of buying and selling; buying and selling that is the result of human action. Therefore, charts are nothing more than a visual representation of the prevalent dominant buying or selling psychology. Sometimes we get so carried away with patterns etc that we forget this is so. Thinking in terms of the dominant psychology, provides trading opportunities especially for short-term trades and entries for longer-term ones.

In this blog, I want to illustrate this idea with reference to my blog S&P VI and last night’s price action.

On January 30 we were awaiting the FOMC decision. The 0.50% was anticipated by most. Readers of this blog know that more often than not, I tend to take a position against the crowd. But in this case, I could not see how Bernanke and Co would not cut by at least 0.50%.

  • The FED’s reaction to the turmoil – brought about by the Societe Generale’s liquidation of positions – meant that if the FED cut less than 0.5%, the market would probably tumble because the FED is now perceived to be reacting to financial markets rather than the US economy.
  • Since the majority was expecting a 0.50% cut, the immediate response would be a rally as the crowd piled into the US stock market.
  • Since the US stock market is probably in the first phase of a bear market (what Wyckoff and Tubbs called a Distribution Phase), the rally would be met by professional selling at resistance points. I was lucky enough to identify such a possible point at 1382 to 1386 basis cash S&P.

The same sort of thinking again provided opportunities yesterday.

The market gapped down on the open. Now, bearing in mind that we have Non-Farm Payrolls today – in my view this is currently the KEY monthly number – what would a short-term professional do if he had gone short the night before? Would he carry his entire position into tonight’s figure? Unlikely in my view.

His tendency would be to take at least some profits. The crowd would see the rally and would probably initiate long positions. Since there would not be serious opposition to the buying, and we might even see some stops go off, we could expect a rally to last most of the day.

Based on this reasoning of the psychology of the markets, I anticipated that the market would cover the gap and, if the market would accept above the bottom of previous day’s Value Area, we’d probably see the other side of the Value Area. In addition we could anticipate the range for yesterday once we accepted above the bottom of the Value Area. We do this by adding 59 to 33 to the low. (Mean, 42, + 17 [1 stdev] and -9 [1/2 stdev]; this is the mean of true range and ‘+1 std to – 1/2 std’ measured from the timeĀ  volatility increased).

This was the game plan a couple of my day-trading students developed and they implemented it by leaning against the gap open in the “B” period with stops below the low of ‘A’. They planned to take partial profits at or slightly above bottom of the prior day’s Value Area and the rest at the position was to be liquidated around the top of Value. This was on the proviso that top of the Value Area from the low did not exceed mean +1 i.e. 59 points. (It didn’t).

Figure 1 illustrates the strategy.

es-02-01.jpg

FIGURE 1 Market Profile Data

Tonight we can apply the same reasoning. I’d be less of a contrarian tonight for these reasons:

  1. I judge that even the professional would need to see more evidence of a top.
  2. Apart from last night, the crowd has been burnt, so I’d expect that they too need to see some confirmation.

The consensus for the Unemployment Rate is 4.9% with a range of 4.9% to 5.0%; the Non-Farm consensus is 58k with a range of 25k to 120k (http://www.nasdaq.com/asp/econodayframe.asp?page=http://www.nasdaq.com/econoday/index.html). So for tonight:

  • If the figures are around consensus say 75k to 50k range I’d expect a quiet night – after an initial flurry – and expect an unchanged close.
  • A figure of above 120K would be bearish for the S&P and bullish for the US$. I’d expect to see a lower close.
  • A figure below 25K would be bullish the for S&P and bearish for the US$. I expect to see a higher close.

What would be my trading strategy?

First I want to repeat what I have been saying in previous threads. The ES ranges are too rich for my blood. I’d be standing aside. If I had to trade, I’d have a sell-stop below the market and below Delta support; at the same time, I’d have a buy stop above the market and above Delta support.

I’d be looking for a smaller or larger range than consensus for N-F to trigger my entry. BTW, for this sort of trading to be successful, it’s a given that you know from previous experience that you are unlikely to suffer much slippage).

If an entry is triggered without the N-F payroll aligning with entry, I’d exit immediately wherever the market may be trading. If the N-F conditions align with the entry, I’d exit 50% before 9:30 EST if I can pocket 10 points. The remaining 50%, you’ll have to manage. If I don’t get my 10 points, I’d consider exiting before the opening bell on the basis that generally the market will cover an opening gap.

Take it easy, it may get rough out there tonight.

S&P VII Final Words on This Series

Thanks for the e-mails regarding the call last night. I’ll say a little more about that later in this post.

Tonight will be the last post in this series. My aim in tracking the S&P was to flesh out the way I trade the markets:

  • What is the trend of the timeframe I am trading? Continuation or change? The answers give me my strategy.
  • Where do I take a trade? That is where is the price zone where I look for…
  • ….My setup and trigger?
  • Where are my initial stops and targets to work out the Risk/Reward for the trade?

Last night on a 30-min basis the Market Profile and Market Delta would have got me into the trade around 1380 to 1382. I’d have waited for selling volume to be evident before entering the trade. The stop for last night’s entry would be above 1404 and preferable 1409 (basis cash).

But what if I were an end of day trader without access to intraday data, what would be my setup, entry and stop?

Last night would have formed a setup bar. The market reached the zone and produced a neutral to bearish bar. Generally I’d be looking for today to form a strong bar down and I’d enter near the close. My stop would be above 1400 (10% current swing above last night’s high, assuming it remains a possible 1-d swing high i.e. we will not see a higher high tonight).

I’d use the Rule of 3 and I’d be looking to exit part of the positions in the Primary Buy Zone (see Figure 1). However, it is unlikely I’d take the trade under these conditions. A bearish bar would mean about a down 30-point day with close no higher than 1/3 range above the low. So, we’d have an entry say a -20 point from yesterday’s close. Entry would thus be around 1330 with stops above 1400 and a core profit target around 1278: very poor risk reward.

So I’d pass on the trade unless I could get in on a low volume rally. In addition, tomorrow we have Non-Farm Payrolls and normally I don’t initiate positions ahead of major figures.

That’s it then for the S&P for now. I hope it’s been of some benefit.

I’d now like to address some of the less experienced readers. Don’t get too carried away with my call for the S&P.

Last night’s call was a measure of luck and skill.

  • The skill comes from assessing what the market ought to do given the circumstances and in providing for a series of responses.
  • The luck comes in because on a trade-by-trade basis, the market could have done anything. For example, it could have finished on its highs.

That’s the nature of markets; it’s a probability game. We have an edge to the extent that over a large sample size our expectancy is greater than 1; but on a trade-by-trade basis, the results are random. So every call that goes our way is part luck, part skill. The only aspect of trading over which we have any control is our entry and exit and that’s what we have to manage to succeed.By the way, the previous paragraph does not mean I don’t appreciate all the kind words that you sent. I do and I thank you.