Wednesday, August 02, 2006

Reading the Market: More on What Every Short-Term Trader Should Know

In an earlier post, I outlined a reality that every short-term trader should know. Here I want to follow up on that with a practical application and example.

Imagine the market oscillating from moment to moment. It trades a number of contracts at the bid price, then several at the offer, then more at the bid, and yet more at the offer. This is happening from second to second as you focus on the order book and what is actually trading. What is actually trading is different from the bids and offers in the book, which may or may not actually trade, given the frequency with which large traders will pull their bids and offers before they are hit.

So we want to focus on what is real. What is real is what trades and *where* it is trading. Second to second, it is trading alternately at the bid and offer.

When a large trader lifts 500 from the book (i.e., purchases 500 contracts at the market's offer price), that, in the context of the moment-to-moment market, is a breakout trade. The only reason for buyers to take the offer price is if they think the market's oscillation is going to end and we will find a new, higher bid-offer range.

In that very short-term context, every buyer at the offer and seller at the bid is a breakout trader. The degree to which the market is trending at this shortest timeframe is reflected by the ease with which these breakout traders get paid out. In a rising market, the purchaser of 500 contracts at the market will find other demand coming in to support the price and the market will move higher.

If a large trader lifts an offer or hits a bid and doesn't get paid out, by definition his or her order was not sufficient to budge the market from its oscillation range. (And, of course, if the large trader' s position goes more than a tick in the red, the market is trending against that trader).

Yesterday AM, I had two points of profit in a short trade. The market had already made a nice down move and suddenly a seller hit the bid with 1500 contracts. I knew from experience that, on average, large size hitting bids after sizable down moves have already occurred often provides liquidity for smart buyers who perceive short-term value in the market. When the market did not immediately go lower in the face of that large trade, I took my profit and avoided a nasty run upward shortly thereafter.

If the market could easily absorb a large sell order after having moved steadily lower on orders that were no larger, that told me that we were nearing an equilibrium point. If the large trader is not getting paid out, the market is not trending on the shortest time frame.

This is not theory. This is not hammer and shooting star chart patterns, Fibonacci retracement numbers, wave sequences, oscillator readings, news events, statistical models, or monetary/economic conditions. This is simply how the market is trading and the ebb and flow of supply and demand in the marketplace.

When you combine historical market tendencies (such as those researched on this blog) with a keen reading of real-time supply and demand shifts, it is indeed possible to generate short-term edges in the market. The key is watching the market and what is actually happening, not getting lost in theories and what you think should happen.


John Wheatcroft said...

Excellent observation, Sir. Couple that with my rule 1 - nobody knows nothing and one might be able to make a profit every now and then.

But the hammers and stars, fibi sequences, and pivot points are what I use to "listen" to the market. These things speak to me like nothing else does.

Brett Steenbarger, Ph.D. said...

Hi John,

Nice point; thanks. Different ways of construing market movement may speak to different traders. The key is finding what helps you make sense of the ebb and flow of supply and demand--


oldsoothsayer said...

Excellent entry & exit strategy.
Letting smart money test the market for you is evidently a smart scheme.

This is manifestly the last confirmation you should get before you step in a trade (when you can).

Well seen!

Brett Steenbarger, Ph.D. said...

Thanks for your note; that's *exactly* the idea: let other people's trades test the water for you. If big traders are on one side of the market and aren't getting paid out, you know they'll have to exit those positions once the market turns the other way.


durga said...

Dear Sir,

How to we get the data. I would like to know about the 08/01 reversal in the last half hour and also 08/02 mkt getting good support in the last 30 mins.

Brett Steenbarger, Ph.D. said...

Hi Durga,

Most real time data feeds, such as RealTick, will provide you with trade by trade data in either tabular or charted form. I export those data to Excel; the data feed saves some past data for future reference. I use the Market Delta program to track large trades at bid and ask, and that program allows you to save the data at the end of the day for future reference. Linnsoft's Investor RT program also has a feature that charts trade by trade data by bid offer.


dave said...


You made a great point on the comment about what is "real ". I realized recently you need to be cautious with what is in the order book. Inet may show 700k at the offer on the qqqq and , only 25k at the bid. But then size appears from no where on the bid and the ask is pulled. I have seen that time and again . It isn't reliable.

Brett Steenbarger, Ph.D. said...

Hey Dave,

Very good point. What is in the order book is, indeed, not necessarily real. But what actually trades in size--and whether it trades at the bid or offer--is much more reliable as a guide. Thanks for your note--


John Cook said...

Brett great post. Do you have any ideas on how you could adapt this strategy to a swing trading timeframe?

Brett Steenbarger, Ph.D. said...


Thanks for the note. I do think being able to track very short term buying and selling can help longer time frame traders get better prices on entry and exit. Also, tracking the differential between volume at offer vs bid over time provides a useful trend measure that applies to swing timeframes.


DrFox said...

Hi Brett,

Sometimes it is difficult for me to follow your descriptions, such things like level 2 screen and this tick data are not offered in Brazil and I can't correlate.

Would it be too much if I ask for you to post a screen picture or even e-mail it?

Brett Steenbarger, Ph.D. said...

Hi DrFox,

Thanks for your question. I'm on the road and don't have the ability to send screen shots at this time. If you go to the Market Delta site ( and look at their "footprint charts" with bid-ask data, you'll get an idea of how I see the information displayed. Those footprint charts can be on any time frame, from trade by trade to half-hour.


yinTrader said...

I was just toying with the Market Delta which is the best indicator for volume on bid and ask prices, in my opinion.

However, there seems to be some problem downloading from its site in Singapore. I am seriously looking into this subcription, too.

Brett Steenbarger, Ph.D. said...


I do find Market Delta helpful to my own trading. The 30 day trial should tell you if it might be of use to you. I'm sure if you email Trevor Harnett directly, he'll assist you with downloading. My understanding is that a new--and significantly improved--version of the program is coming out within the year. Thanks--


Yossi said...

Hi Brett,

Would you please explain how I can figure out from reading the tape wheither big traders were or were not paid out after position was taken.

Brett Steenbarger, Ph.D. said...

Hi Yossi,

To figure out if large traders are being rewarded after taking a position, you would need a real-time data feed that would show you each trade placed and the volume for that trade, as well as the price at which the trade was transacted. A time-and-sales screen will accomplish this. You then note the price of the trade and see in the next minute or so whether or not the market moves in the large trader's favor.

There are software platforms, such as Market Delta, CQG, and Investor RT that allow you to track this on charts, as well.

Thanks for the question--


Mark Sanchez said...

Great observation on "trapped" money. Could you help describe the reasoning for assuming the large order closing on the Bid is "New" money electing to sell and looking to get "paid" on a newly initiated trade? Couldn't it simply be someone covering their shorts, paying across the spread and taking profit?

Brett Steenbarger, Ph.D. said...

Hi Mark,

You raise a valid point. All we know when we see an order hit the bid is that someone is so eager to exit the market that they're not willing to work an order at the offer. That could be because they're eager to initiate a short or because they're eager to exit a long position. Either way, it does reflect the sentiment of that trader--and that's where I think the data has the greatest meaning and relevance. Thanks for the solid observation.


subq said...

One thing that I think is very important on an index future is realizing that volume doesn't move the price directly.

If you previously traded equities it is an easy mistake to make.

The price of the index future will rise and fall from the underlying not directly from buying/selling of the index future itself.

This is actually quite easy to see in volume profiles or market delta. If you switch to delta volume you will notice that delta is almost always green at the top of the bars and red at the bottom of the bars.

This is showing the traders following (anticipating), not driving, the index price.

I only point this out because it was something I didn't take into account when I started trading index futures. I was looking at volume incorrectly thinking that buying would directly drive the price up and selling would directly drive the price down.

Of course, it is much more complicated than that...but the basic idea is key to understand when looking at volume on an index future vs an equity.

By much more complicated I mean that buying/selling of an index future can indirectly move the price by causing buying/selling of the cash index and/or underlying stocks, etc etc...

Brett Steenbarger, Ph.D. said...

Thanks, subq, for your observations. It is, indeed, a complex relationship between the futures and the underlying stocks. Futures will move the stocks in the very short run as a function of program trading. You can see, for example, the ES futures lead the cash index, the NYSE TICK, etc. on a second-to-second basis.

Longer-term, I think you're right: the supply/demand for underlying stocks provides support and resistance for the futures and dictates the participation of large institutions. Tracking ES volume patterns is, IMO, more helpful for the intraday trader than the investor for that reason.