Thursday, December 13, 2007

Using Short-Term Sentiment to Avoid Market Head Fakes

The most basic unit of sentiment for the short-term trader is whether a given trade occurs at the market bid or the offer. When a trade occurs at the bid price, it means that a seller was willing to give up the edge in order to exit his or her position. Similarly, when a transaction occurs at the offer price, it means that a buyer was willing to pay up in order to enter the market.

Over time, by correlating the size of trades with their location within the bid-offer matrix, we can detect how large traders are leaning: to the buy or sell side. This is the concept that underlies the Market Delta program. Similarly, by observing how many stocks at one time are trading at their offer vs. bid price, we can see if the broad market is tilted toward buyers or sellers. This is the logic underlying the NYSE TICK measure.

By cumulating the volume at offer vs. bid over the course of the day and by cumulating the NYSE TICK values through the course of a market session, we can see how market sentiment is shifting over time.

When we rose sharply yesterday in response to the Fed announcement of coordinated action, the market looked very bullish. As Rennie Yang observed in his excellent Market Tells newsletter, however, the NYSE TICK action was telling a different story. Relative to the 20-day average, we were actually seeing reduced buying interest. The TICK told us that traders were selling into the strength, which ended up being a great market tell.

I like to sit out the first 15 or so minutes of price action and see how the Market Delta and TICK are unfolding. Rennie uses extreme TICK action to anticipate a trend day; his trend-catcher strategy has performed admirably of late. By watching the sentiment underneath price action we gain valuable short term information that keeps us out of head fake markets.

RELATED POSTS:

Using Market Delta in Trading

NYSE TICK Volume
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2 comments:

EFree said...

Brett,

Great post. I looked back at some of your previous tick posts, and was wondering if you used a simple or exponential moving average for the one day value of the cumulative adjusted nyse tick line. Also, do you do anything to account for the effect of a series of extreme values being removed from the moving average (when they are no longer part of the moving average and a series of extreme positive values exactly a day ago can appear to make the sentiment go down when in fact it could be relatively neutral)? Thanks.

Eric

Brett Steenbarger, Ph.D. said...

Hi Eric,

I use a simple MA. By looking at the "emerging moving average" (the moving average for the current day with the opening value anchoring the series) as well as the standard MA, I try to address the concern you raise re: getting misleading readings by eliminating extreme values from the prior day.

Brett