Wednesday, March 18, 2009

Reasoning With Price Levels: A Key Trading Skill

I recently mentioned that I'm using the intraday Twitter tweets to model a certain kind of reasoning process with respect to intraday market movement. One element in this process is what we might call "thinking in price levels". Here is an example from yesterday's market:

In the morning, my Twitter post indicated:

10:42 AM CT - Seeing if we can hold above open price to test AM & overnite highs. Watching TICK closely.

If you go to an intraday chart of the ES futures, you'll see what I was looking at. The market had moved below its overnight range in early trade and then rallied back into that range. In an earlier post, I had noted the reduced relative volume and raised the issue of a range day. A range day, my earlier tweet reviewed, should oscillate around the volume-weighted average price, with VWAP not differing greatly from the market's opening price.

From about 9:45 AM CT to 10:30 AM CT, we moved lower, with volume dwindling on the down move. I noticed some signs of selling drying up as we approached the market's opening price. From my perspective, that was important, because it suggested that not only could we not sustain selling below the market's overnight range. Now we weren't sustaining selling below the market open. Any market that cannot move below its open in morning trade should be a good candidate to hit its near-term upside targets.

When I posted the 10:42 AM CT tweet above, I had already noticed buying coming into the market on the bounce off the opening price. From an execution vantage point, I don't want to try to pick market bottoms. Rather, I wait for initial buying to validate my idea, then take the first pullback for entry. That is why my post emphasized the need to watch NYSE TICK carefully. If, indeed, buying interest was dominating above the market open, the Cumulative TICK from that point forward should stay positive. As long as that is the case, a normal, expectable pullback in TICK provides an entry to the upside, with the previous day's pivot and the morning high as immediate profit targets, followed by the overnight high.

Although this particular example focuses on the market open as an important level, the same reasoning process holds for any key level. If, for example, we hit R1 on strength and then pull back but manage to stay above the previous day's high on the pullback, I'm thinking of buying the pullback for a move certainly back to R1 and, depending on the strength of the buying that unfolds, to R2. If we can't take out the overnight high in early trade and move below the previous day's pivot, then bounce higher but stay below the pivot, I'm thinking about selling the bounce for a move all the way through the overnight range and perhaps to the previous day's low price.

In other words, we're using the ability or inability to hold price levels as an ongoing assessement tool for markets. These levels are not just price targets; they are reference points. (Clear areas of support and resistance in a range also serve as key reference points). If I'm an active trader, I'll think about exiting a long trade at one level, waiting for a pullback to show me that the market can't go to the next lower level, and then entering again in the direction of the day's trend to target the next higher level. (From this vantage point, your trade's failure to hit a target level is also diagnostic and can set up worthwhile trading ideas).

Many traders draw their levels on their screen in advance to aid with this reasoning process. I will be illustrating with future intraday Twitter posts. As always, subscription to the Twitter messaging service is free; you can also view the last five tweets on the blog page under "Twitter Trader". For more on the reasoning process in trading check out this previous post.
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4 comments:

Jeff Pietsch CFA Esq said...

Hi Brett, I thought perhaps this chart showing pivot levels and cumulative tick may add to the excellent article. JP

http://4.bp.blogspot.com/_uzVbkLlVFKM/ScFGNocqI6I/AAAAAAAAB14/jw3NYcTBJbE/s1600-h/Int031809.jpg

jordan said...

Hi Brett,
When u talk abt overnight trading in ES, you referring to trading times outside of 9.30amET and 4pmET, is that correct?

Brett Steenbarger, Ph.D. said...

Thanks for your link and excellent Market Rewind blog, Jeff--

Brett

Brett Steenbarger, Ph.D. said...

Hi Jordan,

Yes, I'm referring to the time outside of regular trading hours (after 15:15 PM CT and before the 8:30 AM CT open) as "overnight trade" in ES futures.

Brett