Monday, March 19, 2007

Trading Short-Term Range Breakouts With The NYSE TICK


When stocks trade in a relatively narrow range for 30 minutes or more, we have the opportunity for a meaningful breakout move. The general rule is that the longer the range, the greater the magnitude--and often the duration--of the subsequent breakout move. The challenge for the short-term trader, of course, is determining the ultimate direction of the breakout.

The mistake many traders make is trying to crystal ball the breakout direction, committing their capital before the market shows its hand. Rather than try to pick tops or bottoms within a range, we can let sentiment be our guide. Let's take a look.

Above we have a chart of Friday's morning market. This is taken from my RealTick screen and shows Eastern time. The red candlesticks represent the June ES futures; the blue lines are the NYSE TICK. Both are one-minute values. Note that we have a trading range in the futures from roughly 9:55 AM to 10:30 AM.

Now recall that the TICK is showing us sentiment: the number of stocks that are being traded at their offer price minus those traded at their bids. (For more background on the NYSE TICK, go to Technorati, click on "advanced search" in their search box, enter "NYSE TICK" for the search words, and limit your search to the TraderFeed URL. You'll get a listing of every post that deals with the TICK). The question I ask during the range is: What is the level of sentiment (i.e., the level of TICK) needed to keep this market in a range?

We can see from the chart above that the average TICK level during the range is a bit over 400 (it's actually 433). I also know from my research going into the day that the average TICK level over the past 20 trading sessions was 250.

What is that telling us?

It is taking above average bullish sentiment just to keep the market moving in place. This is the very embodiment of inefficiency: the inability of sentiment to move price. As a rule, uptrends lose efficiency before they turn into downtrends.

Here is where context matters. The trading range is also occurring just above the previous day's high price. If this were a valid breakout move (note that we're viewing the prior day as a trading range in itself), we should be gaining efficiency as we move higher. The loss of efficiency is a nice tell that we're going to at least move back to the middle of the prior day's trading range (its value area). For that reason, I did not have a problem selling the futures with an initial position while we were still in the range. (One of my primary stop-loss exits was a breakout high in TICK. That probably would have invalidated my thesis of inefficiency and waning bullish sentiment).

The second, and more secure, point to enter the trade idea is on the first bounce following a breakout low in the TICK. When the TICK makes a new low relative to the trading range (as we see a little after 10:35 AM) and then bounces back to positive territory, that becomes a high probability entry. It's showing us that sentiment is waning, and--as long as price on the bounce stays below price prior to the TICK breakout--it shows us that we're making lower price highs and lower lows. You won't catch the exact top of the market with this entry, but by letting the market show its hand, you can ride a move already in progress.

As long as the TICK bounces occur at successively lower price highs and your average TICK level is falling, you can stay in the trade. That's telling you that sentiment is becoming more bearish and the market is maintaining or even increasing efficiency to the downside. If your initial profit target was the midpoint from the prior day and you are *still* seeing a bearish tilt to sentiment and downside price efficiency, then you want to leave at least a piece of your position on to hit your further targets: either the low from the prior day or the S1 pivot level, whichever comes first. It's helpful to have those targets written in front of you; that's why I post ES targets to the Trading Psychology Weblog each day. This is especially true if volume is expanding on the decline, given the volume-volatility relationship.

Notice how much information you are integrating over time to make this trade and stay in it. I will have more to say about conceptual integration in an upcoming post. Suffice it to say here that you are integrating patterns of range and value with patterns of efficiency with real-time patterns of shifts in price and sentiment (TICK). It takes a fair amount of experience with these patterns to recognize the trade, make the proper entry, and ride it toward a high probability target.

Perhaps now you understand why I say that the notion that trading is mostly mental/psychological is complete rubbish. A negative frame of mind can interfere with the best of skills and experience, but a positive frame of mind won't provide you with the pattern recognition skills and the conceptual integration to make the above trade. The way you learn short-term trading is by seeing one example of a pattern, after another, after another, after another. Eventually those patterns jump out at you and you can make the proper identifications in real time. A blog like this can jump-start your learning process by showing you some of the patterns to look for. But, ultimately, it's your screen time and your degree of immersion in market patterns that will enable you to truly see markets and make the right trades.

9 comments:

Simply Options Trader said...

Hi Dr Brett,
The avg 20 trading session for TICK that you talked abt here refers to SMA or EMA? Thks

Humble1 said...

I have to admit, the overlay of tick onto the index charts is revealing. I did a spread differential on the realtionship between the index and TICK to see if any patterns jump out at me. I also believe this method will work best at important potential spots where major support and resistance reside, at gaps, and at price pattern targets. We will see. Thanks.

Brett Steenbarger, Ph.D. said...

Hi Simply Options,

It's a 20 SMA; thanks for the opportunity to clarify--

Brett

Brett Steenbarger, Ph.D. said...

Hi Humble1,

You've got the right idea; looking at that spread relationship day after day will sensitize you to valuable patterns--

Brett

bwilhite said...

Wow, great post. Someone was asking me the other day if I didn't think I overanalyze the currency markets (because I look at the relationship between various crosses among other things) and of course my answer was 'no, I make all of my decisions and do all my analysis before I enter the trade.'

Anyway, I wish I had this kind of information in currencies, but as you know it's just not there. Still, I've had some ideas lately of ways to integrate new information into my trading. It's damaging, I think, that so many traders believe it should be as easy as just see and click. In some ways it is, but in a lot of ways it's not. As you always point out, even the pure scalper has to spend time immersing himself before getting a feel for the patterns...implicit knowledge.

Thanks for the insight, I find this analysis fascinating.

Brandon

Brett Steenbarger, Ph.D. said...

Thanks, Brandon. I'm far from expert in the currencies, but I have found some value to price/volume patterns in the Euro futures and I do like to look at whether breakout moves in the Euro are confirmed by other dollar relationships. I also suspect that there's good research that could be done on changes in international interest rates and currency moves. Thanks for the note--

Brett

Simply Options Trader said...

Thanks Dr Brett.

While pondering over this idea, a point to clarify occurred to me: The 20 SMA you are applying here refers to 20 trading days and not avg of 20 TICK bars? Because if I'm looking at 15 min price bar for the TICK, the avg of past 20 TICK bars would be different from avg of 20 trading days TICK.

Brett Steenbarger, Ph.D. said...

Hi Simply Options,

Yes, I average 1 min data over 20 trading days to provide a benchmark. I only track 1 min data with TICK.

Brett

crontab said...

Hi Brett

Where do you source your TICK data and charts?

TIA

J