When I first learned trading, I made it a habit to print out daily charts of the "trade of the day". This was a look, in retrospect, of the best trading move of the day and how it set up. After looking at hundreds of trades of the day, I became more sensitive to these patterns in real time. No pattern is exactly like any previous instance, and no setup has every element line up perfectly. But when you see many examples, you can filter out the irrelevant differences and focus on the common elements of the good setups--much like a radiologist can ignore idiosyncratic differences from one person's X-ray to another and focus on what's important in the images.
If you click the Market Delta chart above, you'll see an example of one of my walk-throughs in Friday's ES futures. Let's take it step by step:
1) We make a momentum low in selling at the 13:30 bar, with expanded volume and very heavy volume hitting bids.
2) The market rallies sharply in the next bar, but volume does not expand and the net volume of contracts traded at offer vs. bid is modest relative to the prior selling extremes.
3) At this point, two things are going through my head: 1) V-bottoms are the exception and we should see retests of momentum lows; 2) This market is in a downtrend, with net volume skewed toward sellers (hitting bid) and with a negative TICK distribution.
4) In the next two three minute bars, we make successive price highs. I'm doing nothing, because I don't sell markets that make new highs and I don't chase highs on dwindling volume. The reduced volume and volume at offer suggests to me that the rally is running out of steam (buyers).
5) We get a stiff drop in the 13:42 bar taking us below the lows of the prior two bars. Sellers have re-entered the market. I don't chase sellers, so now I'm waiting for the next rally to see if we get a good entry in the direction of the general market trend.
6) The market bounces higher, but does not expand its TICK distribution and does not expand volume or volume traded at the offer. This is short-covering and I see we're having trouble making new highs relative to the 13:39 bar. I declare to myself that the highs of the 13:39 bar are my "candidate highs" for this bounce and I now view the market as in a trading range defined by the 13:30 lows and the 13:39 highs.
7) I sell when we make positive TICK readings and green Market Delta readings (more volume at offer than bid) that cannot make fresh price highs. We're seeing waning buying interest within the short-term trading range, and my trade idea is that we'll retest the lows of the range and resume movement in the market's longer-term (day session) direction. My stop is above the 13:39 highs--a move to new highs invalidates my idea. My profit target is the lows of the trading range.
8) I sit for quite a few minutes as the market churns, but continues to fail to make new highs as we get bounces in the TICK. Eventually we get to the bottom of the trading range in the 13:48 and 13:51 bars. As one-minute ES volume picks up and we get very negative (-1000) TICK readings, I cover my position. I generally like buyers who can't push the market higher to get me into my short positions and sellers who are panicking out of the market to help me cover my positions.
9) My goal is to enter the position *after* I identify a short-term candidate high, but as close to that high price as possible to keep losses small if I'm stopped out. This creates a favorable risk:reward profile to the trade. My goal is also to simply play for the highest probability move. In this case, it's simply a return to the bottom of the range. I'm not playing for a home run breakout trade. If the market moves into breakout mode, I'll consider that a separate trade and setup.
10) Note that I'm spending a lot of time sitting and doing nothing other than observing market dynamics and planning out the trade. There are times I'll sit for a very long time, just waiting for one great setup. The goal is not to put on trades; it's to wait for things to line up in your favor, giving you an edge.
The type of pattern I'm illustrating above occurs on multiple time frames. A key to trading this way is being able to follow one market across many time frames (which is different from following multiple markets in a single time frame) and focusing on: 1) the market's general direction; 2) the presence of a trading range; 3) a candidate price high or low; 4) an entry that leans on this candidate high or low to follow the market's broader direction; and 5) a high probability price target.
Ultimately, a good trade represents an integration of significant amounts of information. This happens to be one way to achieve that integration. There are many others, and I welcome others to share these in comments to this post.
Identifying Transitional Structures
When Do I Get Out of a Trade?
Catching Short-Term Market Transitions