Friday, February 06, 2009

How to Identify and Trade Trend Days to the Upside

As I stressed in a recent post, early recognition of the structure of a trading day is essential to the active trader's success. Today's market gave us an excellent opportunity to observe characteristics common to uptrend days.

Such trend days often begin as upside breakouts from trading ranges. As we can see in the top chart, the 850 level in the ES contract had been a top for the prior two days (horizontal green line). We vaulted above that level early in today's trading; as the middle chart shows, this move was on expanded volatility and volume. In other words, the upside move gained significant participation from large traders.

A second hallmark of uptrend days is that, once the move is initiated, we continue to trade above the market's volume-weighted average price (VWAP), and VWAP itself trends higher. The green line in the middle chart is a 40-period volume-weighted moving average drawn on the five-minute chart. Note that the VWAP line was sloping higher prior to the breakout move and then moved sharply higher as the upside breakout attracted volume. Price stayed above the VWAP line until late in the day, when we saw price begin to oscillate around the line--one possible indication of a transition to a range bound market to start next week.

Yet another hallmark of uptrend days is that we hit the R1 upside price target early in the day, as noted in today's intraday Twitter comments. This shows significant upside momentum and, as my later Twitter comment explained, it set us up for moves to the next (R2, R3) targets over the course of the day, as long as we saw a positively sloped Cumulative NYSE TICK line. Those SPY price targets are posted each morning prior to the market open via Twitter; the last five Twitter posts appear on the blog page, or you can subscribe free of charge via RSS.

The bottom chart displays five-minute bars of NYSE TICK, along with a five-period moving average (blue line). Note how the TICK moving average stays above the zero (green) line throughout the day. This tells you that, on balance, we're seeing more stocks trading on upticks than downticks: the buyers are in control. We can see that the TICK average turned negative late in the day on that move below VWAP, another indication that we were seeing sellers enter the market around the 870 level, which is near resistance from late January.

A final hallmark of uptrend days is that we typically see leading, speculative sectors point the way higher through the day. If you look at a chart of banking stocks during the day ($BKX), you'll see that they exploded higher early in the day and moved steadily higher through the early morning. Confidence/lack of confidence in the banking system has been an important theme for the market, and seeing buying in the banks on the eve of expected stimulus and rescue packages was a positive for the trading day.

When you identify a range day early in the session, you're prepared to fade moves away from the volume-weighted moving average. Many of these moves will revert to the other side of the VWAP line; in a multi-day range, they will also revert to the prior day's pivot level. When you identify a trend day, however, your job is to enter on the first pullback and ride the move higher. By definition, trend days will tend to close near their highs and furthest from their day's open. While trading in and out of a range market can be quite successful, patience and riding a move is often the best strategy for a trend day.


Matthew said...

Hi Brett. Thanks for this blog. You have a lot of very useful and practical information for serious traders. For me personally, your posts on trading psychology have been extremely helpful, but I also appreciate your commentary on market conditions, trading opportunities, and the like.

I am mostly a trend trader and focus pretty exclusively on the ES / S&P emini futures contract. I pretty much stay out of the market unless I think I see a significant trend happening with substantial confirmation and have a good opportunity to catch it. Today was one of those days.

Brett, do you have any suggestions on closing out these heavy trend days when you have traded the day correctly and are carrying a large and profitable position late in the day?

I also identified the upside trend today, although in my case it was simply the fact that the market traded from flat to +15 ES in a couple of minutes on large spiking volume. After seeing that explosive move I strongly suspected an upside trend day. I started nibbling on /ESH9 at 854. As I saw the sideways consolidation and no breakdown I began to add to my position. A bit before 11 EST I was half-full to my maximum trading size with a cost basis around 855 buying on pullbacks.

I finished filling up my shopping cart with a final cost basis around 856 as the trading range moved up in the 860 range. When the market broke out again I took half profits at 868. As the market moved down to 865ish without breaking down I loaded back up the cart in anticipation of a move back up to the 868 1/2 high (thus far). Unfortunately it did break down later and I was stopped out of my entire position at 861 1/2. I gave back 50% of my maximum profit position today.

I haven't yet figured out exactly the best way to trade these uptrend days. Because they do sometimes break down pretty hard around 2:45 - 3:30 EST, and then (usually) they pop back up to the high (at least) just like we saw today. Although occasionally they break down hard and don't come back!

One thing I am toying with as a strategy is to take 50% profits late day on a spiking high, then don't get back in at any lower (or higher!) levels and leave my stop at breakeven (for the remaining 50% position). That will mean leaving some profits on the table on some days, but will allow more profitability when the market breaks down, preserving 50% of profits, but also allowing lots of room to avoid a stop-running temporary breakdowns and also take additional profits if the market runs up through the close. Today that would have led to profits closer to 75-80% of the maximum high water mark, instead of the 55% I ended up with.

Does that strategy make sense to you?

leon t said...

great article , now to complete the package. will you write a post about trend days to the downside. and the ultimate killers of equity, trendless, sideways days.

adan said...

brett, any chance you might do a vwap update during the day on twitter?

i checked esignal (you'd recommended, as one source, as having daily chart info on vwap) and it's more than i need or want right now

got a few indicators i want to get much better at first :-) but really need to balance what i'm doing with the daily trend info that seems to come from watching the vwap

trader station (i believe) also has vwap info on etrade, but it's more like stocks running above or below vwap; at least that's what i've been able to see so far

i'll also check decisionpoint, as they have a lot of info there too

thank you much

Mr. Pooks said...

Hi Brett,

I have a related question regarding the usefulness of market information that does not specifically relate to the timeframe that is being traded.
I am exclusively an intra-day trader, with most of my trades lasting from 1 to 20 minutes. On Friday, I was able to correctly identify the upward trend using the TICK, however I ran into some trouble fully committing to trades on the long side due to a directional bias I had taken into the session. I believed that the market was "due" for a fall, so I had a bit of cognitive dissonance when I saw it was clearly trending upward. This directional bias was developed as a result of following some longer-term (elliott wave) analysis. My question is, for a scalper/daytrader like myself, is it best to simply ignore long-term directional indicators and just "trade the day"?
Or perhaps the difficulty I'm running into is more a symptom of the recent range-bound market. Thanks in advance for your consideration here.

Brett Steenbarger, Ph.D. said...

Hi Matthew,

I use the pivot/target levels and moves well above VWAP on strong TICK and volume to exit long positions on an uptrend day. Moves back to or below VWAP on pullbacks in the Cumulative TICK line are opportunities for entry--


Brett Steenbarger, Ph.D. said...

Hi Leon T,

Thanks for the interest. Over the last month, I've posted on topics related to downtrends and range markets. More to come--


Brett Steenbarger, Ph.D. said...

Hi Adan,

Unfortunately, I cannot update VWAP in real time, as my work with traders takes me away from the screen. Constructing intraday moving averages and checking on slope and how we're trading relative to those averages may prove helpful in terms of gauging trending--


Brett Steenbarger, Ph.D. said...

Hi Mr. Pooks,

Yes, I think on the very short time frame, the most recent market data are more important than the bigger picture fundamentals or technicals, which is why I find TICK, Market Delta, volume patterns, etc helpful--


John said...

Take a look at 4/29 on a 3 minute chart and you will see that today sets up almost exactly. Look for a push higher at 2:30 which can be faded.
Ordinarily, up trend days behave exactly as you suggest, but today has the FOMC dynamic.
We will see ....