Friday, February 13, 2009

Using Price Levels to Frame Short-Term Trades

If you review this morning's Twitter comments, you'll see that signs of range bound action were present in the first half hour of trading. (Check out this post regarding trading range bound days). Recall that the R1/S1, R2/S2, and R3/S3 upside/downside pivot-derived price targets represent price levels that we are likely to hit on roughly 70%, 50%, and 30% of trading days, respectively. When we identify a likely range day, what we're saying is that this is one of those roughly 30% of occasions in which price is unlikely to hit either R1 or S1 levels.

With that in mind, and knowing that range days tend to oscillate around the day's VWAP (green line above = 20 period VWAP MA), we can formulate more modest price targets for range days. For example, we came into the session expecting some weakness following the strong reversal day. Seeing that we opened above the pivot level from the prior day (bottom horizontal blue line above), led to the idea, mentioned in the Twitter comment, of a retracement to test that pivot level. Overall, 75% of all trading days touch their pivot levels at least once during the regular trading hours; that proportion is higher during range days. Seeing early weakness in trading set up that move in the opening half hour.

Similarly, the trader who saw that we were holding above the overnight lows and pivot on subsequent weakness could anticipate a test of the previous day's high (top blue horizontal line), per this morning's Twitter comment. Overnight highs and lows, as well as previous day's highs and lows and--of course, VWAP-- represent modest price targets that we are likely to test even on days that don't run to the R1/S1 levels. Knowing these levels--and closely tracking how we're trading during the day--can help traders set up worthwhile short-term trade ideas.

Twitter is a particularly helpful tool for messaging about these levels and patterns as they emerge. The latest five "tweets" appear on the blog page under "Twitter Trader"; subscription for real-time tweets via RSS is free. I'll be posting additional market-based tweets next week.