Friday, March 20, 2009

Catching the Breakout Trade: Recognizing Rejection of a Key Price Level


Here we see today's S&P 500 e-mini (ES) futures market (blue line) plotted against the day's volume-weighted average price (VWAP; pink line) and the previous day's support level drawn in red.

Notice that we traded around that resistance level for much of the morning in a range trade, but could not sustain rallies above VWAP and largely remained below the day's opening price.

As noted in the Twitter post just prior to the noon CT hour, selling picked up along with volume and volatility, as we rejected both the resistance level and the current VWAP as an estimate of value. This breakout from the morning's range led to a significant downmove that took us near the S2 support level.

Differentiating moves with normal volume and volatility that meander around an average price from moves away from that price that are accompanied by expanding volume and volatility is key to recognizing breakout trades.

Tells that I did not emphasize in my Twitter posts that deserved greater attention were the inability of the market to trade above its opening price and the consequent downward slope of VWAP. Even with extensive preparation, there are always things we miss; things we need to work on. That's one of the things that keeps the trading game endlessly challenging.
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17 comments:

Matthew C. said...

Yeah I thought support looked pretty "sick" today, I traded the bounce off it once, not trusting more than 4-5 points, then figured it would collapse sooner or later today, unfortunately I had a rousing game of pickup b-ball scheduled and then meetings all afternoon so I left the rest of profits to the rest of you honorable TFers. . .

Zen said...

Dr. S,

Thanks as always for your fantastic blog and twitter posts.

How exactly do you measure volume expanding/contracting/average, etc.? I know there are several ways to do this, but I would like to know what method in particular you prefer.

Thanks again!

Valentin said...

Brett,
great posts during the past few days, especially the one on preparation before trading. I think it is a must for people who begin to trade. At least that is my experience as a "newbie". Your confindence level comes from constant preparation. Even if you experience some losing trades, your confidence stays with you... Many thanks for your work! Greetings from Germany, Val

Charlie G. said...

Thanks, another great post. Also, excited to get your book in the mail. Have a good weekend!

OV said...

Dr Brett,

While your observations seem clear after the market closed, I still don't understand how one can take advantage of this knowledge in the middle of the action.

On the same chart you posted, should one interpret "price rejection" when the price turned from 768 (to touch 765), or when it turned from 772?

The first trade could have been a whipsaw (when 765 was hugged and SPX moved higher than entry/770), the second was the right move - but could eventually be a copy of the first.
And nothing signaled at the time that we could not have a 3rd attempt to touch or take over the VWAP.

What other signal one can use to identify the first price turn as a "fake" and the second as the "breakout" or rejection?

BTW, looking at traded volume, tick and trin - they were similar around these time frames.

How close to the VWAP line do you expect price to get (to qualify as "rejected", as some days the line is being touched and some days not...


Many thanks for your posts,
- OV

OV said...

Uch, please ignore my previous comments.

Re-reading your comments I guess your point was that once the price went away from VWAP (around 11h50) don't trade against the trend unless the same thing happen on the other side - that points to trend reversal (which did not happen).

thanks- OV

Brian said...

Actually, I would love it if you could revisit OVs comments with the specific goal of pointing out where the good risk, reward entry on this trade could have been.

Your post is a great analysis of what occurred but I am curious how one could have traded it in realtime.

The ideal entry would have been a retrace back towards the 775-776 after the break down, but no retrace occurred (which is a bit unusual). Prior to breaking 776, i don't see how there was a low risk short entry in the 778 area?

If you could expand upon how you traded it, or felt you should have traded it, I think that would be very enlightening...

Matthew C. said...

Brian,

I was shooting some hoops, but here is how I might have traded it:

1) Short some "scalps" on the initial breakdown as the tick was very negative.

2) After the first bounce at 11:42 I would be watching to see if the price levels went back up or if the market traded sideways. You can see it traded sideways with a probe down then back up a couple times between 772 - 773.5 -- selling consolidation -- this is a clear indication for a short. I would have shorted at the 773 area with a stop around 774.5

Those "consolidation ranges" are extremely profitable entry points for long and short trades -- I prefer them on bullish days but they work almost as well on bear days like yesterday. Just make sure you short at or near the top of the range, I will often close out part of the position at the bottom to build "cushion" for my core short -- helps to smooth out my P&L over time and sometimes gives me a "free trade" in case the market goes back up and hits my stop -- I end up flat on the trade instead of losing $ even if the trade moves against me.

I have switched over to that kind of trading almost exclusively -- it turns my home runs into triples, but it also turns many of my strike-outs into singles.

It is psychologically much much easier to deal with a P&L that trends up more slowly with some flattish days and the occasional small loss, than a P&L that goes up large amounts on some days, then retraces 2/3 of the movement a bit later. I used to trade like that and it was so emotionally draining I knew I had to find another way. . .

Mark said...

Matthew,

Thanks for a great idea! Very intelligent approach. Makes me reassess my approach (i.e. all or nothing).

Regards,

-Mark-

tait said...

Dear Brett Steenbarger,

In this article* you mention the market closes near S2. (Support 2.)

Where on your website do you list support ranges for the day or week?

Thank you,
Tait

*titled "Catching the Breakout Trade: Recognizing Rejection of a Key Price Level" http://traderfeed.blogspot.com/2009/03/catching-breakout-trade-recognizing.html ]

Brett Steenbarger, Ph.D. said...

Hi Zen,

I use the relative volume idea that I've described on the blog (and track periodically in my indicator updates)to gauge volume.

Brett

Brett Steenbarger, Ph.D. said...

Thanks, Val; I agree that preparation builds confidence. It's interesting how those who work hard and smart at their trading internalize the feeling that they deserve success--

Brett

Brett Steenbarger, Ph.D. said...

Hi OV and Brian,

My Sunday AM post addresses some of your question. Once you recognize a breakout from a range, your task is to enter as near to the breakout as possible (usually the first bounce in TICK) so that your trade will have a good risk/reward profile.

Brett

Brett Steenbarger, Ph.D. said...

Nice perspective, Matthew; thanks--

Brett

Brett Steenbarger, Ph.D. said...

Hi Tait,

I post my profit target levels in SPY each AM via the Twitter posts:
www.twitter.com/steenbab

Brett

Brian said...

Matthew,

Thanks for your perspective on trading the breakdown. It makes a lot of sense.

My only question is on the following "I would have shorted at the 773 area with a stop around 774.5"

From my perspective, you are not "wrong" on the trade unless it returns into the congestion area above 775-776.

The reason I didn't take the trade is that I wanted an entry closer to that level so that my stop wouldn't have to be so far away from entry.

I guess it is just a matter of how aggressive you wanted to trade the situation.

Again, thanks for your feedback.

Matthew C. said...

Brian,

My thesis there was that we were seeing a breakdown with a consolidation range that would relatively quickly break down further. If the ticker started to trade up that would invalidate the consolidation thesis, so a tight stop would get me out with minimum loss.