Friday, March 20, 2009

Morning Preparation for Trading

One of the most valuable trading practices, I've found, takes place before markets actually open. It's the practice of framing "what-if" scenarios for the day, so that you're prepared to act when your market hits crucial price levels. Note that I emphasize scenarios in the plural; the idea is to be prepared for a variety of situations, not to get locked into any single one. The goal is to promote mental and behavioral flexibility, not to pull out a crystal ball that will entice your confirmation bias.

A trader I work with called me yesterday and shared how he profited nicely from the Fed announcement. I was initially surprised, because--going into the announcement--he was leaning the wrong way. He had played out the scenarios in his head, however, and was prepared for an announcement that the Fed would be buying Treasuries. Very shortly after the news came out, he flipped his positions and, from that point forward, made a very nice profit.

The combination of an open mind and an ability to quickly and decisively act upon fresh developments is something I've found in successful traders. Much underperformance comes from the inability to keep the mind open and the inability to be decisive when markets shift.

Above we see a snapshot of an hourly chart of the ES futures just before 7 AM CT. Recall from my Twitter posting yesterday afternoon that 778 was important intraday support. An attempted rally from that point failed late in the day, and we moved lower. Observe also that this support area roughly corresponds to the level at which we launched the upmove following the Fed announcement.

During pre-opening trade, we have moved smartly above that 778 level (blue line), placing us back in the prior day's range. (Green line is 20-period volume-weighted moving average). I am going to be watching that level closely in early trading. If early selling cannot take us below 778, I'm going to expect a bounce well into the previous day's range, with the day's pivot as an initial target. I'll be watching the distribution of NYSE TICK and the advance-decline ratio ($ADD) for confirmation that buyers have the upper hand before committing to the long side.

Conversely, should we fail to hold 778 and we see distinct signs of weakness among those indicators, I'll be thinking about selling bounces for a move toward S1. Should we see weak volume and choppy trade on this expiration Friday, I'll be thinking range market and will look to fade moves away from VWAP and the market open. Most of all, I'll chill in the early minutes of the morning trade to let the market tell me what it's doing.

Going back to the Twitter posts, I have the profit targets set (see 6:30 AM tweet) and written down in front of me; I have the lines drawn on my chart; and I have scenarios laid out. All well before an hour is left before the open, when I can relax, exercise, scope out correlated markets, and update my views.

Whether in sports or trading, so much of the game is won before the initial tipoff, kickoff, or faceoff. Preparation is a powerful psychological tool, because it primes us to act on our perceptions.