Monday, March 09, 2009

The Shakeout, Fakeout Market: Profiting From False Breakout Moves

If you click on the chart above, capturing the S&P e-mini (ES) futures for the past several days, you'll see tricky moves at the numbered points:

* Point 1: The market vaults above the previous day's and night's highs, only to fall back and retrace more than the entire prior range;

* Point 2: We make a new price low, only to spike higher the next day and move above the low from two days prior;

* Point 3: After spiking above the overnight range, the market retraces the entire range and then some;

* Point 4: We make a new bear low, only to vault higher late in the day and after the close, toward the top of the prior day's range;

* Point 5: Despite overnight strength, we fail to make new price highs relative to the previous day and return to the midpoint of the previous day's range;

* Point 6: We spike above the pre-opening highs, only to fall back well into the prior day's range.

What we're seeing with surprising frequency is what traders call "false breakouts": moves that go to or just beyond a commonly perceived trading range or price level, only to retrace that movement. These shakeouts and fakeouts frustrate trend/momentum traders and create unusually choppy trading conditions in which it becomes difficult to hit ambitious price targets.

I'm finding that successful execution waits for these levels to be taken out and then assesses market conditions for follow-up confirmation or reversal. Instead of letting the market stop you out of a trade by hitting marginal new highs or lows, you can use those false moves as profitable entries. If volume at bid/offer (Market Delta) and NYSE TICK cannot be sustained on the seeming breakout move, that's when reversal becomes most likely.