Tuesday, April 14, 2009

Integrating Time, Price, and Volume to Generate Trading Ideas

Here we see a Market Delta footprint chart of the ES futures. What we see is a sequence that I have called a transitional structure. It is a reversal pattern that recurs across different time frames in the stock market. Very often it will occur near the top or bottom of a trading range. That makes a reversion move back into the range--with VWAP as a likely target--a nice trade idea, as noted in today's intraday Twitter posts.

The downside reversal pattern begins with a high volume decline with the majority of volume hitting bids (red histogram at bottom). There is a bounce from the lows with net buying interest (green bars at bottom histogram), followed by tests of the lows on lower total volume and less net volume transacted at the market bid. The inability of lower prices to attract participation on the sell side emboldens bulls and we get a rally on increased volume (and increased volume transacted at the market offer). The idea is to get into the trade as you see the rally getting under way, so that you have favorable reward-to-risk with VWAP (red line) as the target.

(Note: for short-term traders, the target would be a move above the highs registered during the transition/bottoming period).

This transitioning process is one in which dominant selling/buying dries up and leads to a reverse move in which the short/longs have to cover positions. It's a nice example of how traders can integrate price, time, and volume information into a structural pattern that can be exploited for a nice gain.