Friday, April 10, 2009

Volume and The Shifting Rules of the Trading Game

This, I think, is an important topic for all developing intraday traders.

As preparation, first read the post on a simple reality that all short-term traders should know.

Then take a good look at the charts from this post.

The crucial lesson is that volume matters. It reflects *who* is in the market, and it determines *how much* markets will move.

Now here's the thing: Volume patterns change during the day. That means that market movement is not consistent from one time period to the next. Much of the frustration that daytraders experience can be attributed to this simple reality.

I went back to the start of 2009 and found that when one-minute volume in the ES contract was less than 3000 contracts, the average trading range over the *next* three minutes was 1.88 points. When one-minute volume exceeded 8000 contracts, the next three minutes averaged a range of 2.67 points. In other words, price movement was almost 50% greater when volume was relatively high than when it was relatively low.

We can look at this another way. Again going back to January, we find that the average three-minute ES trading range from 8:30 AM CT to 9:59 AM CT has been 2.46 points. From 10 AM CT through 11:59 AM CT, we average 1.8 points, and from 12 Noon through 1:29 PM CT, we average 2.06 points. From 1:30 PM CT through 3 PM CT, the average three-minute price range jumps to 2.72 points.

Once again, we see about 50% more movement in the busier market periods than in the slow ones.

When traders don't account for this difference--and the volume differences from day to day--they set their stops too close during active periods and set their profit targets too far away in slow periods. All of that contributes to frustration and subsequent trading problems.

Imagine playing basketball with the rim 11 feet off the ground in the first quarter, 8 feet off the ground in the second quarter, 9 feet off the ground in the third quarter, and 12 feet off the ground for the final quarter. In the heat of the game, you fail to account for these shifts. You tend to undershoot early and late in the game and overshoot during the middle portion of the game. Little wonder that slumps and frustration would affect your game!

"What is the market giving me right now?" is a wonderful question active traders should be asking multiple times per day. Too many traders are looking for setups, when in fact they're the ones being set up.