It can be overwhelming for a beginning trader: so many things to monitor, and they all can move so quickly. Several developing traders have emailed asking, "What should I focus on?" They realize that trading is all about pattern recognition, but what patterns to emphasize?
I think the more important question is, "What information do you need to understand what the market is doing?" The idea is not to jump into markets to find trades; rather, you first want to observe markets, understand what they're doing, and formulate trade ideas from that understanding.
If you click on the chart from my recent post, you'll see some of the information that I rely upon to understand market behavior. I want to know whether trades primarily are being transacted at the market bid (indicating seller aggressiveness) or at the offer (indicating buyer aggression). The information within the bars of the Market Delta chart (as well as their color coding) gives me that sentiment reading. As a rule, if I'm a buyer, I want to wait for sellers to show their hand (hit bids) and show me that they cannot move price meaningfully lower; if I'm a seller, I want to see the reverse.
I also want to see how sentiment is evolving over time. The bottom histogram of the chart (and its color coding) tells me if, across the day, buyers or sellers have been dominant.
My double check on sentiment comes from NYSE TICK, as illustrated in this chart from today's action. TICK tells me if stocks within the NYSE universe are primarily trading on upticks (buyers more aggressive) or downticks (sellers more aggressive). By observing the distribution of TICK values over the course of the day, I can see if buying or selling sentiment is increasing or waning.
Putting Market Delta data together with NYSE TICK data provides a very helpful picture of institutional behavior, as it is the largest traders who will move the needle on these indicators.
Beyond sentiment, I like to track the various market sectors. Since I primarily trade the S&P 500 Index, I most closely follow those sectors, as well as the NASDAQ 100 and Russell 2000 Indexes. I also track a basket of 40 stocks drawn from the sectors and their price behavior gauged from the market open; this tells me if there is general directional strength (typical of a trending environment) or mixed behavior (typical of a range environment).
Finally, I track asset classes related to stocks to gauge intermarket relationships. These include bonds/notes, the U.S. dollar, and commodities. Many times a theme in one or more of the asset classes will provide a clue regarding a theme that will also affect stock prices.
All of this is placed within a context that includes how the market traded the prior day and during the overnight session, as well as where the market has been trading during the current day. This last measure is captured by volume-weighted average price (VWAP), which is the red line in the Market Delta chart linked above. In a trending environment, we will tend to stay above or below VWAP; range markets will oscillate around VWAP.
Knowing sentiment, sector behavior, intermarket themes, and how we are trading within the context of the most recent days and the current day helps me formulate a view of whether we are likely to hit particular price targets. These are published each day prior to the open via Twitter (follow the tweets here). Historical studies also help me gauge whether or not we might have an edge in formulating trades to hit particular targets.
This may sound like a lot to follow, but it is no more complicated than, say, tracking the behavior of your car and other vehicles when you're first learning to drive. The key is to engage in practice performances so often that the integration of the information becomes near automatic. Failure to master market understanding prior to putting capital at risk is perhaps the greatest source of trader demise.
Ultimately, you want to focus on the information that leads you to your best trades--not necessarily the information that I track. You want to keep things simple, but not simplistic. You want to focus on the data that helps you make sense of markets. I hope to illustrate market reasoning processes in greater detail during the upcoming summer seminar. Details on that session will appear on the blog shortly.