Wednesday, July 01, 2009

Trading With Odds on Your Side

Once you identify key price levels during the trading day, such as the pivot-derived price targets that I publish each morning prior to the open via Twitter, it's possible to conduct research pertaining to the odds of hitting those levels during the trading day. The idea is to trade with the odds on your side, with a concrete target that enables you to execute trades with favorable risk/reward. (See here for more on this topic).

For example, since 2000, 81% of all trading days open in the range between the initial R1 and S1 resistance and support levels in the S&P 500 Index (SPY). By tracking volume and sentiment patterns early in the day, a trader can meaningfully raise the odds of identifying whether we are likely to hit one or another of those levels first--or whether we will continue within the R1/S1 range.

Interestingly, when we open between R1 and S1, we will hit the previous day's pivot level (an estimate of the prior day's average price) 76% of the time. For that reason, weak early trade in a market that opens above the pivot (but below R1) and strong early trade in a market that opens below the pivot (but above S1) can set up an excellent early trade back to the pivot level.

Conversely, about a quarter of the time when we open between R1 and S1, we will start out above the pivot and promptly trade higher with returning to pivot and vice versa. Those are the days that start with strong or weak Delta and TICK, facilitating trade to a morning hit of R1 or S1.

Knowing how correlated markets are trading--and which themes are moving markets in early trade--can also meaningfully raise the odds of figuring out which target we'll hit. More on this topic to come in future blog posts and especially in the seminars and webinars that I'll be offering.