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.
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3 comments:
Dr. Brett,
Excelent information. For me, coming from a math, science and engineering background, knowing these probabilities makes the trade decisions a lot easier with less anxiety. I still rely on patterns, but I don't (yet) fully trust my judgement about them.
Dr Brett,
This was the kind of day that is very difficult for me -- strong first hour then a slow grind lower.
What didn't I see that would have told me the top was in?
Thanks
Hi Brett,
knowing where we are and what levels we will most likely hit from here can for sure add huge to your profitability.
None the less reality will give you different numbers as Stops are not factored in the equation. The statistic you mentioned is made in hindsight.
Take the open betweeen R1 and S1 and the 76% probability that the previous days pivot will be hit on 76 out of 100 trading days. Say we open below the previous days Pivot, which would give any long trade a 76% probability to make the range between my open and the previous days Pivot as profit.
But that statistic tells me nothing about the probability of the trade selling off below R1, R2 or even R3 and recovering later in the day to the previous days Pivot level. Volatility is down again, but 10 to 20 point range swings are still there in the ES.
To really have a trading system, that captures the 76% Win/Loss probability you would have to setup a Trading System without Stops, but with a Market on Close order at the close of the day, in case we have one of the 24% days, where the previous days pivot is not hit.
I have not calculated such a system, but it is my feeling, that that system would actually lose due to very high losses incurred on 24% of all trades, while the profits do not counter these losses, even if the Win:Loss ratio is 3:1, as profits are limited to the range between my open, which is above R1 and below yesterdays Pivot.
If, on the other hand, you introduce stops into the equation, to limit your losses, you will see a less than 76% probability, that the individual trade will win during the day, as you will cut yourself out of the not so rare examples, where we have nice turn-arounds in the markets during the day. Days, where we try to breakout of the range, just to go back into it into the close.
I have no solution to that dilemma other than doing the statistics on intraday charts and trying to find good stop values, which tell me, that from now on the chances of a reversal compared to the chances of that day becoming a trend day are no longer in my favor.
Best regards,
Chris
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