Tuesday, March 23, 2010

Thinking Like the Computers

One thing I've learned from observing the actual trading of prop traders--those who are trading actively in and out of the market through the day--is that, as a rule, they are drawn to movement and momentum. They like to trade breakouts from ranges, and they like to see clear signs of strength or weakness before they buy or sell.

Many algorithmic (automated) programs that trade actively take advantage of these tendencies by selling strength and buying weakness. If you imagine hundreds of computers, each programmed to work offers at X period highs and work bids at X period lows--and if you imagine X as scalable across time frames--you get a sense for what drives markets on the short time frame when directional, institutional traders are not active.

Traders can benefit from thinking like the computers.

This morning we broke the overnight lows in the ES futures, but small caps were not making morning lows; nor were other risk assets.

If you were looking only at the S&P index, you wanted to be a seller and catch the downside breakout.

If you were thinking like the computer, you were working a bid and profiting from the move back to the average price in a range environment.

Much short-term trading success comes from doing what doesn't come naturally.