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.



Flowtastical said...

Dr. Steenbarger,

I trade US equities only. I have a basket of the XL_ ETF's. The basket was mixed today. I also use the cumulative tick.

Do you think this is a sufficient basket of indicators to make the same analysis you did?

Ed said...

Do you think that these Algos like the ones Jump Trading use dont ever break any rules? Since at least two of the Board of Directors have a huge financial stake in Jump and others why is there a difference between what some of these Forex dealers do and what the CME does? The only difference is that the CME Group gives more to Congress than any other corporation so any form of stealing can go on. CME group sells itself on transparency-you can see all the bids and offers but what they need to disclose is the relationships with the largest Algo entities that provide liquidity and rape and pillage the retail trader.

Brett Steenbarger, Ph.D. said...

Hi Flowtastical,

Yes, I find tracking the sector ETFs to be helpful. Advance/decline intraday numbers also are useful.


Matthew C. said...

ES bottomed at 1159, just a couple ticks below the earlier day's low. I wanted to see a 1158 print before the breakdown was legit. We never saw it and I shifted towards a range bias. Once we got a couple ticks near 1000 and no negative tick below 600 it became clear that a test of the day's highs was likely. The breakout on 1200+ tick / ESH0 1166 was a strong buy signal given the importance of the 1165 (SPX 1170) resistance, and signalled to everyone that it was time to go long. Of course I was in a meeting at the time, but I caught the tail of that move. . .