Wednesday, September 26, 2007

Opening Range Breakouts: False and Real

If you click on the chart above, you'll get a clearer view of trade in the S&P 500 emini futures (December ES) vs the NYSE TICK for yesterday morning. Volume in the futures is captured on the bottom X-axis. The chart was created in Real Tick.

One way short-term traders attempt to gauge direction early in the market day is to look for opening range breakouts. That is, they note the high-low range of an opening market period and then look for breakouts above or below that range. The problem is that such breakouts are just as likely to reverse and return to their range as to continue in a trending move.

The first yellow arrow indicates where we saw the market attempt a breakout from the opening minutes of trade. The NYSE TICK to that point had been in a clear negative range, and note that the attempted breakout did not attract any enhanced volume. The return to the range was an indication that we were likely to at least probe the lows of the range as the market sought to establish value.

When the 10 AM ET economic news came out, the initial reaction was a burst of selling. There we did see enhanced volume and a downside break of the opening range. Not all sectors were participating to the downside, however: the semiconductors and many NASDAQ stocks, for example, were holding their own.

Very shortly thereafter, also on enhanced volume, the market ripped higher and the NYSE TICK made an upside breakout of its range (second yellow arrow).

So think about what that meant: The market attempted a downside break, but buyers came in within two minutes and swiftly returned stocks to their range. Moreover, the buying was broad, lifting the TICK to a morning high.

That is not how stocks behave if they're in a downtrend. Lower prices attracted buyers, suggesting that longer time-frame participants perceived value at those levels. We never returned to those levels for the rest of the day. The sellers are forced to cover their positions, helping turn a false downside breakout into an upside trending move.

If you understand, in Market Profile terms, what happened yesterday morning--how lower prices can attract value-oriented buyers and prevent a downtrend--then you are well on your way toward understanding the August market downdraft and the subsequent market reaction.

The principles are the same. Only the time frame changes.


Failed Opening Range Breakouts

Trading Opening Range Breakouts