Monday, September 10, 2007

UsingTrading Range Information to Frame Trades

If you click on the chart above, you'll see a portion of my premarket preparation for trading. My goal with this perspective is to identify and understand relevant trading ranges that are likely to affect the coming day's trade.

Note that, after Friday's weak jobs report came out, we made an initial decline just below the 1465 level in the ES futures. This is what I view as the market's efficient response to the data: it is the market's estimate of how equity prices should be revalued in light of the new information.

After an initial, weak attempt to move higher than this 1465 level, we moved lower still, all the way down to below 1455. This I view as the market's emotional response to the data; it represents the "giving up" of the bulls once it becomes clear that the market will not reverse its initial decline.

For fundamental reasons we cannot sustain a move above 1465; the market no longer views such pricing as value. As long as that's the case, I view us as being in a short-term downtrend. The market is repricing value lower over time.

But for sentiment reasons--inability to find sellers to sustain a move below 1455--we've essentially moved nowhere since midday Friday.

That is the relevant trading range that I work with. Some of the best day trades occur at the edges of those ranges, as we either fail to sustain moves out of the range (and return to at least the range midpoint) or we see that moves out of the range attract additional volume and encourage a repricing of value (trending move).

It's when the moves to or slightly beyond the range extremes fail to attract volume and are not accompanied by meaningful repricings in other, related markets (dollar, rates, equity sector indices) that I am most likely to fade these moves. Conversely, large moves in rates and the dollar are most likely to encourage repricing of value among stocks.

By focusing on longer-term ranges and trends in rates and currencies and then following short-term volume flows (such as Market Delta), sector movements, and sentiment (NYSE TICK), I'm handicapping the odds of moving out of or back into these ranges. One or two such trades per day can catch worthwhile swings in a market with decent volatility. Much of the rest of the market's movement I treat as noise. By requiring myself to frame trades in this manner, I gain clarity about what would make the trades wrong (stop levels) and where to place targets to take profits. I also avoid those impulsive trades based on market noise.


How to Identify and Trade Breakout Moves

The Importance of the Overnight Range

Anatomy of a Market Breakout