Monday, March 17, 2008

Using Trading Ranges to Frame Trade Ideas

Here's an example of a great setup from this morning's trade. It's an example of how I think about morning trading, which may be useful for some readers.

My trade idea usually begins with a "reference range". This can be the overnight range (as in the example above) or the range from the previous day's trade. As the current day unfolds, I look at several indicators to handicap the odds of either breaking out of this range or returning toward the range midpoint when we're near a range extreme:

1) NYSE TICK - I look not only at the raw values of the TICK (which indicate how many stocks are trading at their offer vs. bid price), but how the distribution of these values is shifting over time and how the values are impacting price. What was unusual in today's trade is that we started the day with negative TICK values, but could not make new price lows relative to the overnight range. This told me that selling pressure could not move the market lower and bolstered my expectation that we'd return toward the midpoint of the overnight range. As the early morning progressed, we saw an upward distribution in the NYSE TICK values (rising moving average of TICK), which indicated increased buying interest.

2) ES Volume at Bid/Offer - I read this from a Market Delta screen, and it complements the NYSE TICK quite well. In this case, it showed buyers in size lifting offers in the ES futures, even as the NYSE TICK was still giving negative readings. This suggested to me that large traders in the futures were using the downside opening gap to buy value, again leading to an expectation of a return toward the range midpoint.

3) Leading Sectors - The major leading sector for the recent market has been the financial stocks. When I saw C, GS, and LEH catch a bid in early trade, I expected the broad market to follow suit, against suggesting a return toward the range midpoint.

Because the overnight range was so large, the setup led to a nice move and gain. I was in the trade at 8:40 AM CT (bought SPY) and exited at 9:30 AM CT once we stalled near my price target.

By organizing your perception in terms of ranges and then tracking how stocks are behaving at the edges of those ranges, it's possible to anticipate breakout moves and reversion moves back into the range. A majority of my trades follow this logic.


How I Trade

Using the Opening Minutes of Trading