Tuesday, August 26, 2008

Reading the Communications and Metacommunications of the Markets

Think about reading a market like reading a person: you'll listen for the communications of the market--what it's doing--but also for the metacommunications: how it's expressing itself. Let's take yesterday's market as an example.

* How did markets in Asia and then Europe open? How might a trader have picked up on overnight underperformance by U.S. stock index futures and weak performance by individual stocks in their pre-opening trade to anticipate weakness during the regular trading day?

* What news came out early in the morning trade? How did stocks respond to the housing news? How could the failure of stocks to rally on the news have helped a trader anticipate a retest of the prior day's low price?

* How did sentiment unfold during the morning trade? How could traders note that institutional participants in the market were dominantly hitting bids across the universe of stocks (negative NYSE TICK) and hitting bids in the S&P 500 futures (negative Market Delta) to identify a weak trading day?

* How was volume behaving during the day? How could traders have noted the increase in volume on downward moves early in the day relative to bounces? What does that tell a trader about the participation of large traders and institutions?

* What were support and resistance areas from the overnight session? The previous day? How did the market behave as it approached these? How can traders anticipate that the failure to break one end of a trading range will lead to efforts to test the other end? How can traders distinguish valid breakouts from such a range from unsuccessful retests by noting sentiment and volume at those price levels?

* What were interest rates doing during the day? How were leading stock sectors, such as financial stocks and consumer cyclicals, behaving? How might that have been linked to the housing news earlier in the day? How could a trader have noted risk-aversion evolving over the day's session from such themes?

* What were market indicators, such as the new highs/lows noted in my indicator review and the money flows noted in my recent post, noting about longer-term market strength? How might a look at such measures help a trader anticipate weakness from day to day?

It's not about imposing your views of what markets *should* be doing; it's about reading what they *are* doing by placing price action into a broader context and reading how that price action is evolving. These are performance skills that are developed over time; they're like the expertise of a physician who learns to piece together signs to arrive at diagnoses. The skill is in the ability to connect new, unfolding information with the information you've already gathered to constantly update your views of market activity. That skill serves you well over any time frame.

Note: The topic of market communications and metacommunications is a major theme of my first book, The Psychology of Trading. I personally find it interesting that traders who lack social skills--who don't read people well--also seem to struggle with markets. I listen carefully to the market views of defensive, abrasive, or socially inept people; they're uncommonly wrong, which makes their opinions useful in unintended ways.