Friday, February 06, 2009

How to Identify and Trade Trend Days to the Upside

As I stressed in a recent post, early recognition of the structure of a trading day is essential to the active trader's success. Today's market gave us an excellent opportunity to observe characteristics common to uptrend days.

Such trend days often begin as upside breakouts from trading ranges. As we can see in the top chart, the 850 level in the ES contract had been a top for the prior two days (horizontal green line). We vaulted above that level early in today's trading; as the middle chart shows, this move was on expanded volatility and volume. In other words, the upside move gained significant participation from large traders.

A second hallmark of uptrend days is that, once the move is initiated, we continue to trade above the market's volume-weighted average price (VWAP), and VWAP itself trends higher. The green line in the middle chart is a 40-period volume-weighted moving average drawn on the five-minute chart. Note that the VWAP line was sloping higher prior to the breakout move and then moved sharply higher as the upside breakout attracted volume. Price stayed above the VWAP line until late in the day, when we saw price begin to oscillate around the line--one possible indication of a transition to a range bound market to start next week.

Yet another hallmark of uptrend days is that we hit the R1 upside price target early in the day, as noted in today's intraday Twitter comments. This shows significant upside momentum and, as my later Twitter comment explained, it set us up for moves to the next (R2, R3) targets over the course of the day, as long as we saw a positively sloped Cumulative NYSE TICK line. Those SPY price targets are posted each morning prior to the market open via Twitter; the last five Twitter posts appear on the blog page, or you can subscribe free of charge via RSS.

The bottom chart displays five-minute bars of NYSE TICK, along with a five-period moving average (blue line). Note how the TICK moving average stays above the zero (green) line throughout the day. This tells you that, on balance, we're seeing more stocks trading on upticks than downticks: the buyers are in control. We can see that the TICK average turned negative late in the day on that move below VWAP, another indication that we were seeing sellers enter the market around the 870 level, which is near resistance from late January.

A final hallmark of uptrend days is that we typically see leading, speculative sectors point the way higher through the day. If you look at a chart of banking stocks during the day ($BKX), you'll see that they exploded higher early in the day and moved steadily higher through the early morning. Confidence/lack of confidence in the banking system has been an important theme for the market, and seeing buying in the banks on the eve of expected stimulus and rescue packages was a positive for the trading day.

When you identify a range day early in the session, you're prepared to fade moves away from the volume-weighted moving average. Many of these moves will revert to the other side of the VWAP line; in a multi-day range, they will also revert to the prior day's pivot level. When you identify a trend day, however, your job is to enter on the first pullback and ride the move higher. By definition, trend days will tend to close near their highs and furthest from their day's open. While trading in and out of a range market can be quite successful, patience and riding a move is often the best strategy for a trend day.