Thursday, April 02, 2009

Tracking Large Traders by Tracking Large Trades

If you click on the chart above, you'll see a unique display that I was using to track weakness in the ES futures during the afternoon. Major props to Trevor Harnett of Market Delta for his assistance in setting this up.

In the top pane, we see the Market Delta "footprint" chart. The numbers inside each of the five-minute bars represent the number of trades--not volume--of 50 contracts or greater at each price. So we're only looking at the trades placed by relatively large traders. That is crucial market information, as I explained in an earlier post.

Actually there are two numbers within each bar, such as 11 x 4. The first number represents the number of large trades that occurred at the market's bid price. The second number represents the number of large trades that occurred at the market's offer price. Thus, in the above example, we have 11 large trades at the bid and 4 at the offer at that price and at that five minute period.

When we have more large trades occurring at the bid, it tells us that professional traders are eager to get out of their positions. Instead of working an order to exit at the market's offer price, they are "hitting the bid" and accepting the lower price as the cost of getting out right away. (They could also be aggressive short sellers initiating positions). Conversely, when we have more large trades occurring at the offer, it tells us that professional traders are eager to get into their long positions or out of their shorts. They are "lifting the offer" and accepting the higher price as the cost of going long or covering a short position right away.

Note how the bars are color coded green if more trades are occurring at the offer price and red if the majority of trades are occurring at the bid price. The total number of large trades at each time and price tells us how active large traders are in the market at any one time--a key insight if we're trying to gauge the market's potential for movement (volatility).

By parceling volume into the number of contracts or shares transacted at the bid vs. offer, we gain insight into the moment-to-moment sentiment of traders. What makes the chart above unique is that we're eliminating all of the small trades and just focusing on the trade location of the largest market participants. I find that this view provides us with a unique perspective on the sentiment of the traders who truly move the markets.

Notice in the chart above how the distribution of large trades shifted dramatically a little after 11:30 AM CT. The bottom pane histogram shows us the net volume of trades at the bid vs. offer during each five-minute period. When the value is positive and color-coded green, we have more volume at the offer (bullish sentiment); when the value is negative and color-coded red, we see more volume transacted at the bid price.

A look within the bars from 11:35 AM CT forward shows us that large traders began hitting bids around 840 in the ES contract. The balance between trades at the bid vs. offer became even more skewed as the market moved lower, showing that large sellers had taken control. This dynamic was clear well before we started seeing significant selling pressure in the NYSE TICK.

While I find the NYSE TICK to be an invaluable measure of general market sentiment, as it assesses the number of stocks trading on upticks minus downticks, the Market Delta numbers--especially filtered for large traders--provide us with a more sensitive assessment of sentiment in a specific trading instrument. We can have large traders hitting bids in the ES futures even as traders overall are not selling the broad market. Locating sentiment for the symbols we're trading and placing it in the context of general market sentiment is quite useful in catching market turns.

And, oh yes. The red line at the bottom of the top pane is VWAP in real time. (Even with the weakness we were trading above the volume-weighted average price for the day). The vertical histogram at right is the distribution of volume at each price, which gives us a Market Profile-like distribution of activity. That is very helpful in detecting the emerging structure of the market day.