Friday, November 20, 2009

Simulation and Making Sound Trading Decisions

My recent post described how traders can use information within the bars of Market Delta footprint charts to make short-term trading decisions. I notice that the newest version of Market Delta supports trade entry and management from the chart itself; it also includes a simulation module that enables traders to practice making trading decisions from the chart data.

Let's go back to the chart from yesterday morning's post. If you look at the last three bars of that chart, you'll see that we've consolidated in a tightening range after having moved steadily lower through the early morning hours. Your job as a short-term trader would be to profit from a break out of that several hour range. You would begin with a bigger picture view: How is the morning trade comparing with the trade from the prior day?

You would see that we've broken below two-day support and are now hovering near Monday's day session lows. You'd also see, within the morning session, that the volume-weighted average price (VWAP) is moving steadily lower and that we are building value steadily lower (side histogram). That tells us that, on the chart's timeframe, we're looking at a downtrend--but that it is also the start of a potential breakout move and longer-timeframe downtrend.

Now we look within the bars. Note at the top of each of the three most recent bars how trade has shut off as we've approached the 1100 level. Note also how trade has shut down around the 1098 level. At the time of the chart snap shot, we were trading at 1099.75. If you did not see volume building and lifting offers at 1099.75 and above, what would your trading decision be? Clearly, you'd be a seller, expecting at least a rotation back down to the 1098 level.

If volume dried up as you approached 1098, what might you think of doing? If you saw volume accelerate as you approached 1098, what would you want to do? The information within the bar would be key to deciding whether to fold the trade or hold (and maybe add to) it.
Such decisions are based on real demand and supply data provided by the marketplace; not by untested assumptions regarding chart patterns or mystical numerological sequences. All those decisions can be practiced in simulation mode, scanning incoming data, processing the data, pausing the flow of volume, and rehearsing your reasoning.

One value of simulation is ensuring that decision making is coming from the executive centers of the brain; see the link below.

But, of course, there is more that goes into making good trading decisions. We'll take a look at some of those elements in the next posts in this series.