Wednesday, December 11, 2019

Putting Our Trading Edge Into Practice

In my previous post, I laid out the source of my most durable--and really my only--trading edge:  the ability to detect selling that cannot push the market lower and buying that can't push us higher.  When sellers or buyers are "trapped" in that manner, they need to cover, and that leads to good trading opportunities in the other direction.  This is a pattern that shows up across multiple time frames, and identifying the most relevant time frames is a big part of trading this way successfully.

So here's the ES futures market as it's setting up this morning.  Note the cyclical action captured by the blue arrows.  Note also that the most recent down-phase of the cycles has not been able to retrace price very much thus far.  The middle panel of the display captures the amount of volume transacted at the market offer price (green) versus the amount at the bid price (red).  The bottom panel is a moving average of the ratio of volume at offer (buying pressure) to volume at bid (selling pressure).  We can see that recent selling pressure has come into the market, as noted in the previous post, but has not moved us meaningfully lower.  

All this leads to a hypothesis--*not* a conclusion--that we will make a higher price low above the market's point of control (left side graphic) when the down-phase of the cycle ends, setting up a potential buying opportunity where the shorts are trapped.  I don't act on that hypothesis until I see evidence in the day's trading that the pattern of sellers unable to move the market lower is continuing.

This is all relevant to trading psychology, but it's focusing on the psychology of the market itself.  In reading the patterns of buyers and sellers, we can identify unique opportunities that take advantage of skewed supply and demand.

Further Reading: