Sunday, December 15, 2019

What's Really Important In The Market

Above we have two screens that I watch in tracking the market on a short-term basis.  (A third screen appears in this post; yet another screen in this post.)  All screens are from what I've customized on the Sierra Chart platform.  What we're looking at above is the one-minute opening action in SPY for Friday, 12/13/19, along with relevant indicators.

Here's what's on the screens.  On the top chart, the top panel is SPY on a one-minute basis.  The panel just below that is volume for the one-minute period, color-coded green (if the market was up for that minute) or red (if the market was down).  The third panel is a five-minute moving average of the ratio of volume transacted at the offer price (values greater than zero, representing buying pressure) to volume transacted at the bid price (values less than zero, representing selling pressure).  The very bottom panel of the top chart is a three-period RSI, to show very short-term overbought and oversold conditions in SPY.

The bottom chart is an advance-decline ratio specific to the 500 SPX stocks, drawn on a one-minute basis.  

So I'm looking at the two above screens, this screen, this screen, and also screens for the sector ETFs and ETFs for the NASDAQ and Russell Indexes, all on a one-minute basis.  I'm also keeping an eye on breaking news and markets relevant to stocks, such as interest rates.

What am I not doing?

I'm not chatting about where I think the market could go.  I'm not opining as to whether the trade deal is a good or bad one.  I'm not speculating about the future of Brexit.  I'm not looking at chart patterns, wave counts, moving average crosses, or the like.

Here's an analogy:  Doctors in the emergency room have to gather much relevant information in a short amount of time to know what to do.  Time is of the essence.  Many different readings are taken, from blood pressure and heart functioning to temperature, scans of injured area, and respiratory functioning.  A great deal of measurement and cognitive bandwidth is needed for effective and rapid functioning in the ER, which is why the ER is always staffed by a team, not a solo physician.

This is also why teams are effective in trading, especially when following multiple markets and time frames.

What I'm trying to do with all the screens is track the market's vital signs.  Sometimes those signs take a turn for the better (buyers are coming in) or worse (sellers are coming in).  Those become short-term trading opportunities.  If we're chatting about what we think will happen or what we think should happen, we're no longer attuned to the vital signs.  If we're looking at random shapes on charts, we never read the vital signs.  Does any competent physician look for chart patterns in a patient's blood pressure readings, brain waves, temperature, or respiration rate?  If shapes and chart patterns aren't informative in the ER, in weather readings, or in baseball statistics, why would they be any more so in financial markets?

Most of what is taught to developing traders by would-be gurus is randomness.  When I went undercover and monitored a number of trader education services, the great majority of what I saw and heard had no relationship whatsoever to what I was seeing among the successful traders I work with every week.  

Similarly, what I see offered as "coaching" for traders or "trading psychology" is self-help advice, with no specific market content whatsoever.  Come on.  Would a basketball coach advise team members with no reference to actual plays being run or maneuvers on the court?  Would a chess coach advise students and never refer to actual moves on chess boards?  If I tried "coaching" an ice-skating team with platitudes about mastering emotions and having a good mindset, how far in the Olympic trials would my students get?

So let's look at a few important things, walking through the two charts above with the arrows as guidance.

Note that a little after 10 AM EST, we get a spike higher in price (top panel, first chart) on expanded volume (second panel, first chart) and coming off a short-term oversold condition (bottom two panels, first chart).  We get a corresponding spike in the advance-decline stats for the SPX stocks (second chart).  In short, significant buying has just entered the market:  new participants are lifting offers and creating momentum.  Such momentum tends to continue in the short-run, as it does indeed over the coming minutes.

But what happens after those minutes of momentum?  The vital signs change significantly.  Notice that volume declines considerably (second panel, top chart) and we get a meaningful decline in the advance-decline statistics (bottom chart).  By the time we make a fresh short-term overbought reading around 10:19 AM, already it's at a lower price high and weaker advance-decline levels.  In other words, after the initial spike, volume dries up and with it, the buying strength.  That tells us that the market cannot sustain this level of valuation and the prior buyers will be trapped.  That creates the conditions for meaningful selling through the remainder of the morning.

That is one way a momentum thrust and turning point manifest themselves in the market.  When we track supply and demand--volume and its distribution among buyers and sellers--we can pick up on those episodes of momentum and reversion, within the context of larger cyclical patterns.  (See the series of posts on how to trade).  It takes cognitive bandwidth and focus to track these things in real time, and it takes experience to recognize patterns in supply and demand as they unfold.  If it was as easy as looking for price-based "setups", a lot more people would be making a fortune in markets.  Look at the proportion of daytraders that actually sustain success in markets, and then ask yourself why that would be.  An important start toward success is following what's really important in the market.

Further Reading:

RADICAL RENEWAL - A free online blog-book on taking the ego out of trading