Tuesday, April 21, 2020

Where To Look For True Edges In The Market

In yesterday's webinar, we took a look at how new and different information can help us identify turning points in the market.  Specifically, we saw that tracking the order book over time to see where large buyers and sellers are getting into and out of the market helps us see significant price levels that don't show up on plain vanilla charts.

Above is my main trading screen (Sierra Chart platform; here is a useful post that links to all the major charting programs that provide the information discussed below) and how the market was looking a little while ago this morning.  I went short the market based on what we see with the purple arrows above, and that has been a good trade.  As I emphasized in the webinar, many of the short-term edges we're seeing in the market are spots where buyers can't move the market higher or sellers can't move the index lower.  Those participants are trapped and have to cover their positions, fueling a move in the opposite direction.  (See my post on navigating market fear and greed in this market for more context).

So let's break it down and see how we can find edges in the psychology of other market participants.

The top panel is the ES futures, where each bar represents 80,000 contracts traded.  As I've emphasized in the past, such event bars standardize our charts, as we draw fewer bars at slow times and more when trade picks up.  I find that technical indicators in general--and ones that track cycles specifically--work better with such event charts.

The green line through the ES futures chart is simply a 40-period exponential moving average line.  It provides context to tell me if the market is stretched to the upside or downside and whether the trend is rising, falling, flat, etc.  

The middle panel represents the proportion of volume traded in each bar that transacts at the market's offer price (green) vs. the market's bid price (red).  This Delta measure tells you, transaction by transaction, if buyers are more aggressive (lots of green) or if sellers are more aggressive (lots of red).  The bottom panel takes a moving average of the Delta data. 

What we're looking at are occasions where the aggressive buyers can no longer move the market to new highs.  As we stressed in the webinar, this is because there are many (often hidden) orders in the market absorbing the buying flows.  Note where I placed the purple arrows:  those were telling me that buyers were becoming exhausted, could not move the market higher, and eventually would be trapped.  That, indeed has played out.

Finally, note the yellow arrows at the side, where we have a histogram.  The histogram captures the amount of volume transacted at each market price, so that we can actually visualize where buyers and sellers are most active (and the cards they hold in their hand).  This information, similar to what we see in Market Profile displays, identifies where value exists in any market and helps you visualize if we're breaking out of a value range or staying rangebound.  Note how we broke out of the top value region (top yellow arrow) and have come down to test the lower value area (bottom yellow arrow).  This can be very helpful in framing both entries (breakouts from the value areas) and targets.

What I find most helpful is that all of this is on one screen.  If I want to look at shorter or longer term perspectives, I simply create a new bar size and all the indicators refresh.  

In the webinar, Scott made a good point:  Many times our frustration in markets comes from not understanding what is going on and why markets are moving.  My experience, having worked with many successful traders in proprietary trading firms and hedge funds, is that simple charts are not enough.  We need to see beneath price and volume to understand the intentions and psychology of large market participants.  That is where we can find true edges in the market.

Further Reading: