Friday, June 21, 2024

The Importance of Market Cadence

In my recent post, I discuss a conclusion from the writings of many trading psychologists:  that successful active trading requires an intuitive feel for market action.  My experience is that looking at relatively static chart patterns or indicator readings does not provide that market feel.  A structural view of markets can be informative, but we get a feel for how a market is moving from the flows of market activity.  It's interesting that many of the experienced traders I've been reading emphasize the value of "reading the tape".  By watching the flow of bids and offers and seeing how price responds to these, it's possible to get moment-to-moment readings of how the market is moving and whether buyers or sellers are dominant.  From this flow of information, we gain a sense for market cadence--and that provides us with a "feel" for the market we're trading.

It's not so different from carrying on a conversation with a person.  We don't just listen to the words a person speaks and their literal meanings.  We also hear their tone of voice and the cadence of their speech.  Those provide us with a feel for whether the person is excited, fearful, cautious, etc.  Consider the difference between a conversation carried out through text messages versus a live, face-to-face conversation.  The latter is far richer in meaning.  No therapist would work people solely through text messages!

It doesn't surprise me that a trading firm that has been successful in training new traders, such as SMB Capital, makes tape reading part of their curriculum.  It's that feel for when buyers or sellers are becoming more aggressive and dominant that allows us to identify solid risk/reward entries and exits for our trades.  Yes, idea generation may come from our research, reading, and conversations.  What allows us to trade these ideas well, however, is gaining a feel for real time market behavior.  When the cadence of price action shifts, we are alerted to changing dynamics among buyers and sellers and suddenly that good idea becomes a good trade.

I'm not convinced that tracking the order book is the only way to gain a sense for market cadence.  One thing I've been doing in my own trading is tracking high frequency market action by using volume bars.  If I'm trading stock index futures, for instance, I might track a chart of open/high/low/close for each 1000 contracts traded.  When the cadence picks up, I feel the volume rising in real time.  When market direction changes with the cadence, I'm alerted to a new dynamic among buyers or sellers.  Gaining a feel for the market does not magically result from being relaxed or focused.  We can meditate all we want, but if we don't understand the dynamics of price behavior, we will calmly lose money.  Our sense for markets comes from absorbing the flow of information, much as a psychologist absorbs the flow of conversation in a therapy session.  We feel markets the same way we feel music on a dance floor:  through shifts in tone and cadence.

Further Reading:

Feeling the Next Trade