A Most Important Lesson for Traders

Who is in your market will determine how--and how much--your market moves. This is one reason the Twitter posts note relative volume during the day: whether we're likely to get much movement or very little depends crucially on the level of participation of large traders in that market.

I decided to illustrate this with a different market: USO, the oil ETF. Notice (top chart) how the average daily high-low range has been cut about in half during 2009. That's half the movement--and for active traders, half the opportunity--over the course of just a few months.

Now take a look at what's happened to volume (bottom chart): that, too, has been cut by more than half.

If the institutions are not actively participating in your market, your market--on average--won't be active. Adapting to this reality by either trading other symbols/markets or by adjusting one's expectations for the slower market is an essential ingredient of trading success.
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Achieving a Structural Awareness of Markets

I want to call attention to an excellent bulletin written by Jim Dalton, expert in Market Profile and co-author of the excellent books Mind Over Markets and Markets in Profile. Jim works with Terry Liberman in teaching traders an approach to understanding markets grounded in auction theory. In the bulletin, he raises an important issue to those developing market mastery.

Whereas many traders are focused on analyzing markets--from technical and fundamental analysis to statistical analysis--an equally important component of expertise is synthesis: the ability to assemble parts into meaningful wholes. A physician does not perceive a mere collection of symptoms; rather, he or she groups these into diagnostic categories that guide treatment decisions. Similarly, an experienced trader does not simply see low volume, balance between advancing and declining stocks, and mixed performance among sectors. Instead, these features cluster together to suggest a rotational, bracketing market--which, in turn, suggests trading strategies that will involve fading moves away from value that cannot sustain participation (volume).

We learn synthesis by seeing so many examples of how individual features cluster that eventually we can recognize the categories for ourselves. As Jim's bulletin article points out, many times we can't verbalize this clustering: the whole (the overall pattern) is more than the sum of its individual parts. Market mastery begins with the ability to move beyond a perceptual level of awareness to a conceptual one. The beginning trader sees trees; the advanced trader understands the forest. When we develop a structural view of markets, we're seeing, not just indicators, price, and volume, but how those are connected to create trading patterns.

Our doing is limited by our viewing; our cognitive grasp determines our mind's reach. Someone who doesn't understand football sees only a random movement of players. A beginning student of football can follow the game and determine who is winning. An expert scout for a professional team appraises the various components of offense and defense to understand why one team has an advantage. Markets are no different.

RELEVANT POST:

The Epistemology of Trading Expertise

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Watching Growth Themes in the Stock Market

During the stock market's recent rally, we've seen investor and trader interest turn from deflation and recession to inflation and growth. That has implications for commodity and currency prices, as well as equities.

Two ways of monitoring the growth theme include the relative performance of NASDAQ 100 stocks to S&P 500 large cap issues (growth and technology vs. overall market) and emerging market stocks vs. S&P 500 U.S. issues (growing, young economies vs. mature economy).

During the rally, NASDAQ stocks have outperformed S&P 500 shares handily. As noted in yesterday's Twitter post, 32% of NASDAQ 100 shares were trading above their 200-day moving averages, compared to 16% for S&P 500 stocks. We can also see from the bottom chart, that emerging market shares (EEM, pink line) have handily outperformed S&P 500 stocks.

In recent trade, the S&P 500 stocks (ES futures; top chart) have been rangebound, while NASDAQ 100 shares (NQ futures; middle chart) have pulled back further from their highs. If the growth theme is to continue, we should see new highs out of this consolidation, with sustained strength in emerging market shares. Failure of the growth leaders (NQ, EEM) to participate in attempts at new highs would suggest the start of a rotation that could precede a more significant price correction.

Understanding market themes can be useful for both swing and daytraders. I will be tracking these growth themes in future tweets (free subscription).
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The Capacity to Dream

Thanks to a very special reader who passed along this video of Susan Boyle's eye-opening audition for Britain's Got Talent, the UK equivalent of American Idol.

No matter how many limitations you might have, no matter what others think of you, there can be happy endings if you pursue what you're meant to be doing and refuse to compromise your dreams.
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Adapting to Range Bound Market Conditions

I've been in meetings all day with traders and, not surprisingly, the major topic that has arisen is the challenge of adapting to slower, more range bound market conditions. Between meetings I took this Market Delta snapshot of the market; it illustrates well so many of the identifying characteristics of range trade: the relatively flat VWAP (red horizontal line), the mixed volume at offer vs. bid (bottom histogram), and the bunching of volume at price (right histogram). As the Twitter posts have noted, we've also seen mixed performance among sectors, with some relatively weak (NQ, for example); others stronger (financial stocks)--as well as below average relative volume

Identifying range conditions as they're setting up is key to setting trading strategy--but it's also key to setting expectations. The slower the market, the less the movement, the more modest the expectations for any anticipated market move. More on this topic to come.
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Illusions and the Blowup of a Trader

A trader I've known well recently blew up. His money is gone, as are his dreams. He doesn't know what he'll do with his life.

Why did he blow up? The profits he was making weren't enough. He needed to make more, because he wanted to be more. He wasn't enough as he was.

What killed his trading was an illusion: an image of success that ever receded beyond his grasp. Long time readers might recognize this video. It's about the illusions in life that try to change you and what happens when you take great risks to become a different person.

Look hard at the final image of the mechanical doll in the video. That is the trader I knew.

Trading can be an expression of self esteem; it cannot substitute for a self. To change yourself is noble, but only shattered dreams come from efforts to change your self. You will succeed by becoming more of the person you are at your best, not by overreaching in vain hopes of transformation.

RELEVANT POST:

The Doll Face Trader

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Integrating Time, Price, and Volume to Generate Trading Ideas

Here we see a Market Delta footprint chart of the ES futures. What we see is a sequence that I have called a transitional structure. It is a reversal pattern that recurs across different time frames in the stock market. Very often it will occur near the top or bottom of a trading range. That makes a reversion move back into the range--with VWAP as a likely target--a nice trade idea, as noted in today's intraday Twitter posts.

The downside reversal pattern begins with a high volume decline with the majority of volume hitting bids (red histogram at bottom). There is a bounce from the lows with net buying interest (green bars at bottom histogram), followed by tests of the lows on lower total volume and less net volume transacted at the market bid. The inability of lower prices to attract participation on the sell side emboldens bulls and we get a rally on increased volume (and increased volume transacted at the market offer). The idea is to get into the trade as you see the rally getting under way, so that you have favorable reward-to-risk with VWAP (red line) as the target.

(Note: for short-term traders, the target would be a move above the highs registered during the transition/bottoming period).

This transitioning process is one in which dominant selling/buying dries up and leads to a reverse move in which the short/longs have to cover positions. It's a nice example of how traders can integrate price, time, and volume information into a structural pattern that can be exploited for a nice gain.
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Indicator Update for April 14th

Last week's indicator review concluded that it was premature to fade the rally as long as the indicators were strengthening. We did get a mild pullback early in the week, but once again the lower prices found buyers and we closed last week on a strong note, with most sectors displaying an increasingly bullish trend. (Note: the charts above are updated for Monday's close). As the morning Twitter post noted, 28 of the 40 stocks that I track in my basket are currently trading in uptrends, 7 are neutral, and only 5 are in downtrends. Particularly noteworthy is the dramatic upside breakout in banking stocks ($BKX, bottom chart), which has been a market leader to the downside (during the decline) and now on the rebound.

A bullish pattern that I have been emphasizing for a while is that we're seeing the market stay at overbought levels in the Cumulative Demand/Supply Index (top chart), with pullbacks leading to higher price highs. What this means is that we have persistently strong upside momentum: many more stocks are closing above the volatility envelopes surrounding their short-term moving averages than closing below them. This persistence is only seen in bull swings; it was not present during the bounces during the market's decline.

Similarly, we're seeing consistently elevated levels of new 20-day highs versus new lows (middle chart). On Thursday, we registered 903 new 65-day highs against 57 lows, the highest level since September. This tells us that the market is strong on an intermediate-term basis and gaining strength over time.

Again, we're at those levels in the Cumulative DSI when pullbacks are common. Pullbacks that stay above last week's lows will keep the above bullish picture intact. Signs of problems for the bulls would be a notable increase in the number of stocks registering fresh 20-day lows and a reversal of the bullish sector themes noted recently (growth sectors outperforming defensive ones). I will be updating indicators via Twitter (free subscription) to keep tabs on developments during the week.
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Five Things You Never Hear Traders Say When They're Making Money

There are certain comments that traders make only when they're losing money. The comments are meant to pertain to the markets, but you can reliably take them as P/L confessions. So, drumroll please, the top five countdown of things you never hear traders say when they're making money:

Number Five: "Just wait 'til the bubble bursts" - Translation: I'm not long and the market is ripping higher. Coach's comment: The market doesn't give a rat's posterior about your economic and political views. Trade what the market is doing, not what you'd like it to do in your nihilistic fantasies.

Number Four: "It's a slow market" - Translation: My timing is off and I'm not making money. Coach's comment: Volume is down and volatility is down and you're trading like it was October. Someone's slow here, and it's not the market.

Number Three: "This market is manipulated!" - Translation: It can't be my fault that I'm not making money! Coach's comment: Who manipulates the market on your winning trades?

Number Two: "I was early" - Translation: My timing sucks and my trade is under water. Coach's comment: Being early is no more consolation in markets than in the bedroom.

And the number one thing you never hear traders say when they're making money:

Number One: "That had to be the PPT (government Plunge Protection Team)" - Translation: I was short and the market is ripping higher. Coach's comment: Very subtle of that PPT to turn market indicators bullish prior to the breakout of financial stocks and lead the breakout with moves in emerging markets.

So there you have it. Armed with the above five observations, you're now prepared to read and translate at least 50% of the financial blogs out there. Coach's comment: People's frustrations make for some of the best contrary indicators.
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A Look at the Day's Price and Volume Dynamics

Here we see an interesting chart view of today's market action in the S&P 500 e-mini (ES) contract (60 minute bars), courtesy of Market Delta's software. In the top pane, we see volume at each price displayed in histogram fashion, alerting us to regions where large traders are transacting. In the bottom pane, we have the net volume transacted at offer vs. bid displayed as a histogram. When the bars are green, we have bullish sentiment (large traders lifting offers); the red bars show a dominance of bearish sentiment (large traders hitting bids).

Note the upside breakout above the morning trading range and how that was anticipated by a dominance of volume lifting offers. As noted in the intraday Twitter comments, this reflected the reverse of Thursday's trade, when the ES Delta (volume at offer minus volume at bid) was weak and NYSE TICK was strong. This morning, we had weak TICK readings, even as traders were lifting offers in ES. That was a great tell for subsequent ES strength once buyers returned to the broad market.

Observe also how we saw late significant selling pressure, as we came off the day's highs back toward Thursday's highs. That sets up some interesting dynamics for Tuesday's trade, as we will have to find fresh buyers to surmount the 860 region. We can see from the cumulative volume at price histogram at right that a failure to break that 860 level will target the value area bulge from the morning's range trade. That's but one illustration that good hypotheses regarding tomorrow's trade can be developed by observing the price and volume dynamics that evolve over the course of market action today.
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Diagnose Before You Intervene: The Challenge of Slow Markets

Here is a chart that illuminates a topic of discussion that I've had with several prop traders of late. They're finding that the market has become "slow" and it's more difficult to make money than it had been earlier in the year and especially in 2008.

Learning to trade in the recent markets is a mixed blessing. There have been good opportunities--price movement has been abundant--but the downside is that new traders implicitly expect high volatility to be the norm. Once a VIX of 50 seems normal, moving below 40 feels slow, even though that is still good volatility from a historical perspective.

The chart shows five-day average high-low range in SPY (a measure of daytrading opportunity) versus SPY itself for 2009. Notice how, in the last five days, we've seen about half the average range (and thus half the average intraday movement) that we saw early in March and late in January.

That is nowhere near the sub 1% ranges we used to see when VIX was in the teens, but someone learning markets in a super volatile environment can't appreciate that.

It goes back to the issue of volume, participation, and the changing rules of the trading game. Developing traders are playing blackjack as if there are a fixed number of decks in the shoe; they assume that, if picture cards haven't been showing up for a while, we're due for a run. Meanwhile, Mr. Market, the casino dealer, is changing the number of decks periodically, foiling the card counting.

Once volatility changes significantly, old assumptions about where stops should be placed (how much the market is likely to go against you) and where targets should be set (how much the market is likely to give you) go out the window. Much trader drawdown and frustration starts with a failure to adapt to this reality.

But, if you're really sharp, you'll realize that volatility changes due to volume shifts also reflect a difference in *who* is in the market. Markets move differently based upon who is participating; setups that work in one set of market conditions don't necessarily work in others. Many, many active traders I meet don't get that and spend a great deal of time spinning their wheels with erratic results.

Markets dominated by directionally oriented fund traders move differently than markets dominated by market makers and market making algorithms. A good physician diagnoses a patient before selecting an intervention: a medication or a surgical procedure. Developing traders would do well to follow that example: first "diagnose" market conditions, then figure out what is most likely to work in that environment.
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Sector Update for April 12th

Last week's sector update concluded that the eight major sectors of the S&P 500 that I track had moved solidly into an uptrend mode, with defensive sectors lagging and signs of risk appetite on the rise. With Friday's solid rally, we saw upside breakouts across many sectors, continuing the market uptrend. Here's how Technical Strength (a quantification of short-term trending) looks for the eight sectors as of Friday's close:

MATERIALS: +400
INDUSTRIAL: +340
CONSUMER DISCRETIONARY: +400
CONSUMER STAPLES: +140
ENERGY: +120
HEALTH CARE: -120
FINANCIAL: +460
TECHNOLOGY: +400

Recall that Technical Strength varies from +500 (extreme short-term uptrending) to -500 (extreme short-term downtrending), with values between +100 and -100 suggesting no significant trending. We can see that the Financial sector has been extremely strong, with notable weakness among the defensive Health Care and Consumer Staples issues. Raw Materials are showing strength, as is Technology and Consumer Discretionary shares, suggesting that investors are betting on growth and economic recovery.

As long as pro-risk themes are dominating and the majority of sectors are displaying Technical Strength, it is premature to fade this rally for anything more than a short-term trade. As always, I will be tracking the trending behavior of the 40-stock basket of stocks in my pre-market Twitter posts (free subscription). I'll also be updating market themes in my Twitter posts, most particularly the themes of growth/recovery vs. weakness/recession.
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Emailing and Other Housekeeping Notes

* Cutting Back on Emailing - One downside of increasing blog traffic is the simultaneous increase in emails. In the last month, blog traffic has risen by close to 50% and emails have kept pace. It's quite gratifying to see that the blog is reaching a wide audience; it's also quite daunting to face dozens of emails each time I log into my account. From a purely statistical vantage point, if only 1/2 of 1% of daily readers send an email, I would have to spend a little over 3 hours each day reading and responding. Over a seven day week, that's a half time job in itself! For that reason, I will need to limit coaching-related emailing to traders that I work with professionally. If readers of The Daily Trading Coach have questions related to the self-help coaching techniques in the book, please use the dedicated email address provided in the text and I'll get right back to you. Sorry for any inconvenience.

* A Note on Themes - The recent blog post took a look at intraday themes that connect markets and their relevance to trading. From a thematic vantage point, it might be useful to view range markets as rotational ones, in which capital is shifted from certain sectors to others. The behavior of other assets classes will often dictate the direction of this rotation. Look for broad stock market shifts when the rotational shifts themselves undergo change. More on this in my Twitter posts.

* Always Looking for Links - You'll notice that many of the Twitter posts link articles from the mainstream media and blogs that capture big picture market themes. If you come across articles or blog posts that provide unique insight into markets, by all means feel free to use email for that purpose to send me the links. I'll be happy to pass along to the Twitter and blog readership. This can be a great way to bring attention to good work out there.

* A Thought - Too many traders judge their trades by where the market went after their exits, rather than by whether they had a good idea and executed that idea well. If you judge yourself by criteria outside your control, you'll never sustain confidence and well-being.
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Trading by Themes

One of the most important calls an active trader can make is the dominant theme of the day's trade. Sometimes a news or earnings report will set the theme of the day, as in the case of Friday's market, when bullish earnings from WFC sparked a major rally in the financial sector. Other times, we will see themes carry over from trade in Asia and/or Europe. Seeing which asset classes, stocks, and sectors are strong and weak in pre-opening trading, for example, can provide useful clues regarding themes. For instance, we may see strength in oil and other commodities overseas, and that will carry over to bullish trading among materials and energy shares. ETF price performance and volume can provide especially useful clues as to market themes.

During the past year, an especially important theme has been whether markets are bullish or bearish on risky assets. For example, a market that is buying Treasuries, selling speculative grade debt, and selling stocks is exhibiting relative risk aversion: a preference for assets perceived as safer. In such markets, we'll tend to see emerging market equities underperforming U.S. stocks, and we'll tend to see defensive sectors (consumer staples, health care) outperform more growth-oriented sectors (small caps, technology, consumer discretionary).

When institutional traders and investors are bullish on risky assets, they will tend to buy more speculative currencies and stock sectors and commodities tied to economic growth. They'll also be likely to sell safe Treasuries and buy more speculative debt.

Traders who become caught up in the tick by tick action of their particular stocks or indexes often miss these themes--and shifts in themes during the day. Much of the financial world is trading globally, following intermarket relationships and macro themes. Knowing those themes can help you anticipate ways that your particular stocks, ETFs, and indexes are likely to trade during the day.
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Recharging Your Emotional Batteries

I'm writing this from the oceanfront (literally) in Virgina Beach; it's early enough that there aren't too many people around. Just the wind and the waves: ocean as far and wide as I can see.

Something about sitting by the ocean on an empty beach is quieting. There are few distractions; eventually, it's as if you adopt the rhythm of the waves and are just left at peace with yourself. It's at those times that I often have my best and biggest thoughts: fresh inspirations and insights.

Following my sophomore year at Duke, I sat on a Florida beach early in the morning reading a book called The Fountainhead by Ayn Rand. Looking over the water, I was suddenly seized with the recognition that this was what I was meant to do with my life: use psychology to help people find their greatness--not to fight mental illness.

That was almost a quarter century ago. The memory of that morning on the beach--and the mission I felt at that occasion--is as strong today as it was when I returned to school and reorganized my life.

We could not survive without life's routines. Routine helps us perform repetitive tasks automatically, so that we can direct our attention elsewhere. As Colin Wilson emphasized, however, we become so caught in routine that there is no "elsewhere". Life becomes a series of routines, our work and relationships become stale, and suddenly we find ourselves growing old before our time.

Not everyone will find their break from routines in travel and the ocean. Some find it in spiritual pursuits; others in the adventure of hiking or sports. Sitting with the ocean reminds me of the need to escape the mundane and recharge mind and body. At those moments, our most productive times--those that can shape a lifetime--can be our moments away from work.
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Refining Twitter as a Decision Support Tool

I recently outlined ideas for using the Twitter application as a daytrading analyst. Experience with the tweets and especially the feedback of subscribers has proven quite helpful in shaping this resource. What I'm finding is that the tweets that are most helpful are those that highlight market conditions that are not readily visible from charts and popular indicators.

For example, it was useful in yesterday's trade to recognize the mixed market strength early in the day in the S&P 500 Index, but the underlying buying interest in the broad market (very positive NYSE TICK, strong small caps). It was also quite useful to track the behavior among the financial shares, as their turnaround midday led both the large caps and the broad market higher into the close.

When commuters travel to and from work during rush hours, they commonly listen to the radio for traffic reports. Those reports of road and traffic conditions help drivers take the best routes to their destinations. A driver may be headed toward a variety of destinations for a number of purposes, but the traffic reports can be useful for almost any commute.

Similarly, reports on market conditions can be utilized by a variety of traders, from short-term, intraday participants to longer-term portfolio managers seeking good execution of their ideas. Just as a radio announcer will update which roads are moving and which are not, intraday tweets can shed light on markets and sectors that are moving--and the factors responsible for the movement.

The key to making such reports work is keeping them brief and timely, so that users can quickly absorb the information that they need and don't become bogged down with irrelevant data. Importantly, the tweets need to stay at a descriptive level, not a proscriptive one, so that traders can make their own unbiased buy and sell decisions. I will be implementing these modifications next week.

I welcome further feedback and suggestions on the tweets via comments to this post. I also encourage interested traders to look into mechanisms for receiving the tweets, such as Tweetdeck, so that they can receive information in a timely fashion. Subscription to the Twitter feed is free; readers of the blog can always pick up the most recent five tweets on the blog page under the heading "Twitter Trader".

Thanks for the interest and support!

Brett

Volume and The Shifting Rules of the Trading Game

This, I think, is an important topic for all developing intraday traders.

As preparation, first read the post on a simple reality that all short-term traders should know.

Then take a good look at the charts from this post.

The crucial lesson is that volume matters. It reflects *who* is in the market, and it determines *how much* markets will move.

Now here's the thing: Volume patterns change during the day. That means that market movement is not consistent from one time period to the next. Much of the frustration that daytraders experience can be attributed to this simple reality.

I went back to the start of 2009 and found that when one-minute volume in the ES contract was less than 3000 contracts, the average trading range over the *next* three minutes was 1.88 points. When one-minute volume exceeded 8000 contracts, the next three minutes averaged a range of 2.67 points. In other words, price movement was almost 50% greater when volume was relatively high than when it was relatively low.

We can look at this another way. Again going back to January, we find that the average three-minute ES trading range from 8:30 AM CT to 9:59 AM CT has been 2.46 points. From 10 AM CT through 11:59 AM CT, we average 1.8 points, and from 12 Noon through 1:29 PM CT, we average 2.06 points. From 1:30 PM CT through 3 PM CT, the average three-minute price range jumps to 2.72 points.

Once again, we see about 50% more movement in the busier market periods than in the slow ones.

When traders don't account for this difference--and the volume differences from day to day--they set their stops too close during active periods and set their profit targets too far away in slow periods. All of that contributes to frustration and subsequent trading problems.

Imagine playing basketball with the rim 11 feet off the ground in the first quarter, 8 feet off the ground in the second quarter, 9 feet off the ground in the third quarter, and 12 feet off the ground for the final quarter. In the heat of the game, you fail to account for these shifts. You tend to undershoot early and late in the game and overshoot during the middle portion of the game. Little wonder that slumps and frustration would affect your game!

"What is the market giving me right now?" is a wonderful question active traders should be asking multiple times per day. Too many traders are looking for setups, when in fact they're the ones being set up.
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A Multifaceted View of Intraday Sentiment

Among the short-term sentiment indicators that I find most useful are the NYSE TICK (the running balance between stocks trading on upticks vs. downticks) and Market Delta (the relative balance between volume transacted at the offer price vs. the bid price).

Today's trade was an example of an occasion when these two measures gave somewhat different signals. Volume transacted at the offer vs. bid for the ES futures had a very modest bearish cast in midday trade as the S&P 500 Index churned in a range, but significantly more stocks were trading on upticks than downticks (positive TICK).

The reason for this disparity, as I noted in the Twitter posts, was that buying was significantly stronger in the broad market--particularly the small and midcap stocks--than in the large cap S&P 500 names. While traders hit bids in the ES futures, in part reflecting early consolidation among the financial stocks, net buying interest sustained the rally in the Russell 2000 shares.

Only once we saw net volume transacted at the offer in the ES *and* strong buying interest in the TICK later in the day did all the markets move to new highs in tandem, completing an uptrend day.

A multifaceted view of sentiment, in which we look at the sentiment specific to a single index (such as ES) and the sentiment across the broad market, can be helpful to traders in teasing out when markets are prepared to move in sync and when they are not. I notice that the new version of Market Delta can display cumulative NYSE TICK and cumulative Market Delta--even a price-weighted version that approximates money flow--on the same screen. This strikes me as a valuable way for traders to obtain a well-rounded view of moment to moment sentiment, all at a single glance.

I will be further investigating the relationship between these two indicators and how traders might benefit from the information.
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Brief Trading Psychology Videos

MoneyShow has been assembling a group of short interviews with market professionals on topics ranging from currency and oil to trading setups. Here are my interviews on the following topics:

Depression Among Investors

Improving Trading Psychology

Personality Traits of Successful Traders

Avoiding Self-Sabotage

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Six Questions to Prepare for the Trading Day

I consistently find that preparation--the work on markets that is done before the trading day begins--is correlated with trading success. "Where observation is concerned," Louis Pasteur once observed, "chance favors only the prepared mind." We're most likely to find the "lucky" trade if we know what to be looking for.

Here are a few things I look at prior to the opening of regular trading hours:

1) Are we in an intermediate-term uptrend, downtrend, or range? I look at the number of stocks making new 20-day highs vs. lows; the number of stocks in my basket that are trending upward, not trending, and trending downward; the readings for Demand vs. Supply; and the percentage of SPX stocks that closed above their 20-day moving averages. All of these data are updated daily before the market open via Twitter posts (subscription is free, or you can see the latest five posts on the blog page). If new highs outnumber new lows; if a majority of stocks are in uptrends; if Demand (index of number of stocks closing above the volatility envelopes surrounding their short-term moving averages) exceeds Supply (index of stocks closing below their envelopes); and if more than 50% of SPX stocks have closed above their 20-day moving average, I grade the market as being in an uptrend and vice versa. When the indicators are flat and/or mixed, I consider it a non-trending intermediate-term environment.

2) Was yesterday stronger, weaker, or in a range with respect to the day previous? Here I'll look at the high and low prices for the day across various sectors, as well as for the major indexes. I also look at the day over day changes in the above-mentioned indicators. If yesterday's readings for new highs/lows, Demand/Supply, etc. were stronger than the day before, I'll consider us in a short-term uptrend and vice versa. When the day over day price changes among sectors and indicator readings are mixed, I view the market as in a short-term range.

3) Are there special circumstances likely to affect today's trade? If we're in a holiday period or if we're awaiting a Fed announcement, volume and volatility are likely to be muted. If we're expecting a major economic report, that can move the market. I like to rehearse various what-if scenarios when those special circumstances arise, so that I'm prepared for trades that may arise. For example, I'll prepare to fade an initial move if an important economic report at 9 AM CT cannot keep the market out of its overnight or previous day's trading range. I'll prepare to be less active in a market that is slow due to a holiday period.

4) Where are the relevant trading ranges? If the market is in a multi-day range, I will be especially cognizant of those levels, as these will either provide a good breakout trade or a good fade back toward the opposite range extreme. About 85% of all days take out the prior day's high or low, so I want to know where those levels are. Often the first trade of the morning will be a test of the overnight high or low; that becomes an important area to reference.

5) What are the relevant price target levels? The pivot price is an approximation of yesterday's average trading price. About 70% of all days will retouch yesterday's pivot, so that's a price level worth keeping in mind, especially on failed moves outside the overnight or prior day's range. For reasons mentioned above, the previous day's high and low are important reference points. The R1/R2/R3 and S1/S2/S3 levels represent upside and downside targets respectively that will be hit 70%/50%/33% of the time based on research going back to 2000; those are important targets in trending markets. In intermediate-term range markets, we can go for a few days without hitting those targets; indeed, the failure to hit R1 or S1 is generally a good sign that the market has been in range mode. (Those target levels are also published via Twitter before each market open).

6) Where did we close on the previous day? Where do we open today? If we close near the top of the range for the day, that suggests intraday strength. If we open today above yesterday's pivot, that suggests overnight firmness, especially if today's open is above yesterday's close. When we see such firmness, we think about testing upside price targets, such as the previous day's high and R1/R2/R3. When we see weakness--closing near the bottom of the range for the day and opening below the prior day's pivot level--we think about testing downside price targets, such as the prior day's low and S1/S2/S3. A mixed open (near yesterday's pivot, mixed advances/declines in early trade) suggests a possible range environment and we want to think about fading moves away from the prior day's pivot, today's open, and today's volume-weighted average price.

Many traders focus on short-term setups without understanding the general condition of the market and the price targets that we're likely to hit. The important issue is not just when and where to trade; it's also where the market is likely to be headed. Once you have basic strategy right, it's great to refine your tactics. Too many traders, however, don't prepare adequately for the trading day and hope--in vain--that tactics will replace strategy.
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