Fast Track - Summer 2015 Intensive. Broad Concepts and Terms You Will Hear Every Day

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1 Fast Track - Summer 2015 Intensive Broad Concepts and Terms You Will Hear Every Day This document has been prepared to help keep you focused as you observe various market environments and concepts and how these affect your market logic, perspective, and trade decision-making. We all know there are no short cuts; however we can accelerate the learning process through immersion, looking at the correct information, and adding structure. This is intended to reinforce the market-generated information that you will continually observe throughout the Intensive. It is certainly not all-inclusive but serves as a guide to help you over the coming weeks and to keep as a reference. You re welcome to add to it as you make your own observations and experience a-ha moments. Exactness Kills Most of us would enjoy some exactness regarding where we enter and where we exit a trade; unfortunately, it doesn t really work this way. That is not to say that there aren t occasions when the references become quite clear; however, if this exactness were commonplace the algorithms would have already been identified with a trading system to pick them off in millionths of a second this is not an exaggeration. Whether it is a static reference, which is a reference identified from previous market activity, or a dynamic reference, which develops more on-the-fly during the trading day, it is the context surrounding that reference that helps us assess the odds of the reference being reliable. It is being able to understand this context that gives us a clear edge over the algorithms. The Market s Earliest References 1. The Opening a. Is the opening within yesterday s range, which we would consider to be an opening that took place within balance. The closer an opening is to the center of the previous day s range, the more we consider the market to be in balance. The more in balance a market is, generally, the opportunities are smaller and we are wiser to let the market shakeout before becoming involved. In this case more information is usually better. b. The closer an opening is to one extreme or the other of the previous day s range, the more alert we should be for an earlier opportunity. In these instances the opportunities are likely to be larger and may require us to trade earlier. Take Your Trading to the Next Level! 1

2 c. Gaps We measure gaps relative to the previous day s high or low. We do not measure gaps relative to the previous day s close or settle. A gap is a clear example of an opening that takes place out of balance; gaps quickly alert us to the probability of the largest day timeframe opportunities. The larger the opportunity, the more likely we want to trade early. May 26, 2015 is an excellent example of a gap situation where we want to trade early. d. Market confidence The best trading opportunities occur when the market is exhibiting a high level of confidence; what occurs relative to the opening quickly allows us to begin assessing the market s confidence. For example, a market that opens and auctions directly away from the opening is an example of high confidence. A market that opens and trades back and forth through the opening several times is an example of a low confidence beginning to the day. The higher the confidence, the more likely we are to trade early. Lower confidence suggests that we let the market shakeout and enter at a later time. e. The opening as a continual reference References help us identify who is controlling the market on any given day; the opening is our starting reference for the session. We want to determine as early as possible what timeframe(s) are dominating the market. Approximately 85% of the time markets are dominated predominantly by a combination of the day timeframe and shortterm traders. Day timeframe traders are the weakest and most fickle of traders; these are the traders that are most often prone to quick reversals. The most difficult trading timeframe to understand we classify as short-term traders. Short-term traders, in many instances, have large pools of capital and leverage at their disposal. It is all too easy for us to mistake this timeframe for the longer-term sticky money. As you observe a market and see how price responds, often with the opening price, you begin to sense who is dominating the market. The more time, during the first thirty minutes, that the market spends hanging around the opening, the greater the odds that only the day timeframe traders have shown their hands so far. The more time the market spends hanging around the opening the lower the odds that the intermediate or longer time frames are particularly interested in the market on that day. It is a rare day that the shorter-term timeframe doesn t eventually become active during the day. On those days that the short-term timeframe doesn t show up, the market will continually adhere to shorter-term references. The shorter-term references are the opening, halfback (this is a dynamic reference that changes as new highs/lows are made throughout the day), the overnight Take Your Trading to the Next Level! 2

3 high and low, and the previous day s high and low. The entry of the short-term timeframe will be evidenced by more aggressive trading either above or below the previous day s high or low. A market that moves quickly away from the opening can be more confusing. If you are within a fairly well defined trading range or bracket, as seen on the weekly and daily bars, the odds are fairly high that the aggressive move away from the opening is the result of the shorter-term timeframe. The expected behavior is for the day timeframe to pile on. These high confidence openings often lead to dynamic moves supported by increasing volume and range extension, with the market easily surpassing shorter-term references described above. Value During one of these more aggressive moves you want to focus on developing value. Is value going to be overlapping, overlapping to higher, overlapping to lower, or clearly higher or lower. These observations will help keep your emotions in check. Distinction Long liquidation and short covering can easily be confused with large short-term traders and/or longer timeframe participants. Forcing action (short covering and long liquidation are included in this category) usually sees too much range extension which happens too fast leaving the Market Profile too elongated. Markets are always seeking levels where two-sided trade can occur; forcing action usually terminates in the market coming into short-term balance. The important thing is to have patience letting forcing action run its course. 2. Short-term versus long-term participation There is always participation from all timeframes going on in the market. The question we want to answer is, who is dominating. First and foremost, in the spirit of Fast Track, traders newer to the process can break it down into two timeframes; day timeframe and all others. This is a great starting point and will help you differentiate and apply this knowledge in your trading. We are often asked questions about longer timeframe participation such as, Do you believe the move up yesterday was the result of the longer-term players? Or, Are we seeing longer-term money entering the market today? The answer to these types of questions can usually be simplified with very visual observations made from the bar charts. The reason we begin with monthly, weekly, and daily charts is to identify where the longer timeframes are more likely to enter or exit. Having these areas recorded not Take Your Trading to the Next Level! 3

4 only helps anticipate where longer timeframes may become interested, but this recognition also keeps you from getting caught fading a potential breakout of a higher timeframe move (and having the opportunity to go with the move). You can also label major references as intermediate-term or longer-term so their significance in your nightly preparation is reinforced as you write your daily narrative over time. When we approach these major levels that likely interest the longer timeframes, then we can formulate scenarios of bigger players entering on a breakout, a breakout failure, or the potential of staying within the bracket as the market awaits more information. These market situations encompass a completely different context than what we ve seen, for example, in March through May 2015; multiple weeks of balancing, net-net no change auctions in an approximate 100 point S&P trading range or bracket. If we are aware that we are in the middle of a bracket, we can probably rule out the question of the longer timeframe dominating any particular session or opening; sometimes it s simply a process of elimination. If most of the price action is respecting the shorter-term references and, in addition, we are in the middle of a trading range, it is likely that the longer timeframe is not aggressively in the market. A final note on who is dominating Take it one chunk at a time. Grandiose scenarios of a 10% break or new all-time highs are better left to the longer-term money managers to contemplate. As day and short-term traders, most of the time we can only go so far with these scenarios before they become counterproductive to our primary job; taking advantage of day timeframe and short-term opportunities. Every so often we encounter a market situation to participate in a longer-term move; if we are doing our nightly preparation and keeping an open mind and imagination, these opportunities will present themselves. Our tag line sums this up; Imagination + Analysis = Comprehension. 3. Overnight Trade and Inventory a. Both the overnight high and low are standard day timeframe references; you want to assess how much confidence surrounds these references. Does the market rally to the overnight high, for example, and do anything more than elect the stops at the reference? A high confidence environment will easily see the reference taken out with the market continuing directionally. A lower confidence environment will either fail to take out the reference or, having looked above the reference and electing the stops, will reverse. Take Your Trading to the Next Level! 4

5 b. Overnight inventory is a more ambiguous reference; however, it is important. Approximately 65% of the time we experience a counter auction that forces overnight inventory back into balance. Overnight inventory is measured from the previous day s settle. For example, a market that has traded higher with all trade above the prior pit settle during the entire overnight session would be considered 100% long. Context is extremely important when understanding overnight inventory. If overnight inventory is long and it appears that inventory was short on the prior pit close, for example, the odds of an overnight inventory counter auction are reduced. If inventory on the close appeared to be more neutral, the odds of a counter auction relative to long (or short) overnight inventory would be increased. When overnight inventory is long (or short), and there is no counter auction, that is an indication that the market will trade higher. 4. Halfback Halfback is simply the midpoint of the current range (H+ L)/2. Halfback is a dynamic reference that changes as the range extremes change. Along with the opening discussed earlier, halfback is another reference that helps us understand who is dominating the current market. When you observe that halfback is providing either support or resistance, this is solid evidence that the weaker, more fickle, day timeframe traders are in control. Longer-term investment or sticky money, which exerts a more lasting effect on markets, has no idea where halfback is, nor do they care. 5. The previous day s high or low How the auction behaves relative to the previous day's high or low also allows us to assess the market s level of confidence. A high confidence market will easily take out the previous day s high or low and continue directionally. A continuation failure at the previous day s high or low increases the odds that the auction will begin to rotate towards the opposite extreme (the prior pit session high or low). 6. Price Price is not a reference; price is simply an advertising mechanism. Most trading failures can be traced back to failing to recognize the context underlying price. For example, a new high price made on increasing volume is far different contextually than a new high price made on declining volume. 7. Value area The value area represents one standard deviation or approximately 67% of the day s activities; we trade value rather than price. Approximately 85% of the trading days involve a meaningful level of rotation. Rotation occurs when we are experiencing a continuous two-way auction process. Continuous two-way Take Your Trading to the Next Level! 5

6 auctions can be confusing and unsettling; the best way to corral the two-way auction process is by observing developing value. The best way to break the habit of trading price is by internalizing developing value. Trading value versus price will help you better sort out rotational days. Value is determined from the point of control (POC). The POC is the widest line, reading from left to right, closest to the center of the range. For a technical description of the calculation of the value area refer to the Appendix in the Updated Edition of Mind over Markets. We calculate the value area using TPOs versus volume. TPOs incorporate time and estimate volume. Volume based value areas use exact volume; however, time is not included. The three building blocks of the continuous two-way auction process are: 1. Price advertises opportunity, 2. Time regulates all opportunities, and 3. Volume measures the success or failure of these advertised opportunities. We use the TPO construction because it incorporates one of the primary building blocks, time. This is not to say that we aren t aware of price levels where concentrations of volume may appear. In a rotational environment we look for gradual shifts or migration of the POC to help us assess developing value. For example, on a healthy, rising non-trend day the POC will gradually shift higher. 8. Time We not only incorporate time into our Profile analysis but also in our trade monitoring; every trade should have a time stop as well as a structural (price) stop. If you are taking a countertrend trade, your trade, as a general rule, should work relatively quickly. Time should be part of monitoring for continuation. 9. Trend days While a trend day isn t technically a reference, it does impact two references we have already discussed the POC and the value area. There are two types of trend days; the first and most aggressive is a trend day that trades directionally from the opening. The second type of trend day is a double distribution trend day. First let s address the more aggressive trend day. a. A trend day is an exception to monitoring price; price leads value in this environment. Price moves much faster than value; however, as the day materializes it is important for value to continually migrate higher. A healthy trend day will be neither too elongated nor too truncated; a healthy trend day, in the S&P s, would likely see the profile approximately five or six TPOs wide max. Take Your Trading to the Next Level! 6

7 One timeframing, which is a hallmark of an aggressive trend day, occurs when, for example, in a rising market, each successive thirty minute bar fails to take out the low of the previous thirty minute bar by more than a single tick. More often than not the successive bars will also take out the high of the previous 30 minute bar; however this is not required to keep one timeframing intact. It is generally unwise to fade a one timeframing market. In fact, the biggest mistake that traders generally make is fading a trend day rather than going with it. It is quite common, during a healthy trend day, for the market to stop one timeframing once later in the afternoon to allow inventory to rebalance. All too often this inventory correction whipsaws short-term traders as they fade the one-time cessation of one timeframing. b. The Double Distribution Trend Day A double distribution trend day occurs when a market trades rotationally and then dramatically spikes either higher or lower and forms a second distribution. Each distribution of a double distribution trend day is treated as a separate auction or day and is separated, at least at its forming, by single prints. On the following day we will observe if the market opens in or out of balance relative to the final distribution. It is important to recognize that markets can progress from rotational to trend as well as from trend to rotational. Once a market becomes rotational, we again focus on the POC and developing value. 10. Poor Highs and Lows or Unsecured Highs and Lows A poor high or low conveys different information. Think timeframes for example, a poor low, in the day timeframe, can suggest that a market is getting too short. (Similarly, a poor high, in the day timeframe, would suggest that a market is getting too long.) However, in the next higher timeframe, this same poor low or high conveys a lack of auction completion and the likelihood that we will see a revisiting or repair of this poor low (or high) as the auction comes back to check out this suspect price level. Remember that this repair does not have to be immediate. Poor highs and lows can last for days and even weeks depending on how short or long a market is in various timeframes. Short covering or long liquidation takes precedence over structural repair as the market takes care of current business first ; do not anticipate that short covering or long liquidation will adhere to structure or conform to references. These market modes are driven by emotion and are over when they re over. Take Your Trading to the Next Level! 7

8 11. Exponential Information One poor high or low, prominent POC, or anomaly is something we see often. When we begin to record multiple poor lows or highs, prominent or very prominent POCs, and anomalies, this accumulation of poor structure is considered exponential. Meaning that cumulative poor structure is beginning to increase the odds of revisiting or repair. 12. Recognizing the Behavior of Your Competitors Very early in the session we can discern who is dominating by observing price action around references, where we open, confidence, and volume. As part of our structured preparation, we come into the day with the following: a. Review of our longer-term charts for perspective, while also understanding where we are on the playing field b. At least three scenarios written down c. Price levels we are following d. Poor profile structure recorded Now we can add who is dominating as the pit session opens and develops. This latest information can be a gateway to open up your imagination to envision tactical trades. Tactical trades (namely your preparation to identify them) allow you to see the possibilities. Weak references, as they relate to who is in the market and what this conveys is at the heart of this. Take Your Trading to the Next Level! 8

9 13. What Doesn t Happen is Often More Important Than What Did Occur We have often made the statement that what doesn t happen in the market can provide more information or as much information as what did occur. On the afternoon of May 29, 2015 we saw the release of the FOMC minutes from the last meeting. During the webinar on that same afternoon I pointed out that the late break in the S&P s clearly had an opportunity to provide us with an outside day to the downside; I speculated that what didn t happen, the completion of the outside day, might be relevant for the following session. The market rallied for most of the following session on May 21 st. Any trader can tell you what happened during any particular trading session. A successful, professional trader will also reflect on what could ve happened but didn t. Gaining an edge requires thought. 14. Acceptance Rejection It is quite common, during the Intensive, to hear me say, for example, that acceptance at a level is positive or acceptance at a level is negative. While we have broad definitions for acceptance and rejection there is still room for ambiguity. Take Your Trading to the Next Level! 9

10 Everything is a series of facts surrounded by other circumstances; this is just another way of expressing the importance of context. Sometimes we will rephrase this with the statement, a price that is not accepted is in fact rejected ; acceptance means over time. Generally, double prints would offer clear evidence of acceptance. Another example of acceptance would occur when price moves easily through a level where it is fairly obvious that we will not be returning to that level in short order; in this instance there is no need to wait for double prints. It s important to always remember that trading is very much an art. In the above example we will discuss a level of prices that appeared to have been accepted; however, the surrounding circumstances negate that acceptance. 1. In A period price traded into the buffer shown in yellow above. 2. In B period price overlapped the A period giving us double prints; by our standard definition prices were accepted within the buffer. 3. Confidence The market had opened on the high in A period, trading back and forth through the prior settle or within a tick of it six times prior to B overlapping the single A prints in the buffer. This very low confidence reduced the odds that price would trade substantially lower. Reflect on how often recording (and ultimately internalizing) confidence compliments your reads while also serves as a great trade filter for entries and exits. Take Your Trading to the Next Level! 10

11 4. Volume was low during the initial A period; this did not support downside continuation. 5. Given these surrounding circumstances context suggested that prices were not actually being accepted within the buffer. Conclusion It is seldom this difficult to determine if price has been accepted or rejected; however, context always has to be considered. Take Your Trading to the Next Level! 11