Do You Like To Trade Markets That Make Big Moves? Here’s My Formula
A couple of readers recently asked me, “In the chat session (for Traderswire) you said that you were looking at who is in the market. How do you identify this?”
Most short-term traders monitor price and volume, but a surprising number
aren’t aware of who is in the marketplace at a given time. This is
important, because, as we’ll see, who is in the market is an important
determinant of opportunity in a given time frame.
To be sure, the majority of traders cannot precisely identify their
counterparties. They can, however, monitor the size of trades hitting the
market and ascertain the degree to which large traders are participating.
While large traders might occasionally execute trades of 1-5 lots, we know small
traders do not transact lots of 50 and more. Keeping an eye on the number
of 50+ lot transactions is one simple way of identifying when large locals and
institutional traders are participating in the marketplace.
Let’s take Friday, August 26th as an example. We traded 764,321
contracts on the ES that day, covering 41,233 trades. The average size per
trade was thus around 18.5, which is higher than the mean of roughly 15 that
we’ve seen over the past two months. Interestingly, of the 41,233 trades
of the day, only about 10% (N = 4161) were in lots of 50 or greater. About
60% of all trades (N = 26,304) were in lots of 1-4 contracts. The largest
10% of trades, however, accounted for over 70% of total volume (569,304
contracts), and trades of 200 contracts or more (just a little over 2% of
trades; N = 888) supplied over a third of the day’s volume. By contrast,
roughly 40% of all trades (N = 16,788) were one-lots and about 55% (N = 22,063)
were one or two-lots, accounting for only 3% of the day’s volume.
An even closer look finds that roughly 60% of the large trades (50+
contracts; N = 2380) occurred either during the first 90 minutes of trading or
during the final hour. Nearly 70% (N = 606) of the very large trades (200+
lots; N = 888) were transacted during that same period. Only about 12% of
large trades (N = 528) and 10% of very large trades (N = 94) occurred between 12 noon
and 2 PM ET. Not surprisingly, those early morning and late afternoon
hours display the greatest intraday volatility, and the midday hours show the
least price movement. Volume alone does not move the market, as we can see
from the one-lots. The concentration of volume is what makes
for market movement.
Viewing volume per trade on a one-minute basis is a quick and dirty way of
seeing who is in the market. Over the past two months, the average number
of ES contracts per trade has been over 16 for the first 90 minutes and last 30
minutes of trading and under 14 from 12:00 noon to 3:00 PM ET. That
difference of almost three contracts per trade amounts to more than a full standard
deviation. Little wonder that short-term traders find their greatest
opportunities early and late in the day and often take breaks in the midday
hours.
Because the correlation between the average volume per trade over the past 30
minutes and the next 30 minutes is a considerable +.53, we can monitor the average
size of current transactions and assume that unusually large size, when it
occurs, will persist in the near term. In other words, there is a
statistically significant tendency for large players to stay in the market once
they’ve surfaced. Moreover, there is a correlation of +.33 between the
average volume per trade for a 30 minute period and the average price movement
during that period. Indeed, if you want a formula for a superior trading
market (one that offers the greatest price movement), it would be to look for
high total volume and high volume per trade. That combination means that
many large players are transacting business, leading to large short-covering
rallies and liquidation breaks when one group of participants loses out.
Many trade ideas and systems among individual equities and futures can be derived from such
information.
Have a comment or question about minds and markets? Send me an email at
sonderstel@aol.com. Anonymous posts are welcome.
Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY
Upstate Medical University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com.