How to catch a market turn
It isn’t everyday that the market gives you a
textbook pattern, so it’s worth learning from examples as they arise. Take the
intraday bottom we formed during Thursday’s trade. It was as pretty a pattern as
you’re likely to see.
We’re looking at the September ES
contract, Central Time. The bottom set of numbers represent volume traded in 15
minute bars. Within the bars at each price, we can see with the
Market Delta program how much of the
volume was transacted at the bid price (red color; sellers more aggressive) and
how much was transacted at the offer (green color; buyers more aggressive).
Think of bottoms (and tops) not as
single points on a chart, but as processes that occur as buyers and sellers seek
to establish value. The bottoming process begins with a high volume selloff
(12:30 PM bar), in which volume is disproportionately transacted at the bid.
This typically represents long traders who are trapped in positions and who are
now exiting as a herd. This high volume selling creates a momentum low: a point
of maximum selling intensity. We typically get a smart rally off the momentum
low 12:45 PM bar, as buyers perceive value and jump into the fray. This rally
commonly peters out and leads us to further selling and an actual price low.
Most often, this price low will occur on lower total volume than the momentum
low and on a lower degree of selling intensity (volume transacted at the bid).
Notice that up to the point of the
price low, we’d been making lower highs and lower price lows. This makes it
very difficult for the trader to try to catch a seeming falling knife and buy
those prices below 1252. Two clues, however suggested that nibbling away on the
buy side was the right strategy. First, the price low was achieved on lower
volume and lower volume at the bid. This suggested that lower prices were not
attracting more sellers–as they had during the 12:30 PM bar. Second, and most
crucially, many stock sectors did not make price lows when we saw the lows in
the ES contract. The NASDAQ 100 futures (NQ), for example, and the S&P 400 Mid
Cap stocks
(
MDY |
Quote |
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PowerRating) did not confirm the lows.
Off those lows, we once again saw a
brisk rally of several points before sellers once again took their turn during
the 1:30 and 1:45 PM bars. By this time, however, you can clearly see that
volume among sellers had dried up considerably. At those secondary lows, which
held well above the prior price lows from the 1:15 PM bar, the volume in the red
areas (at the bid) was a mere fraction of their previous levels. Once it became
clear that lower prices were not attracting business, buyers became emboldened
during the 1:45 PM bar and aggressively lifted offers. From that point forward,
buying dips (areas in the red) became the profitable strategy.
The gist of Devon’s trading lesson
for the day was that market tops and bottoms are like snowflakes. No two are
the same, but each has a recognizable structure. If you think of tops and
bottoms in process terms, look for momentum extremes, then for price
peaks/valleys, and then for secondary rises/declines–using volume and
correlated markets for validation–you’ll find good setups each week. The key
is keeping tabs on the market over multiple time frames, as these patterns set
up both intraday and on a swing and longer-term basis.
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 and a
blog of market analytics at
www.traderfeed.blogspot.com. His book, Enhancing Trader Performance,
is due for publication this fall (Wiley).
Devon Steenbarger is an entering
senior at Naperville Central High School in Naperville, IL. She is
participating in Dr. Brett’s summer experiment to teach professional trading
methods to new traders. When she is not following the markets, Devon
participates in modeling and ballet. She has shown an interest in markets
from the age of 10.