Today’s Trading Lesson From TradingMarkets
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Each night we feature a different lesson from
TM University. I hope you enjoy and profit from these.
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any questions.
Brice
Getting An Edge With
Cross-Market Analysis
By Alan Farley
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Chart readers fall into two
distinct categories when
it comes to cross-market analysis. The first group focuses solely on the
individual price chart becausef it believes that all market influences lie
hidden in the candlesticks of that single view. The second group doesn’t have
quite so much faith in simple price patterns. It contends that market prediction
ties together many unrelated forces and that their ultimate success or failure
depends on how these primary influences dominate the overall trend during the
specific times that their trades are held.
All in all, this second group has a much firmer
grip on trading reality. Most times, market direction is only as strong as the
leadership that guides it. Individual stocks tend to follow the leader even if
their chart patterns carry a contrary bias. The unfortunate truth is that pretty
patterns won’t stop price from heading in the “wrong” direction when broad
market influences take over.
We tend to migrate toward the single-chart theory
because it makes our trade preparation a lot easier. Why study five or 10 charts
when you can look at just one? We also recognize that trying to interpret
cross-markets isn’t child’s play. It takes a lot of skill to sort out all of the
different forces, how they interact, and which ones will take control at any
given point in time.
It’s a Big World, After All
Traders must digest a vast amount of cross-market
information to reach simple conclusions about opportunity and risk. The first
thing you need to do is determine whether local or world conditions will more
likely guide the short-term price action. World conditions take control
infrequently, but can exert a major influence when they do. The Asian meltdown
in 1998 offers a great example of this type of cross-market leadership.
The broad interplay between debt, currencies and
commodities can dramatically affect the US equity markets. These major forces
trigger arbitrage between index futures and debt that can move stock prices
quickly. Fortunately, major shifts between these universal markets tend to occur
slowly. You can often prepare for their impact through a few well-chosen news
articles or a weekly index chart analysis.
Simple arbitrage generates primary influence
during quiet periods but broad issues may rise to the surface at any time and
shock American markets. Always defend active positions by staying informed and
planning a safe exit in the case of an emergency. Avoid overnight holds during
very volatile periods and think contrary at all times. The best trading
opportunity may come right after the crowd jumps for the exits.
Local influences dominate trading considerations
most of the time. Stay informed. Today’s excitement won’t move tomorrow’s
markets. Learn to see the big picture and anticipate leadership through the
media hype. Fortunately, markets have a self-fulfilling mechanism that pushes
the most emotional issues right to the top of the trading heap. Try to identify
proxies for these issues in the indices, futures or even individual stocks that
reflect the short-term mood.
The markets constantly seek leadership. In the
absence of larger forces, that role can shift at any time from the S&P futures
to the Nasdaq to the Dow-30 Industrials. A major sector, such as semiconductors,
can quickly move into the limelight and carry other markets higher or lower with
little warning. These fluctuations may or may not affect your individual
positions but your risk decreases when you pay attention to the guiding forces
at work each day.
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| Troubles in Asia and the collapse of LTCM trigger violent movement in the credit markets. Bonds and equities are tied together through a natural inverse relationship. For example, when one goes up, there is a tendency for the other to go down. But it often takes specific market conditions, such as those in 1998, to awaken its great influence. |
TICK Oscillation
TICK measures the transaction flow running
through an individual market. The classic TICK indicator captures in real time
the number of stocks whose last trade represents an uptick vs. a downtick. The
NYSE TICK provides a highly predictive indicator for all American stock
activity. Specifically, Nasdaq traders can avoid that exchange’s TICK
information and use the NYSE version instead to watch the flow of buying and
selling within the broader markets.
Follow the TICK through real-time quotes and keep
an active chart that illustrates recent historical activity. TICK routinely
forms trendlines and parallel channels that reveal complex intraday
support-resistance. This oscillating behavior also tends to reverse at recent
horizontal extremes that set natural limits on buying and selling activity.
Start TICK analysis by drawing lines and channels that define the recent action.
Then extend these lines and watch how they align to intraday reversals,
breakouts and price congestion.
TICK identifies natural entry and exit zones.
TICK may surge when channels or trendlines break, and just like individual
stocks, it often pulls back quickly to test new support before the breakout
pushes further. Align position entry with expected TICK behavior. Use
oscillating reversals and breakouts as cross-verification. Also, prepare to
terminate a trade without price verification when TICK flashes important
contrary information.
Watch TICK readings at important market turning
points. In past years, strong reversals began when the indicator struck extreme
+1000 or -1000 levels. These natural overbought/oversold boundaries persisted
for years. But modern markets exhibit greater volatility than in the past. TICK
readings from +1500 through -1500 now occur during severe conditions. You can
still apply the older limits when estimating market turns on a relative basis.
But always seek cross-verification through index chart patterns for larger-scale
reversals.
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| The most effective TICK charts match the nature of the intraday markets. Try five-minute or 15-minute data with two to three days of market action or a 60-minute chart with 5-10 days of history. Use candles in place of price bars. TICK charts print many predictive Doji and Hammer reversals. |
Indices & Sectors
Perform stage analysis on the major indices to
identify leaders and laggards. Are they rangebound or trending? Are oscillators
rising or falling? Do they converge or diverge? Each index has characteristics
that affect and distort daily results. Take the time to learn their construction
and how individual stock movement can generate lopsided information.
Follow those indices and measurements that impact
daily decision making. Nasdaq Composite, Nasdaq-100, SP-500 and the Dow
Industrials provide most of the data required to understand short-term market
direction. Apply modern Dow Theory that looks for convergence/divergence between
these four indices. Which is outperforming and which is underperforming? Keep in
mind that an index sitting near major support or resistance is more likely to
draw attention than the one caught in the middle of its range.
The index leader/laggard relationships define
most current market conditions. When the Nasdaq leads the blue chips up or down,
it signals a retail-driven technology phase with volatile price change. The
dominance of the SP-500 or Dow points to a flight to safety, with big money
moving the markets. This often signals a period of lower volatility and a high
probability that a sideways price pattern will develop.
The Nasdaq has several quirks unfriendly to
traders even though it attracts most retail attention. Three separate
sub-sectors comprise this dominant market: behemoth mega-techs, middle
technology/service and a large universe of small caps. Evaluate Nasdaq price
action after inspecting the current performance of each sub-sector. Frequently,
the largest Nasdaq stocks will account for most price change in the index.
Lethargy in the large-cap stocks may mask
small-cap rallies or selloffs. Mega-techs trade like small indices and often
require little external analysis. But positions in thinner Nasdaq issues can
depend on the right sub-sector acting in a supportive manner. So watch a
small-cap index, such as the Russell-2000, in order to filter out these index
distortions.
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| Keep one eye on the semiconductor sector at all times. This volatile group leads many Nasdaq selloffs and short-covering rallies, especially when the markets lack direction from other common leadership. |
Futures
The E-Mini contracts for the SP-500 and
Nasdaq-100 have expanded retail awareness of the futures markets. Now many
equity traders won’t make short-term buying or selling decisions without first
peeking at these market leaders. Even longer-term traders often consider the
influence of the futures markets before entering their equity positions. The
reason is simple: a sudden futures selloff will have an immediate impact on
stock prices.
Keep futures data on your real-time screen if you
are an active trader. Start by replacing the SP-500 cash quotes with the E-Mini
contract. Then add the Nasdaq-100 E-Mini and watch how most liquid technology
stocks respond to its considerable influence. This interplay reveals a very
short time interval in which you can enter or exit an equity position just
before it reacts to the contract. This can save a substantial loss or add to an
already profitable position.
The futures markets have a higher percentage of
professional traders than the stock markets. This induces a variety of
conflicting strategies at almost every major price level. You can see this
conflict on the intraday charts where quick fading movement follows many
wide-range bars. This often gives an odd porcupine appearance to the flow of
price movement.
You can use this phenomenon in two ways when it
appears. First, apply it as a noise filter for execution of equity positions.
Real breakouts and breakdowns will thrust past these fade points, while false
moves terminate at them. Pay close attention and learn to stand aside when
others get caught in these small price ripples. Second, the porcupine fade
focuses timing for very short-term equity scalping strategies. Use the long
price bars to signal entry in the opposite direction. Then watch closely for the
fade on the next bar, and exit the trade into it.
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| Sudden price shifts and rangebound conditions often characterize the S&P E-Mini futures contract. Use the short-term reversals to time quick daytrades but always keep an eye out for sudden breakout movement that will ramp the contract to a new price level quickly. |
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