Taking Advantage of the Market as it forms!

Lee GettessHave you ever given any thought to how a bar forms? Virtually all technical traders use bar charts in some fashion and we have wonderful computers and graphics packages to display them for us, but I think there is some valuable information regarding just exactly how they get created.

This is very simple, but very important: If you can imagine a daily price bar being created (and this is true for any other length bar as well … weekly, monthly, etc.) we are going to try to take advantage of how it is created.

If the market is basically going up for the day, the probability is that it will open and go make the low first, then travel up to put in the high, then close somewhere up there. It can make the high first, then go down and make the low, then rally back up to close higher but that is a much rarer occurrence. So, if you are trying to buy support, you want to buy it as early in the day as possible. How early? That is hard to say ….. The earlier the better. If a market comes down to valid support later in the day it doesn’t make the support any less valid than it was earlier. The problem is if the high of the day has already been made, where is the market going to go? You can buy right off the low and still not be able to make any money. The ideal situation is to buy off the low when the market has the rest of the day to go make the high.

In preparation for each day of trading I try to determine how I expect the daily bar to form for the T-Bond, NASDAQ and S&P 500 markets. With the stock index futures the greatest volume and liquidity is in the mini version, but my analysis is good for either big or small contracts. Sometimes I am 180 degrees wrong, and that should present a fairly decent opportunity as well. If the market makes the high first on a day I expected it to go up, it still has to make a low somewhere. Selling resistance on those days can be quite profitable. On the other hand, the highest probability trades come when the market behaves exactly as we would like it to. Hitting resistance first when we want to sell, or support first when we want to buy are the situations with the greatest potential. This is how I day trade.

Longer term traders shouldn’t overlook this, either. The weekly low will be made first in an up week; the monthly low normally gets made first in an up month. Hourly, Quarterly, Yearly, etc. …. Each and every time frame must make a high and a low somewhere, and one has to be made before the other. A market either makes the high first, then goes down to make the low, or makes the low first and then goes up to make the high. It isn’t always easy to recognize how the price bar is forming, but attempting to do so can give you a tremendous advantage.

The proliferation of electronic trading has made this a bit more difficult because we have less of a “day” structure. Rather than a clearly defined time when the trading pit opens in any given market we now see markets that trade almost all around the clock. We almost have to synthetically create a time period that we consider to be “the day”, but in my experience the timing of this is not really critical. I prefer to only analyze data during the period I actually intend to trade, but I have utilized the 24 hour market data and found the signals to be just as accurate. The only problem is that sometimes the support or resistance I care about is reached at 3:00 AM. I’m normally not around to trade that, so I simply have to note that either the high or low has probably been made already and base my decisions for the rest of the day accordingly. I still find the vast majority of set ups occur during normal US trading hours.

I know this sounds terribly simplistic, but I truly believe that focusing on this process is one the greatest keys to my success as a day trader. Please don’t overlook the importance, and let me re-emphasize that this is absolutely just as valid on a weekly or monthly time frame. If you are a Rip Van Winkle trader who puts on a trade on and then goes to sleep for a few days you can trade a monthly price bar just like I trade a daily bar. Look for support and resistance on higher time periods than the one you choose to trade, then attempt to recognize how your price bar is being formed in relation to that support or resistance.

Please check out the examples that follow. I hope you will find this as beneficial for your trading as it has been for mine.

Daily T-Bond chart. Looking relatively strong but sort of running out of gas and going sideways for most of June.

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The next open is lower, and lower opens tend to at least come back to the previous close if not snap back up hard. Here is the first 80 minutes of trading (40 min chart)

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As you can see the market did rally back up, but just barely up to the previous close and the second bar was fairly small. You could sell a breakdown of that small range bar with stops just a few ticks above the high, or you could wait to see if they take out the day’s low. Either way …..

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The assumption that the high of the day had been made was correct. Profits could have been grabbed just about anywhere. Some of you may have been wise enough to hold for the entire move … I’m usually not that smart!

Here is a weekly S&P500 chart. The trend had been up … and up … and up …

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Selling into this rally had been pretty scary for months, but they are ridiculously stretched out to the upside and showing some signs of exhaustion. Those signs include closing the week right at the high and showing divergence in the RSI indicator. 

Over the weekend came the news that Osama Bin Laden had been killed. Great news, but why should it impact the US stock market? Monday opened higher …

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But they filled the upside gap quickly and reversed. An aggressive trader might have sold when the gap got filled, but even after this day was complete we had what the old chartists call a key reversal day. A conservative trade would sell a breakdown of that low with stops above the high.

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They dropped down to the mid Keltner channel on the daily chart to create the weekly low. If you want to look at an even bigger picture chart you can see this was also the high for the entire month and even longer.

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It doesn’t always work quite this well, but it is one of the very best tools I know of. Whatever time frame I’m looking at I’m always asking myself if it seems likely that either the high or low of that bar has already been made.

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Comments (2)

  1. Grace
    July 1st, 2011 at 07:56 | #1

    I like your analysis and will keep it in mind!
    Also I’ve liked the fact that you considered the 24 HOUR MARKET. In the States you always consider the open of whatever commoditiy when the NYSE opens, also for the e minis, but the REAL open is the day before. E minis, oil, forex and for sure other markets trade almost 24 hours a day with a very short stop. Best wishes Grace – Italy

  2. Emmett Moore
    July 6th, 2011 at 04:27 | #2

    Lee, you put a lot of effort into this post. I enjoyed it! Just pulled out one of my old school trading books, a book that most traders would enjoy “The Five Step Guide to Trading Profits”. Go Volpat!

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