Dogpile

You see one of your trade set-ups and you are considering entering a futures position. How do you know if the ‘location’ of this trade allows plenty of room for profit potential? This is an idea for trying to think about location (for entering with good location and therefore implying good profit potential) that uses ATR and VWAP. The goal is simply to create some discussion around this topic. This is certainly not intended to be a lesson. I like to think of VWAP as a starting point for price action. In my opinion, price action relative to VWAP is some of the most consistently important price action of the trading day. What are some of the basic things the market can do if starting near VWAP: 1. The market can cling to the VWAP level – forming a ‘balance’ – a coil. 2. The market can push away from VWAP with momentum and sustained trending action. 3. The market can attempt to go one direction away from VWAP with momentum and strong conviction -- but then reverse (a classic trap) and shoot the other direction. 4. Finally, the market may just not care about VWAP and oscillate with no real respect for this level. I want to focus on the cases where price is in the vicinity of VWAP and you get some kind of an entry signal that you are considering taking as a discretionary trader (entry signals are not really the thrust of this thread). In my view, any well-defined pattern around VWAP or a simple ‘momentum-based push’ away from VWAP may be a good time to take an entry signal. You can never know with certainty which of the above cases will occur but if you can determine a reward point that the market may trade to, you may find it to be worthwhile to get a trade on for the mere potential reward of having the right read. The first attached chart is a situation where I believe the market is ‘in balance’ – price is consolidating near the VWAP price and meandering without conviction. Quantitatively, you could call it a ‘Low ADX’ consolidation-- pattern-wise, you could say the it is congesting because you are able to draw ‘converging trendlines’ (ie, you can draw a triangle type of formation/consolidation). Now let’s think backwards, if you think you know how far the market could carry if it does start to move directionally (break the ‘balance’), then you can probably figure out a location that is ok to enter as it leaves you enough room to take a position and make a nice profit. Then you can take trades whenever your personally-defined trades set-up in this ‘execution zone’… Chart 2 shows the same market coil as Chart 1 but I have added the ‘target’ levels. This is where I am estimating price as eventually moving to over the course of the day. This is simply an ATR function off of VWAP. If VWAP is ‘fair value’ – and the market is ‘in balance (low ADX triangle) – then estimating the future movement off of the existing ‘balancing’ is pretty flawed. A market that is ‘trending’ and a market ‘in balance’ are opposites. Determining a trend off of a period of balance is going to be difficult to make work. But I see this type of thing on the vast majority of trading days – some kind of balancing followed by price auctioning to a new level. A Rashke principle is that of a markets tendency to ‘trend’ in the ‘afternoon session’ (after lunch) – when volume picks up as institutions tend to trade more heavily in the afternoon. Why don’t we use this trending action of the previous afternoon as a guideline for todays trending action? This makes more sense then trying to use the morning congestion because of the difference in afternoon and morning trading. And let’s use Average True Range to estimate such. Chart 3 shows how the market moved after breaking away from its coil/balance on Friday Chart 4 shows how this level has worked over last 6 days. The formula I used was simply to add and subtract 5 ATR’s from VWAP with ATR calculated using the previous days final 3 hours of trading (180 2-minute bars average ATR). I used 5 because it is a Fibonnacci number and I always start with those. This is a 2-minute chart and 5 ATR's off a 2-minute chart seems to be hit a lot. In more extreme days -- 8 ATR's (next fib number up) might be inserted. This is just a guideline for determining potential reward based on previous days ATR. This is not supposed to be any holy grail type of discovery -- its just a way to visualize where price could trade to when you see one of your set-ups -- a time when it is often tough to see the forest for the trees.

http://www.activetradermag.com/strategy.htm This is interesting article discussing how ATR as a proxy for volatility can be useful. Why is this meaningful? Well, normal distributions have well-defined statistical qualities. This topic feels relevant to jperls recent series of excellent topics. I will present one idea using this information with hope of stimulating some useful conversation on this topic with regard to intraday futures trade set-ups. I am still developing this idea but wanted to present the article first to get others to think about the implications of this concept in concert with their own trading methods.

so there is nothing statistical to be gained from Chebysev's inequality other than a general idea that the skewed distribution is somewaht more favorable for trading to occur at +/-2or +/-3 Std Dev level than a normal distribution is??

I tried a long entry on Gold this week and it just refused to move either direction while EC took off ( though EC rolled over later). The inability of Gold to rally when the dollar was weak might be indicating underlying weakness. But for me, I am just avoiding this 'deadness' until it shows some signs of movement.

<<In the second video, we again see price action in the PVP area, but this time price breaks through the VWAP. We show how to apply the Shapiro Effect discussed in post 16541 to enter the trade.>> By my way of looking at it -- the 'Shapiro Effect' is effectively using a pattern to enter a trade (a break of a 2-min high/low to confirm entry at a level with a statistical edge). It is the combination of statistics and price patterns where I think this gets powerful.... Patterns are not so great by themselves and neither are statistics -- but put the two together is where the secret sauce is... just my opinion. I am not so impressed with the 'Shapiro Effect' but I do view this direction as awesome Jerry -- great job in this stuff. Through reading your threads, I have added some statistical concepts to my own pattern-recognition trading that has really made a difference. Thanks to all.

<<For skewed data, that is data that deviates from normal behavior, the best estimate can be obtained using Chebysev's inequality, which states that no less than 50% of the data falls within 1.4 SD, and no less than 75% falls within 2 SD. No less than 89% falls within 3 SD. These numbers are quite a bit different than that for the normal distribution. >> Let’s talk about this for a minute like you would a regular ‘1-tail test’ that many of us probably remember from Statistics classes. In a normal distribution, you would look at 1 end (tail) of the bell-shaped distribution and say that ’97.5% of observations should fall ABOVE -2.0 standard deviations’ (1-tailed test is ½ of 5% since you are looking at ALL action except for 1 of the ‘tails’)…. So your equivalent of this would be that in a skewed distribution ‘75% of observations should fall between -2 Std Devs and +2 Std Devs' Right? Which would then imply something like 1/2 of 25%, or 12.5% of trading to occur BELOW -2.0 std devs... do 1-tailed tests work like that in skewed distributions? I could go on to say that 1/2 of 11% (1.00-0.89%) or 5.5% of trading would be expected to occur BELOW -3.0 std devs.... thus, and maybe this is totally off but I will continue as a conclusion anyway: 'after taking a short at -1.0 std devs in a minus-skew distribution would have expectation of 25% of future trading be below -1.4 Std devs, 12.5% of trading below -2.0 std devs and 5.5% of trading below -3.0 std devs....' is this a general expectation? if not, is there a correct interpretation and would you mind sharing it if so??

you can interact with Bookstaber here by the way: http://rick.bookstaber.com/ he also wrote an article for time magazine recently: http://www.time.com/time/business/article/0,8599,1653556,00.html

good question walter... there is a good argument that when there is so much capital out there, 'the system' quickly arbitrages anything that gets out of line and so price never gets that far before it comes back into line -- causing a loss of volatility. the same though could be said in 1998 when all of Wall Street was basically implementing the same 'relative value' strategies that LTCM was doing. I think you need an 'event' once in a while to keep the volatility going. ie, 1997 had Thai devaluation causing ripple effects. 1998 saw the LTCM event that caused the financial sector (banks -- a major sector in the S&P500) to get really volatile. 1999 had a 'high-beta' sector (tech/media/telecom-TMT) enter a boom. 2000 saw that major TMT sector bust. 2001 was a recession year with 9/11 thrown in. 2002 saw the Worldcom fraud. After that, no major event really hit. You just kind of worked off the hangover of the bubble with real estate stocks steadily climbing (REIT's and financial stocks are generally low-beta and homebuilders are insignificant part of the index). So you had a 4-year bear market in volatility. Now here we are with bank-related stocks (XLF) getting volatile again - just like 1998. A recession would certainly cause more extreme volatility. Alternatively, a boom from a high-beta sector might keep things volatile (emerging markets). Until recently, emerging markets have been noticeably non-volatile. But that could change. Emerging markets are growing 10-15% per year -- you would think that there would have to be some up or down volatility associated with that kind of growth. Inflation and/or recesssion (bust) would seem to be likely at some point. Scandal could also hit. Net net, that is a great unknown. I have loved this volatility. That said, Thursday and Friday were a little too volatile for my taste. Its hard for me to think about 'trade location' relative to previous day when you are having such massive gaps every day.

Merrill Lynch economist equates the recent credit massacre to the market effectively tightening on its own what is the equivalent of 5 Fed Rate hikes.... yes, 5. Keep in mind, we have not had a consumer-led recession in the last 16 years. 2001 was a business-investment bust that remained mild because the consumer (70% of GDP) kept spending. This interest rate ramp-up is very scary prospect as this tightening has lagged effects that will play out in economic activity in a few months time -- not now. This future news could erode confidence and spiral into something more serious. I am not saying a recession is inevitible -- only that the Fed better get its act together soon and act very aggressively when it does. Risking a recession when inflation is really not that high relative to previous economic expansions would be a serious mistake. Here are a couple of links: http://bp1.blogger.com/_5h-SWVGx6Ms/RshmRR72PBI/AAAAAAAAAY8/2-wltGgdvKw/s1600-h/Rising+Recession+Risks.png http://bp3.blogger.com/_5h-SWVGx6Ms/RshmGx72PAI/AAAAAAAAAY0/FdrCLHD7cBY/s1600-h/Recession+may+be+unavoidable+at+this+point.png http://bp2.blogger.com/_5h-SWVGx6Ms/RsHhIOvXbLI/AAAAAAAAAYI/UOEpAcu16YI/s1600-h/140+percent+Rule+Equity+vs+GDP.png

anyone who thinks this rule change is the cause of the volatility hasn't been trading very long. 'volatility storms' are a normal part of market behavior and existed frequently prior to the most recent 4-year period of unusually low volatility. Look at the VIX on a 15 year weekly chart and you will see that recent market behavior is not anything special.

I thought maybe he just didn't know that such a feature was available.

Ed, as Ant said -- why don't you just use Tradestations feature of turning on the orders. Its under the drop down menu: Format Account Orders & Positions Just 1 Check and you don't have to worry about drawing the arrows ever again -- tradestation will show the entry and the exit.. See my attachment (I put asterisks over the # of contracts in this case).

gap down high made first trades 'high to low' (diagonally down) Now 3 straight 'high to low days' --- looking for 1 'low to high' day tomorrow... we'll see.

today in a nutshell (theme for day): big gap up, high made first (makes morning high), trades from a morning high to an afternoon low (diagonally down).

<<When does your right or left brain kick in when you trade?>> I am big believer in the 'synthesizing' part. The ability to synthesize evolving price patterns across multiple timeframes and put them into their proper context is the most important trading function in the brain, IMO -- and that is right-side.

Jerry, seems to me that each contract has its own nuances relative to VWAP. for example, the S&P futures really seem to react as you would expect around the VWAP price -- generally finds support or resistance there -- unless its a strong move -- whereas other contracts (NQ/YM) seem to violate the VWAP without the same regard for it. has this been something you have noticed?

<<One of the setups I trade is to wait the first pivot to be made, and determine if the pivot is a higher low/high (from upward direction of previous day) or lower high/low (downward direction from previous afternoon). >> exactly. that is crucial. this is what George Taylor tried to do with the 'Taylor Trading Technique' -- determine if that morning extreme represented a significant high or low for the day. I think this is very similar to what you are doing Torero. One way to think about it is to think about a diagonal line from the morning session to the afternoon session as the general theme for the day. Is a low being made 'first' or a high being made 'first' (which is the probable direction for the diagonal line)? Then seek supporting information for whatever thesis you come up with. Bringing this back to the opening gap.. A gap down can be thought of as a slight bias towards thinking a low is being made first. A gap up can be thought of as a slight bias towards a high being made first. Even in many times when this is not the case, you will still get some directional action against the direction of the opening gap for a while and can be positioned for that 'play'. The clear exception is when the market gaps and then shows extreme trending action -- this is signalling potential trend day in the direction of the gap. This is when you need to be careful. Rashke says these happen about 2-3 days per month. But the market will 'fake' the trend day and instead reverse and make a high or low for the day probably 4 times for every trend day that actually does develop. Just have to find set-ups consistent with your thesis and watch your back so you don't get run over. re Friday... this was big gap down with 'low made first' -- this is consistent with Market Profile that you would expect 'responsive buyers' on a move far below recent 'value'.... Thursday was also a gap down for a trade back up... but note that a high was made first (diagonal line down as the dominant 'theme' for the day). This is where the 'rhythm' of Taylors work really comes in.. Look how the market made a morning low and an afternoon high (low made first) for 3 consecutive days prior to Thursday. You were 'due' for a down day as Taylors concept calls for a 2-3 day cycle in the market where after 3 'low to high' days, you might be looking for a 'high' to be made first. Gaps definitely add to the complexity of this.

<<But is this an unprecedented act?>> repos are not that uncommon. the size of this one though was biggest since aftermath of 9/11. <<Only because real estate sector problem or they think it's expected to move into other sectors?>> I don't know answer to what the fed thinks. Some have postulated that the Fed might have significant information that isn't public that is really bad but containable if there isn't a panic from here. But the mortgage sector has somewhat stopped working properly. There was news on Friday that Countrywide was citing. Countrywides business is to loan money to investors, roll them up into bonds and sell them to investors of such -- bond funds -- then go do it again. But bond funds aren't buying mortgage bonds right now due to a loss of confidence. So Countrywide is stuck with $1 billion in loans that they can't sell. What does Countrywide do? For one, they stop making new loans. So the system kind of halted there last week and the fed had to do something. The real question is how much of this is loss of confidence (perception) and how much of this is just that we are sitting on major trouble. Nobody really knows the answer to this. There is a good argument that home prices are high but not going to freefall from here because the job market is good and defaults therefore aren't going to take off and spiral out of control. All the fed can do is try to inspire confidence among the participants to go back to each doing their role. The doomsday scenario is that something now triggers to cause the US dollar to start to nosedive and all those foreign countries who hold loads and loads of US bonds start to see their portfolios dropping and sell those bonds to get out of the US dollar. This would cause interest rates to RISE more --- which would obviously be a disaster for bond mangers who are already getting increasingly risk-averse. The key is confidence. Confidence between banks, confidence by foreign countries like China in the US system. I was in the business during the last doomsday -- we got nailed with recession, then 9/11 -- then we go through all that and just as you are starting to regain confidence that we will persevere -- the Enron corporate fraud news hits... the doom and gloomers come out from the woodwork with dire predictions. some try to be optimistic and then in June 2002, the Worldcom fraud hits -- it felt like the system was rigged to go down at that point... Bush starts talking tough on Iraq and the next terrorist attack could happen at any time. CFO's and CEO's were now all considered con-artists and you were considered crazy to trust anyone. Elliott Spitzer was on a crusade to expose everyone. it was like getting hit with a baseball bat over and over again -- anyone who tried to be optimistic about the future was letdown repeatedly. I am not saying that this needs to be repeated. I am just giving an example of how loss of confidence can snowball....

just to make most pertient point: what the fed is trying to prevent is a meltdown that is based only on panic and mis-trust. if there is a true meltdown because a bank has screwed up and is not hedged in the way it thought it was due to bad models -- then this could be very serious problem as it spirals to other banks that did business with the first bank. this was the problem with LTCM in 1998 -- a bad portfolio will blow-up and there is nothing the fed can do except give money away at that point in the amount of loss that the bad portfolio blew up by. the problem could be much more significant today than 1998 given the massive increase in overall derivatives since then.

heard an inteview on Friday that explained this pretty well. basically the problem is that financial institutions don't trust each other right now. they do not know what securities the other firm is holding and so they question each others ability to act as a counter-party for transactions. think of it like you borrowing or lending money to another trader. you don't know what derivatives he might hold in his account. is he a credit-worthy or not? will he be solvent tomorrow if he has sold a ton of puts and the market gaps down huge? now keep in mind that the financial services industry is highly regulated and you need to hold a certain amount of 'reserves' against whatever it is you hold (just like the margin requirement in your brokerage account -- you can only 'extend' yourself so much). financial institutions basically have to value their portfolio of securities and show what it is worth on a nightly basis (as I understand it) and hold enough reserves against that just like you or I do on a nightly basis with our brokerage accounts. but with such volatility, it is unclear what tomorrows volatility is going to do to the value of your current (complex) portfolio that is valued today (especially due to the huge growth of derivatives). what the fed can do is loan money to a firm that ensures that they can borrow from the fed to carry them for 1 more day. this comes in the form of a 'repurchase agreement' (a 'repo'). The fed basically agrees to buy securities from you for a day and you agree to 'repurchase' them tomorrow. this buys you a little time to weather a near-term storm because you will now have the 'reserves' necessary to not get a margin call. this time, the fed did a 3-day repo because there was the weekend and thus the banks will 'repurchase' the securities on monday by whatever amount they agreed to on friday plus the days worth of interest. Or of course a new repo could be issued by the fed to go another day or more. what this does is allow financial institutions to trust each other again as even if a firm has an exposed portfolio... that firm can just borrow the amount needed to cover the loss of value in order to maintain its reserve requirement. basically, the confidence it builds is the crucial element. it shows that the fed is not going to let a crisis spiral out of control needlessly. if a firm does really blow up and the lack of confidence was justified in the first place, then everyone is really going to panic and we will probably crash -- no matter what the fed does. that is how I understand it... comments by others would be helpful.

nice, compare this chart to the bottom of pg 123 of Street Smarts book... they are basically identical. buy the reversal with a stop under this low is the trading strategy associated with it.

<<During the overnight session (from a US perspective) it is the European & Asian markets driving things. Why not watch these rather than the overnight session? >> I have the DAX chart on my screen but my problem with it is just that I can't seem to make any sense of that chart. This is something that I keep saying is what I really need to work on. I just don't really understand the dynamics of 'time of day' and the DAX. I would like to learn this but the DAX chart is just a big choppy mess to me most of the time. I do plan on spending more time on this in the near-future as I agree with you in its importance. In my view, europe does drive action on US markets before maybe 8:30am New York time but Asia is usually just reactive to what happened that day in the U.S. That is my opinion right now, Europe drives early morning, US takes over and then Asia responds to the US action. If asia does something dramatically different than what happened on US markets -- then that is significant -- but this seems to me to be the exception rather than the rule. Admittedly, trading globex is not my strength -- I generally wait for the cash market to open before I initiate any trades. Part of this is that I have so much 'supporting information' when New York opens that I don't watch on DAX... In US, I watch the adv-decline line, volume vs previous day, put-call ratio, VIX, TICKS, sector movers (brokers), upside/downside volume ratio etc... You also have confirmation between contracts (did YM/NQ/ER2 confirm a new high or new low) etc... All of these things offer clues.

<<I find it more effective to use overnight resistance and supports instead of playing gaps.>> Probably best to look at some examples and talk about specifics. My opening post was just to expect some emotional trading to hit as the cash market opens. The overnight chart pattern will offer excellent clues and set up a workable structure to trade with. Certainly one thing that helps is to think about how the last few days have traded and where the open is happening relative to recent structure. Thursday ended with trending action down with price closing 2 std devs below the days VWAP. Thus the 'profile' is 'trending away' from last accepted price (in the 1480's) which continued significantly in the overnight session with action down in the 1440's. At this point, either you are headed for total crash or a period of congestion or a move back up. My point here is just that betting on the crash is really tough location to initiate shorts. Instead, congestion forms on the globex 24-hour chart and now you have a workable pattern to trade with. This is supported by the general tendency that after a significant gap, the market tends to trade back into the gap.

This thread is to discuss the difference between trading in the 'morning session' after a significant gap versus a more 'normal' opening price. This is a very important concept. I post this in the market profile forum because Market Profilers such as Dalton discuss the open with certain desriptions (from Mind Over Markets text): 1. Open Auction In Range -- within previous days high and low subset to #1: open 'in balance' -- in the accepted value range of the previous day open 'out of balance' -- open signifcantly away from the previous day closing price but within yesterdays range 2. Open Auction Out of Range -- the mere fact that the market has opened outside of previous days high or low tells you that short-term traders are not the ones moving the market. this is a market that will be highly emotional. some investors will have made or lost a lot of money and emotional trading will exist as those with big shorts on a gap down could cover/get squeezed and those with big losses could panic. Linda Rashke uses a 4-pt rule. If S&P futures open is more than 4 pts away from the previous days close -- this is considered a significant gap. note that the last 2 days have seen gaps that are MULTIPLES of this standard rule. It is time to be careful. One standard rule is that expect markets to 'spike' on emotional trading. One interpretation of this is to be careful on 'retracement trades' after a big gap. A retracement trade is a 'pulllback' after a large spike. The market could easily spike in 2-way action and form bull and/or bear 'traps' -- when it breaks (with strong momentum) one way that is a fake before a large move the other way...

let me add something here dbntina. Linda Rashke rule is that 'Retracement trades' (entering on a pullback -- such as shorting at the -1SD level) after the market makes a very large opening gap is very dangerous. Believe me, I learned this the hard way a while back. when you have a really large gap (like todays) -- this implies a large increase in volatility -- as investors will be very emotional. The dynamics of the morning session are different when you have a big gap and I would always be very careful after a big gap. my point is that gaps call for a different mindset. I trade nasdaq a lot and can tell you that trading the morning session on NQ can be very tricky as it trades quite differently than ES.. add a monster gap in, and you should expect some serious spikes. trading a retracement with a wide stop is just not a good strategy for that type of environment. The market was trading FAR below recent value and was set-up to make a low and trade up after such a large move. The market was trading at a huge discount to the previous days price already.