Understanding the Auction Process

[firewalker 10]

Interesting point. That goes to further show that they are tied together. That was kind of what I was going for when talking about open interest. Everything moves in relative terms, to its own past moves given the same volume and/or in relation to other markets and how they move on their relative volume.

 

This might interest you:

The DJIA and the S&P have always been strongly correlated. In fact, I just checked the CME website and they say it's been above 95% for some years now.

 

Have a look at the attached correlation matrix file for more comparisons.

[sandpiper 10]

The S&P moves according to the individual stocks. The pit traders are doing nothing but buying and selling at different price levels. They have no bearing on moving the market. The S&P will move up or down on its own. The pit traders are doing what we do at home except they are "in the action". If these pit traders didnt trade for any given day, the S&P will still move in accordance with the stocks in their index....just like the YM and ER are doing at that moment.

 

If the pit traders could move the market, then the ES would NOT move the same as the YM and ER. Come on...this is common sense.

 

Another interesting point...Have you ever listened to the auction process in the pit? It is obvious as the auctioneer is calling out the auction. Have you ever listened to what happens when the market suddenly sells off, or shoots up? The auctioneer stops talking. There is no way the auctioneer could talk that fast...let alone for anyone to understand him and be able to make a trade. If the "pit" was moving the market according to the footprint of buyers and sellers at a given price, then the actual auction would not be able to move up and down that quickly. Yes, the market would move up or down, but it would take a little longer for the auctioneer to move things along.

 

Two new questions for you experts out there:

 

7) Are commodities, like soybeans, corn, gold, etc...traded by an auction?

 

8) Are any individual stocks in the ES, YM or ER indexes traded by an auction?

 

After I get the answers to these two questions, I'll make my next points.

 

By the way, I'm not discounting MP.

.

 

I was waiting to see if anybody else was actually going to READ what you had written rather than seeing what they wanted to see and answering questions that they thought should have been asked rather than what had actually been asked. It seems not.

 

Before you move on to other questions you might want to reflect on the fact that many (quite possibly all) of your assumptions or assertions are incorrect. If you can't work out how to check out the efficacy of things that are public domain and not subject to any degree of subjective interpretation (such as what happens in the pit) then you have absolutely no chance of separating the wheat from the chaff when it comes to anything else that might be less obvious.

 

However, in the spirit of pointing you in the right direction...........

 

The voice you talked about listening to in the pit is not an auctioneer. There is no auctioneer in the pit, in any remaining pit for that matter. The voice you listened to is simply a commentator, probably Ben Lichtenstien or someone like that.

 

The S&P 500 Cash index moves in line with individual stocks. The traded price of the S&P 500 futures can only move if someone buys and someone sells. In the case of the large contract (SP) the buyers and sellers are in the pit (excluding globex out of hours trading). So therefore the S&P 500 futures can only move if someone in the pit buys and sells. There is lots of information on the pit around, including on here somewhere if I recall correctly. I suggest you have a good look.

 

Everything, but everything is traded by auction. But nothing that you have described thus far bears any relationship to that auction process (and btw that includes almost everything that IOAMT have to say about it). So simply asking if other financial instruments are traded by a process that you don't understand but think you do may not be the way to go.

 

I would try and establish some firmer foundations before trying to build a 40 storey building.

 

God Luck.

[Rocky Mtn Trader 10]

Hey MC...

 

I know what your saying, but what if for arguments sake the 30 tickers on the DOW had 0 volume for a day. Does that mean that the YM is not allowed to trade or will have had 0 volume also? Futures may track an underlying index and in turn the underlying stocks...but it's a separate contract and trades as such, albeit somewhat harmoniously with the underlying issues.

 

Would there be many trading something where it's underlying had 0 volume, of course not but it could still have traded. The DJI on the other hand would have 0 volume because that's a raw index tracking those 30 stocks.

 

I don't think the volume on the YM has anything to do with the volume on the 30 stocks in the DJI?

 

Those 30 stocks move independantly on their own. The combination of these 30 stocks moving on their own make up the Dow index?

 

One would conclude that if the 30 stocks in the Dow did not move, neither would the Dow. The value of the Dow would not be zero, because these 30 stocks already have a value.

 

If for some unknown reason, those 30 stocks had no volume and did not move one day, the YM would be a flat line all day...Doesn't a flat line mean something is "dead"? Why would anyone trade the YM at that point in time? We would all be in trouble ! !

 

The YM has nothing to do with the 30 individual stocks. The YM is a measure of how these 30 stocks move together in a unit.

 

So if no one traded the YM one day, the 30 stocks are still going to move (with their own volumes), which in turn would cause the YM to move. Traders trading the YM are merely trading price at time. No one is moving or manipulating the YM...its path is already predetermined (speaking in general terms of course).

Edited June 17, 2008 by MC

[MC 10]

Hey MC...

 

I don't think the volume on the YM has anything to do with the volume on the 30 stocks in the DJI?

 

Those 30 stocks move independantly on their own. The combination of these 30 stocks moving on their own make up the Dow index?

 

One would conclude that if the 30 stocks in the Dow did not move, neither would the Dow. The value of the Dow would not be zero, because these 30 stocks already have a value.

 

If for some unknown reason, those 30 stocks had no volume and did not move one day, the YM would be a flat line all day...Doesn't a flat line mean something is "dead"? Why would anyone trade the YM at that point in time? We would all be in trouble ! !

 

The YM has nothing to do with the 30 individual stocks. The YM is a measure of how these 30 stocks move together in a unit.

 

So if no one traded the YM one day, the 30 stocks are still going to move (with their own volumes), which in turn would cause the YM to move. Traders trading the YM are merely trading price at time. No one is moving or manipulating the YM...its path is already predetermined (speaking in general terms of course).

 

You can either click on the quote button of the post you want to quote or you can do BB code for quote. BBcode you just Cap what you want to show in quotes with [ quote=postersname] and then end in [ /quote]. Remove the spaces before quote and / in the above example though. I had to add a space so it would post and not show as a quote.

 

As for the rest of the stuff...I didn't say anything about a value of 0 only volume being 0. It would look like a weekend where it didn't trade basically. LOL

My point was meant to be that the YM is a separate entity and just because the 30 DJI stocks didn't trade doesn't mean the YM won't trade or move. If they removed the DOW as an index then the YM could cease to exist I suppose. But again this is alot of he said she said and I'm tired of spending brainwaves on it.

 

PM me if you need more help on the quote thing.

Edited June 17, 2008 by MC

[Hlm 10]

Rocky Mtn Trader...you have to remember that we are dealing with derivatives. What is being traded is not the actual exchange index. This is why the futures price does not have to match up exactly to the index. How closely the futures price is to the index depends on the overall market consensus. This is also why index futures are many times used to gauge the direction of the market.

[Soultrader 12]

Soul Trader, you trade the YM...correct? When you speak of volume in the YM, what volume are you speaking of? Is it the traders that are trading the YM?

 

I understand how profit works in the buying and selling structure of society.

 

If you are trading the YM, you are buying and selling price movements of the YM. The YM moves according to what the stocks in that index are doing.

 

I no longer trade the YM. But I am trading the price movements of the futures.... and do not pay any attention to the stocks. I let the insitutional big guys do that for me.... all I do is follow what they do to take quick short term price swings.

 

Volume is # of contracts... how would you identify the number of traders?

[Rocky Mtn Trader 10]

Soultrader...

 

You absolutely hit it on the head...thank you! ! ! You are trading the price movements of the futures...and do not pay attention to the stocks...my point exactly.

 

The institutional big guy trade the stocks...YES...and they are the ones who can, will, or do manipulate these stocks.

 

I think we can put some closure on this whole thread.

 

MP theory has merit and is very helpful while trading futures...although, it is much more useful in its original intent when used in a market where you have "floor traders" determining value during the IB period, and "other market makers" trying to control the value. If indeed the YM (used as an example only) was traded by this process, MP would be much more valuable for trading futures.

 

I totally understand the VSA concept. I'm not so sure it has as much merit when trading futures. All the volume indicates is that "we" are buying or selling at that price at that time.

 

Trading futures is a large portion of what people on the TL trade. Getting your piece of the pie anyway you can with whatever means works for you is the "game" we are all playing.

 

When you try to sell the tops and buy the bottoms using S/R levels...although this does work quite often, it became very frustrating when approaching a S/R level. It was anyone's guess if the price was going to hold, or break through. Volume does not work with this...you can try and convince me til you are blue in the face. There are high volume breakouts and holds and low volume breakouts and holds. Flip a coin.

 

I have found it to be more probable to...as Soultrader puts it..."take short term price swings" based on the momentum of the market. No you wont get the most points or ticks, but you can take a piece out of the middle.

 

I wish there were more threads on here about how traders are taking these short term price swings? I know it would help a lot a people become better traders. There are some very basic, easy to learn setups that have a very high probability. Why don't more people share these ideas?

.

Edited June 17, 2008 by Rocky Mtn Trader

[ammo 10]

I dont think we need to seperate anything.

 

The YM and the ES move almost identically with some minor variations. These variations are obviously in the different stocks that make up these indexes.

 

Notice that the ES trades 2.5 million contracts per day, while the YM trades only 250k contracts per day. Yet they both move up the same and down "proportionatly" the same. Ie., the YM moves 50 points when the ES moves 5 points. This is a very general term.

 

The sheer volume of the ES would cause it to move differently if the

"trading volume" had anything to do with its movements.

 

there are plenty of indexes that rarely trade that move in step with their underlying commodity,gold options , dow transportt options, to name a few

[Rocky Mtn Trader 10]

I have also learned something about the way the ES an YM move in price levels. It is not totally predictable (or I would be rich), but it has help me get out of trades and take a profit before giving it back. It has also helped me stay in a trade longer and get more ticks.

 

This is an easy concept that all traders should be aware of. I'm sure most of you experts out there already know this. My trader IQ is only 10%...lol.

 

It is also fascinating how close the ES and YM move together. There was an earlier post on this thread that told the odds of this...it was something like 95% of the time.

 

There is a lot of information one could obtain from watching these markets move together. Sometimes one will give you a hint slightly before the other.

 

I very much appreciate all the responses to this thread. I hoped this has helped many of you with a different perspective on the market.

.

Edited June 17, 2008 by Rocky Mtn Trader

[MC 10]

I wish there were more threads on here about how traders are taking these short term price swings? I know it would help a lot a people become better traders. There are some very basic, easy to learn setups that have a very high probability. Why don't more people share these ideas?

.

 

I'm waiting on you to share some of those ideas and/or setups. Thusfar it's all seemingly been a ploy to delve into certain intricacies of the markets. :\

[Rocky Mtn Trader 10]

"Its seemingly been a ploy to delve into certain intricacies of the markets"

 

MC...isn't that what this Forum is for...to help people see the whole picture?

 

Trading futures at time and price is not determining perceived value. That value is being determined for you in the underlying stocks. You are merely trading a price movement.

 

A futures market is a barometer for what the underlying stocks are doing. Surely you knew this MC ?

 

.

Edited June 17, 2008 by Rocky Mtn Trader

[MC 10]

"Its seemingly been a ploy to delve into certain intricacies of the markets"

 

MC...isn't that what this Forum is for...to help people see the whole picture?

 

Trading futures at time and price is not determining perceived value. That value is being determined for you in the underlying stocks.

 

.

 

HLM, whom I respect highly, has already confirmed my thoughts for me (though he worded it much better than I did). I'd take his word over either of ours any day.

 

We are trading a derivative contract. There are times when the futures being almost a 24 hour contract will influence the DJI and it's underlying stocks as well as vice versa. Why does the YM have a different closing price than the DJI if it's all predetermined by the root index. 12,093 close on regular market hours for the YM and 12,261 for the DJI. They simply don't move in exact harmony, that's undeniable.

 

And the jab at my signature...it describes how ALL markets including the YM work. The markets move to seek out accepted perceived value. If the YM had no pursuit of it's own value and it's fate was sealed in the DJI stone then nobody would bother trading it. The "perceived" part is because they are paper assets and have no true tangible value.

 

But enough on all that jazz...this horse is dead and already had it's carcass picked to the bones. We know where you stand, and I don't have intentions to argue or belabor my beliefs any further. Cards are all on the table and this thread can be used to "help people see the whole picture" should they choose to read it.

 

I still want to see you post some of your trade setups or concepts. I am honestly interested in everyones approach to actually trading the markets. Much moreso than their thoughts on how tangled the markets web is.

[Rocky Mtn Trader 10]

I understand your point MC. Im not debating the things you said in your last post...they are true statements.

 

My intentions were to show how the futures markets work, why they work, and why they move. I was hoping some of you experienced traders would help me with this thread without debating things.

 

The information provided in this post was to shed a little light on the subject. There is a lot of head scratching sometimes by traders wondering why things are happening. I have done the same. I did some research and talked to many traders to get these exact answers. It did help me better understand the whole picture. I was hoping to help others who might of asked these same questions in their own minds.

 

Whats the point in posting threads on this Forum?

Edited June 17, 2008 by Rocky Mtn Trader

[BlowFish 10]

Personally I didn't jump in as there was too much conjecture and not enough 'fact' market micro structure and inter market relationship is fairly well documented. I was also a wee bit confused what the core premise for the thread was. Chalk that up to me being a bit slow sometimes.

 

For example no mention of weightings until the second page. An assumption that the underlying somehow has more 'value' (value meaning 'usefulness' as well as its traditional trading meaning) presumably as its more tangible than derivatives. This seems to have lead to an assumption that the future simply follows the underlying where most of the time the reverse appears to be true (this empirically rather than through statistical study). I guess its because its much easier to short a futures contract than short a basket of 500 stocks.

 

There are lots of markets that are highly correlated (at times) that's before you get into options, leaps, warrants single stock futures and some of the more exotic derivatives. Mustn't forget the Spyders either. Of course things like bonds, oil and gold fit into the jigsaw. Theres is a whole part of the industry to do statistical arbitrage that will bring things back into line if they get out of wack, so not to worry!

 

By trading one of the 'majors' like the ES you are trading the elephant rather than the flies though it is sometimes fun to trade a fly (Russell used to be enjoyable).

 

I don't use MP but a robust model for looking at a market should 'work' regardless of what's causing the market to move. 9including arbitrage). Is it your thesis that 'models' that don't look at correlated markets are less robust?

[firewalker 10]

Found some very interesting statistics, with monthly correlation numbers for all the indices, going as far back at 1928 for some (DJ Transports for example)!

 

Click month and choose the appropriate index you wish to compare with the others.

 

http://www.econstats.com/eqty/index.htm

 

For example, to see how the DAX relates to the S&P, Nikkei and FTSE:

http://www.econstats.com/eqty/eqem_eu_3.htm

[firewalker 10]

Rocky Mtn Trader...you have to remember that we are dealing with derivatives. What is being traded is not the actual exchange index. This is why the futures price does not have to match up exactly to the index. How closely the futures price is to the index depends on the overall market consensus. This is also why index futures are many times used to gauge the direction of the market.

 

There are times when the futures being almost a 24 hour contract will influence the DJI and it's underlying stocks as well as vice versa. Why does the YM have a different closing price than the DJI if it's all predetermined by the root index. 12,093 close on regular market hours for the YM and 12,261 for the DJI. They simply don't move in exact harmony, that's undeniable.

 

It's indeed important to keep in mind what derivatives are.

 

If there is an offset between the cash market price and that of the futures market, it will converge towards the settlement day (expiration day). Futures contracts are highly standardized... the convergence that with the underlying basically warrants the integrity of a futures market.

 

You can find more about this at the CBOT or CME sites, but personally I've found 'The Idiot's Guide to Options and Futures' most helpful in explaining all of this. And it's definitely not for "idiots", many experienced traders probably don't know a lot about how the instrument they trade actually works.

[firewalker 10]

This might help:

 

It is an important aspect generally of trading futures that the basis – the relationship between the spot price of the underlying and the price of a futures contract – is not constant. This means, day-to-day, that a futures does not exactly track movements in the price of the underlying.

Changes in the basis are determined not only by changes in ‘carry’ costs, such as interest rates and storage costs, but also by speculative trading activity. In some markets the futures price of an asset can be more volatile than the cash price.

 

As a futures contract approaches its delivery date, however, its price must converge on the spot price of the underlying because, on the actual delivery date, the futures contract becomes just another spot market transaction. On the delivery day the basis – the difference between the spot price and the futures price – must be zero. This fact allows hedgers to use contracts

such as FCOJ futures to manage the risks associated with volatile commodity prices. A food-processing company that is concerned about increases in the price of orange juice can buy FCOJ futures. If the price of the commodity does rise, it can sell the futures back into the exchange shortly before the due delivery date, and realize a profit in cash that will offset the increased cost of buying orange juice in the spot market.

 

-- excerpt from: Derivates Demystified (Wiley, 2004)

[BlowFish 10]

The formula is as follows: F = (s * ert) - D

 

where:

F = Theoretical Futures Price

s = Spot Index Price

e = 2.7183 which is the Natural Exponential Function

r = short-term interest rate

t = number of days to futures expiration/360

D = dividends, expressed in index points, for stocks going ex-dividend prior to futures expiration.

 

Fair value = s(1+(r-D))

 

Fair Value is probably of more interest to traders its simply cost of the index plus interest you'd need to pay to buy all the stocks - dividend's you would get on those stocks.

 

http://www.programtrading.com/ for more on fair value.

[Northern boy 10]

Is the auction process directed by those that are not daytraders? As day traders we have no directional bias so in a sense we cancel eachother out... Then the only ones left to really put a bias on the auction are non-day traders, Si?

 

When I think of the concept I imagine kids(daytraders= set A) playing in a sandbox. But If they go outside it, the parents and teachers('set A) push them back in. So 'A define the VAH and VAL, right?

 

I think SoulTrader had said something along those lines... but that it was definded by the first hour of trading or something.. I'm not sure I remember.. but why would it be restricted only to the beginning of the day? That doesn't seem properly founded and I don't remember that it was.

Edited June 21, 2008 by Northern boy

[firewalker 10]

Is the auction process directed by those that are not daytraders? As day traders we have no directional bias so in a sense we cancel eachother out... Then the only ones left to really put a bias on the auction are non-day traders, Si?

 

Why can't day traders not have a 'directional bias'?

[Kiwi 16]

That's true. I spend the first 15-25 minutes building a directional bias then hold it until the likely turnaround time ... at which point I reverse bias or hold, depending. The probable trend is my best buddy

[firewalker 10]

Why can't day traders not have a 'directional bias'?

 

Too late to edit the post, but scratch the word 'not' please

double denial is not what I meant to type (Saturday mornings...)

[darthtrader2.0 10]

To me you have to bring in how these instruments that we are trading are used by the big guys that move the market.

I mean how much of the daily volume on index futures are the big guys hedging? Its fully concievable that alot of times the futures are being sold while the participant selling the futures are expecting the index to go up because they are buying a basket of the underly.

To me its a very important distinction to think about. That at the retail level we tend to use derivatives for leverage to add to risk, while most the volume on derivatives are actually to reduce risk by the big participants.

In some sense though it still may be a non issue as far as volume/auction analysis on the futures. While at the micro structure level things are way off but there is enough activity that at the macro level the futures are a perfect replication of the overal market auction process for the day/week/whatever.

[AbeSmith 10]

The topic started asked a similar question that I asked when I first started trading, but unfortunately I was not able to find that discussion to re-read the answers. He is simply asking about the mechanics of the market. I'm still not certain about it either so I'm curious for the answer:

 

1)I trade the YM. So if someone buys lots of a Dow Industrial Average component stock, like IBM, that will affect the price calculation of the Dow(The big Dow), and YM (The mini Dow). Right?

 

2)If someone buys lots of Dow Future (Big Dow), (is it only traded in the pits?) that will affect the price calculation of the YM (Mini Dow)? Right? Because there is a formula that is in place that makes the price of the YM go up whenever the Dow price goes up, so to keep the Dow and YM correlated. Now, this forumula, when it says the YM must go up because the Dow is going up, triggers a buying of a certain number of YM contracts, right? Who is doing this buying to keep the YM correlated to the Dow? The CBOT? Or the owner of the Big Dow? Or does the YM contract go up without buy orders?

 

3)Now, if I remember correctly, when I posed this question at first, I think someone said that it can go the other way also. That there is a forumula in place that keeps the Dow correlated to the YM? So if someone instead of buying lots of Big Dow, or lots of IBM stock, instead buys lots of Mini dow (YM), there is a formula that makes the Big Dow move based on the YM move? Thus, there is a forumula that buys Big Dow Futres when there is a buying of YM futures? If so, who is doing the buying?

 

4)And finally, when someone for example starts to buy lots of Big Dow, is there a program in place that will buy stocks of the underlying compontents, like IBM, Disney, etc, based on those compontents' weight in the Dow? If so, who is doing this buying?

 

Also, the answer to the question regarding the correlation of different markets, like S&P and Dow, which asked, why do the S&P and Dow move together when they are based on different stocks...is because of traders, institutional traders, quants, not based on an arrangement like the correlation of the Dow and YM.

[darthtrader2.0 10]

If so, who is doing the buying?

 

 

I think this is pretty much impossible to answer. I mean at the fundamental level the indexs are correlated because its a snapshot of the markets pricing economic activity forward. Then above that you have alot of shared components single stock wise between the indexs.

Beyond that is when things get murky IMO.

If Goldman is going to build a position in IBM maybe they sell big S&Ps to hedge the position, that then causes someone to arbitrage the big S&P vs the ES, then that causes someone else to arbitrage SPY vs the ES, causing someone else to spread the ES vs a basket of DOW cash, ect, ect...All which is happening in a non linear fashion, probly hundreds of times per TICK. I don't see how we can really gain any edge at the retail leve from this information.

To me the one possible edge that might be there is to calculate a tick precise PREM client side, server side being sent through your data stream seems to slow. Then figure out on your time frame what leads what statistically, cash or futures and then only enter trades when the higher probability situation is giving you a few ticks as opposed to eating them.