Characterizing Markets

[steve46 12]

Here are a few ideas for those interested in learning to characterize markets

 

From my point of view this technique is the cornerstone of "real" analysis. If you learn to do it skillfully, what you obtain are patterns and tendencies that may provide the basis for a profitable systematic approach to trading.

 

The Open

 

How does your target market open.....think of the characterization process as a blank canvass. You can add structure as you wish, but simply remember that whatever you "add" has to provide value of some sort....

 

For my purposes I start with the concepts of "time & price" and "confluence". For the S&P futures the RTH market opens at 6:30am pacific standard time closing at 1:15pm.

 

I classify the open as the first half hour, and divide that time period into 10 minute pieces. During the first 10 minutes, brokerages process retail orders that come in overnight and during the pre-market. In the industry we call this "shearing the sheep", because these initial orders usually represent the opinion of uninformed participants (also called "noise traders")

 

Because the actions of this segment of the population includes a significant emotional component, we often see what Market Profile adherents call a "test/drive" protocol, where price moves to test a nearby ledge or area of previous supply or demand. This initial test/drive process can best be seen using a short time frame chart. Depending on the time frame you choose, you can either see the "granularity" of price movement (with 1-3 minute bars or candles) or you can go out to 10 minute segments and see the broader strokes (just the reversal points).

 

Homework

 

For those interested, go to your chart package and review the opening half hour for each day of the previous week. Use a short time frame bar or candle (from 1-3 minutes)....look for the following

1. Look for price to open and then test a nearby ledge....(a ledge is a series of bars/candles terminating at the same price) also known as supply or demand, support or resistance.

2. Look for confluence....("confluence" is the convergence of two or more data types) for example.....if we concentrate on the confluence of time & price....look for price to open, test up or down to a nearby ledge, then reverse at a specific time...i.e. 6:40am (remember "10 minute segments"?)

3. For those interested in Market Profile, look for price to "test/drive" up or down to a nearby previous value area high or low...(I also use "time based pivots", but to each his own).

 

The object of this homework lesson is to get folks to begin looking for patterns of behavior that repeat. At first, you want to simply confirm that these patterns exist (prove it to your self first) then you dig deeper and try to find the nuances

 

1. how does the market open on days when we have a report out PRIOR to the open (at say 5:30am) and how does it open when the report is scheduled for release after the open (at say 7am PST).

 

What you will learn is that the markets have different ways of acting on the open depending on whether we have a report early or later (after the open)....and the open is different when participants have some expectation of the likely result

 

As an example, when we have an economic report due out AFTER the open at 7am PST and the result is widely anticipated to be positive....typically you will see the market open and stall, moving horizontally until about 6:45am.....the reason for this is simple....it is a "game of chicken" as participants delay looking for others to signal their bias....they wait for others to show their hand by putting on size....in theory, "informed" participants are likely to act in front of the release, and others follow behind like a school of fish. This can be seen by monitoring the tape (time & sales) and/or by watching the NYSE tick, or by simply watching price as time moves toward that 6:45 "line in the sand".

 

Strategies

 

There are several strategies that a trader can implement depending on risk tolerance and skill level.

 

1. One can monitor and simply "go with the flow" entering at or after the 6:45 time line, depending on their ability to decode the price action.

2. One can wait for the release and find entry at the first retrace up or down

3. Or if one is "informed" (has a strong viewpoint, presumably accurate) one can position themselves in front of the release, and having obtained "breathing room" simply wait and manage the position.

 

Couple of words of advice...for the most part members here will tend to be newbies and not have enough experience to comment....I will post charts to illustrate ideas and concepts but for now take the time to "think" before you post.

 

Thanks and good luck in the markets.

Edited July 11, 2012 by steve46

[steve46 12]

Wasn't planning on posting this example but it presented itself so I will go ahead and show it

 

This is a part of characterizing late day (afternoon) action.

 

I simply call it an afternoon reversal. Lately the S&P market has been presenting this behavior and if you see it, and can organize your system so that you anticipate it, then you can trade it.

 

The pattern lately has been for the markets to respond to Euro news (as well as domestic news) by moving south. In the afternoon, institutions and speculators come in to buy the "marked down" market (at a discount). This reversal action tends to happen on the half hour. We characterize it using the following protocol

 

1. We know that a down market or market that has trended down through the morning may reverse in the afternoon

2. We know that this behavior can occur on the hour or half hour from 10 am PST to close

3. We know that the behavior is likely to happen at or near one of our supply/demand nodes and that the signal is repetitive (one model of this setup calls for a relatively wide range bar or candle, followed by a reversal candle, then two "tests" of that local low)....favorable entry is possible at that point.

 

This is another example of using principles of "characterization" to aid in developing a profitable approach to trading.

[steve46 12]

To summarize for interested readers

 

First, we assume that markets display repetitive patterns can be observed

 

We approach the market by dividing it into time periods. We consider "the open" to be the first half hour, and we divide that half hour into 10 minute segments. The rest of the day we trade in half hour "chunks".

 

We look for ways to characterize price action so that we can anticipate it based on confluence of time and price (we want to be able to "look for" pattern that occurs during a specific time period, and at or near a specific price or range of prices)

 

We start by looking at the most recent market examples and work our way back (we prefer to obtain at least four (4) weeks of data on which to make our observations).

 

Proper characterization should include analysis of entry points, profit targets, risk management, as well as context (reports, events, news, etc)

 

When the analysis of the historical data is complete, one should try to obtain a week or two of "walk forward" data to provide the trader with adequate confidence to put money at risk.

Edited July 11, 2012 by steve46

[joshdance 10]

Thanks for the posts Steve. Nicely different from the usual BS "systems" and it focuses on what's important, the actual behavior of the market. We have had differences of opinion on specifics before, but what you have outlined is in the ballpark of what I am doing as well. I do not put quite the emphasis on the half hour that you do or the initial ten minute segments, but I subdivide the time in a similar fashion with a bit more loose constraints. Excellent no-frills and very professional approach, thanks steve.

[steve46 12]

Thanks for your kind words Josh

 

Characterizing the Globex

 

The S&P futures "overnight" market commences at 1330 hours Pacific Standard Time, continuing until the next day when the futures open at 0830 hours (or 6:30am PST) the next day. From that point on the "Globex" or "overnight" market consists of a series of openings and closings of financial markets worldwide. For the purposes of this small article, we will consider only the open and close of the Asian (Japan, Singapore and Hong Kong), and European Markets (primarily the German DAX and UK).

 

Knowing that this market differs substantially from RTH sessions, we look for a way to characterize it so that we can

 

1. Find a way to trade it that provides us high probabiity entries without having to monitor continously throughout the night.

2. Manages risk effectively while minimizing exposure to systematic risk

 

Based on experience we know that participation, and thus volume, liquidity and volatility are likely to be limited except just prior to, at or during, the open of each regional market (as listed in our initial comment).

 

Our preparation consists of the following

 

1. Review of important (high impact) economic reports for each regional market using Forex Factory, Briefing.com or equal source of information

2. Review of significant economic news for each regional market using any of several news publications including Financial Times or Bloomberg

3. Monitoring of at least one televised source of real time news covering the open of each regional market (again we prefer Bloomberg)

 

To characterize the markets, we look to recent events to direct our efforts. As of this date (July 12 2012) we know that the Asian Markets are minimized as shown by review of the S&P feed during those "opens" at or near 3pm PST and 5pm PST...however the DAX and London show significantly increased volatility and as a result the S&P "Globex" perks up at the open of each of those markets displaying tradable, repetitive patterns.

[steve46 12]

Additional comment with regard to characterizing markets

 

Earnings Season

 

As relates to the broad market (US domestic markets in general) one has to be aware of earnings season. We keep track of what are called "bellweather" stocks, and we monitor markets in advance of earnings reports from those issues. Tomorrow for instance we expect reports from JP Morgan and Wells Fargo...both of significant import to the US economy.

 

We also monitor what are known as "whisper numbers"...and here we suggest that interested parties simply "google" the term. You will find that there are a number of providers of this type of service (sorry but we cannot provide our source on that subject).

 

In terms of characterization of markets, what is important to note is that market tend to move sideways in advance of the earnings reports of "bellweathers"....this sideways or horizontal development is natural as participants wait or try to gather intelligence that they can then use to establish positions prior to the actual report (another form of pre-positioning).

 

Bond Auctions and Credit Rating Agencies

 

Finally one should (if they have sufficient background education) be aware of bond yields and auction results both domestically and worldwide. This data provides (can provide) important clues as to how the market will act as that information becomes available. It is particularly important to professionals in the banking industry. If that isn't enough data to be concerned with, the actions of rating companies including Moodys, Standard & Poors etc

 

Credit rating - Wikipedia, the free encyclopedia

 

These companies and the ratings they provide and update can affect markets dramatically.

 

So, we have gotten a bit off track here but suffice to say that these data points can and do affect the way markets act on a daily basis.

 

In our final comment (next post) we hope to offer a (relatively) simple way of characterizing the overnight market.

Edited July 13, 2012 by steve46

[TheNegotiator 13]

Thanks Steve, nice post. Straight forward look at the open and how it can give you a clue to what trading might lie ahead for the day. I think OTD's or even where there's no actual 'drive' as such, can provide excellent opportunities for those who have done their homework, know the context, appropriately assigned risk and are willing to take information risk early on.

 

I understand what you're saying here but I'm not sure it's strictly fair either.

 

Couple of words of advice...for the most part members here will tend to be newbies and not have enough experience to comment....I will post charts to illustrate ideas and concepts but for now take the time to "think" before you post.

 

To discuss and learn with all levels of traders is good. Challenges to understanding only serve to reinforce sound concepts.

[joshdance 10]

In our final comment (next post) we hope to offer a (relatively) simple way of characterizing the overnight market.

 

Do you still plan to post a comment on the overnight market steve?

[steve46 12]

Hello Josh

 

I will get to it at some point, however I do have some things to think about...this is one of the core elements of a class that I put on each year for institutional clients....I have to make some decisions as to what to put into the public domain...I will do that and get back to this as soon as possible.

 

Thanks for your interest

Steve

[qineqt 10]

That is so nice post. i enjoyed reading it.

[zdo 20]

Hopefully, I’m not beating a dead horse here…

(sincerely, I do hope Steve46 is a ‘forgiving horse’ … not a ‘dead horse’)

 

but when I read “have to make some decisions as to what to put into the public domain” I understood. I thought, if I were in his shoes, putting 'setups', etc into the public domain would be easy. What would not be easy to put into the public domain is when to trust / use it and when not to trust /use it. Having put a lot of time and energy studying, researching, and testing ‘institutional’ and block based trading, I can tell you categorically every setup doesn’t mean you ‘got them’ … in some of the exact same setups, by numbers and by the ‘shapes’ / forms, instead of you ‘got them’ - they ‘got you’ … and I've also 'lived' it in the last week or so - one setup worked the first time and then didn’t when a very very similar / almost identical setup showed up again. Then a pattern with a different ‘form' didn’t work the first time and did the second time. etc etc…

 

 

tangentially related… :sardonicgrin:

charles hugh smith-We Are All Muppets Now

[steve46 12]

Getting started

 

The simplest common sense way to get started is as follows

 

1. Start with a longer time frame bar or candle...depending on your style of trading, this is going to give you a look into the actions of longer time frame players, and it shows you the broad outlines of price movement....I use 30 minute candles

 

What you want to do is to make useful observations about how price acts during the session

 

2. You want to move to a slightly shorter time frame in order to get a look at the granularity of the market...meaning you want to look at the actions of buyers and sellers at specific price points AND at specific times....I use 10 minute candles

 

3. For the shorter time frame traders, depending on your style of trading and your system, you may want to use still shorter bars or candles so that you can see where YOUR setups occur within the session..from my point of view determining if there is any cyclical component to your setups is very important..I use 3 minute (sometimes 1 minute) candles

 

Underlying all of this, you should have a general reference system that helps you to determine where the market is headed...I use "time based pivots"....these pivots are simply a record of the yearly, quarterly, monthly, weekly and daily open, high and low....

 

Working from this starting point, you look at the market and make observations about the way that the market is moving towards or away from these time oriented price points...