Order Flow: A Crash Course – Part 2

Every now and then I see a comment or quip where it seems pretty clear that a trader might not really get it. By it, I mean liquidity… aka order flow. Not being judgmental here, the term itself is confusing. I mean there’re a couple very different aspects to order flow and that’s really the cause of the muddle.

Active vs Passive Order Flow

There’s “active” order flow and then there’s “passive” order flow. Active order flow’s the volume that’s actually traded. Traded volume can be called active because it requires a market order (a willingness to pay the spread) in order for a limit order on the other side to be matched and traded out of the order book. The source of the market order can be considered an aggressor. And then there’s passive order flow – passive because it’s basically an advertisement for business. It’s telling the world I have x number contracts or shares to buy or sell at a given price. These orders are telling the world come and get me… if you’re willing to pay the spread.

So this confusion’s understandable. I like to call the active variety of order flow traded volume or tick analysis and call the ebb and flow of orders in the market depth book what it is… order flow proper.

Key Questions

To that end, in Part 2 (click here for Part 1) I want to show a good example from today in NQ of a counter intuitive order flow concept: liquidity attracts price.  You can use this concept to help you answer (at least) three fundamental, objective questions:

  1. Are buyers/sellers responding to available liquidity?
  2. What’s the potential for price continuing to move in the same direction?
  3. What’s the potential for price to stop or reverse?

An Example

Below we have a chart series spanning 2 hours from about 7:45AM PDT to 9:45 AM PDT, and it pretty clearly shows how order flow can reveal to you what’s about to happen.

1. Just before 8:00 significant bid liquidity steps into the market and sellers begin responding. Bids are added, sellers continue to eagerly respond and drive down through the bids:

 

2. As price moves down, bid liquidity notably dries up around 6215. Offers also dry up very briefly at the same time. This can be an important clue for a cessation of hostilities, or a turn in a swing with power. Astute readers will notice what develops as price bounces from 16ish…

 

3. This move has passed 25 handles in just a few minutes. Some late sellers decide they want in (or out, we don’t really care which), but buyers aren’t reacting. Sellers now start to move at market and press price down another 20 handles in 15 minutes.

4. Notice the difference between the first leg of the move (above) and this one? Yeah, the bids are LESS and the offers are MORE. This liquidity imbalance is a clue that something is likely to happen. You guessed it. It’s about to attract price, but the other way round.

5. After a brief liquidity drought (get it?) new bids step in near 6200 and then begin using market orders to lift the offers for a fast 15 handle rotation the other way.

 

That’s it for this installment – hopefully it’ll be less than a year until my next installment. In the meantime… trade ’em well.

Order Flow and Traded Volume: A Crash Course – Part 1

I’ve had muchas preguntas (many questions) on Twitter lately when I mention things like new offers/bids coming in to support/resist at [whatever price]. It’s really hard to explain in one chart image and 140 characters, and today we had some crystal-clear examples in the ZB futures contract, so lets explore.

Market Depth 101

Before we get to the heart of this, a little exposition is needed. Many traders don’t realize the futures (and most stock) exchanges actually have 2 feeds of data – the most well known feed is called level 1 and contains 3 (or 4) pieces of information for each trade, for each instrument:

  1. Price at which the trade occurred
  2. Volume: number of contracts or shares traded
  3. Time: the time at which the trade was executed
  4. Best bid and ask: the bid and ask prices which where in effect when the trade was executed (optional, not all instruments have this).

The other feed is market depth or level 2 data. That’s all the prices and volume above the best ask price (offers/sellers) or below the best bid (bids/buyers), and this is the information that’s used to populate a DOM (depth of market) display:

The total set of data  – all the bids and offers at a given time – is commonly called the order book. If the price bars on your chart were a cake, this information is the raw ingredients for that cake. The process of matching buyers and sellers at the best bid and ask prices is the baking. Without both the ingredients and the heat, you ain’t getting a cake.

Right now you might be saying to yourself, “Yeah, ok, but why should I care? I don’t really like cake.”

I don’t either. But I do care about making trades at the right prices, so looking at all available data to make those buying and selling decisions (assuming you have that data) is just common sense. So what we’re going to do next is look at how we can combine traded volume at price with the order book to get the clearest possible picture of what’s happening in a market at a given time.

Important Evidence in Volume & Order Flow Analysis

Support and resistance efforts can be seen in both the traded volume history (see: Volume Impression) as well as the order book history (see: Flodometer). Some general patterns we want to look for in quality support/resistance are:

  • Slow price movement/pace of trade
  • Low/no demand/supply (willingness to buy/sell) at the top/bottom prices of a range
  • Absorbtion: as price moves up, sellers are willing to fill every (or nearly every) market buy that appears. Vice-versa as price moves down.
  • Increasing liquidity: for resistance that is volume in the order book increases on the opposite side of the move. If price is moving up, we want to see the total number of offers increase. Vice versa for support.
  • Liquidity at multiple prices: significant market participants aren’t really all that concerned with a tick or two, they’re more concerned with cost bases or average prices. They’ll spread offers or bids out over several nearby prices to actually get filled as price moves in their desired zone.

Example 1 – Resistance that Works

Around 6:45 PST we had a test of the previous days’ value area low as well as the 60-minute initial balance high. These are common prices at which resistance is found, but when price gets there are there any clues it’s going to hold?

 

 

First, let’s look at traded volume. How’d we do according to the guidelines above?

 

Next, let’s look at the same resistance from the perspective of the liquidity, or the order book:

 

 

There are other counter-intuitive ways to look at this information, these are commonly talked about as head fakes, traps or stop runs, but that’s for the advanced lessons. This’s a crash course, remember.

Example 2 – Support that Works

Same session, this time near 7:40 PST we saw ZB make another attempt at a low and buyers were successful and holding price above the Globex low of 148’30.

 

Using the criteria above, what were the signs in traded volume that the low would be held?

Now the same support attempt, from the liquidity perspective:

Example 3 – Resistance that Fails

In this scenario, sudden moves can be really difficult to detect in traded volume, mostly because it looks like nothing at all is happening:

Though this is where watching liquidity conditions has an advantage. Price tends to move quickly in low-liquidity situations, but slowly when liquidity is high. Why? Because in order for price to move, the limit orders at each price in the book must be filled. Fewer orders, the easier it is to clean out a price and move to the next. So, when liquidity is being drained – rather than added  – that’s very often a clue something’s going to happen very soon. With that in mind:

 

Wrapping Up

Like I mentioned at the start, this is a crash course. These are just a few examples in one instrument in one session. The evidence in traded volume and liquidity varies from instrument to instrument, but the signs are generally the same. Hopefully this was helpful and, until next time, trade ’em well…

 

A Walkthrough: The Powder Keg Trade

Been a long time since I was able to blog much. But in the words of Jack Nicholson from The Shining, I’m baaaack!

For the last past few weeks on Twitter I’ve been posting a lot about the #powderkeg trade. I’ve tried to explain what it is, why it works, when its most likely to work. But tweets aren’t always the best way to get a series of points across, and I’ve had a ton of questions about it. It’s not practical or possible to explain it each time someone asks about it, so I thought I’d walk through the finer points here.

First, let me go though what it is NOT (in no particular order):

  • The best trade ever. This isn’t a home-run type of trade. If you define it “right” it has small risk and generally good reward. By “good” I mean somewhere between 1 unit of risk for 2-3 units of reward. It’s a solid base hitter, though every now and then it cracks one out of the park.
  • One pattern to rule them all. This trade works best on non-trending days or later in the day when any drives from the opening of the session have exhausted their fuel.

That said, it has a lot of good things going for it (again, in no particular order):

  • It requires minimal tools, though as you’ll see I use a volume profile. VPs will help tremendously in defining the boundaries and quality of the setup. But truth be told this can be done without a profile.
  • It requires minimal preparation.
  • It requires no directional bias (it’ll be better if you suspend all bias, in fact). So in some ways, it’s the ultimate anti-revenge-trading tool (I’ll post about revenge trading another time).
  • No need to catch a falling knife or catch the top tick.
  • Works on pretty much any kind of short duration bar, ones that take 2-5 minutes on average to complete is best. The more bars there are the easier this pattern will be to identify. That said, many Renko bars will work against you here, they are designed to filter out exactly the kind of “chop” we’re after.
  • It’s the same pattern every time (but the quality – the ease with which its recognized – and outcome varies, of course).

Why it Works

Markets ultimately have one purpose:

quote

The theory behind this trade is simple. It works because it’s catching the end of a short-time-frame auction cycle… i.e. balance. Once a market achieves balance (supply/demand equilibrium, fair prices, etc.) on any time frame, its purpose has been fulfilled and it must start the cycle over again (see above). More about balance and other profiling concepts here. We want to be ready and waiting when it starts this cycle anew.

What to Look For

  • Find an area where price stalls, preferably away from a recent area of balance.
  • We want price to have left and returned to this “stall” (balance) area at least once on each side.
NQ - Powderkeg no profile

Example 1 – No Profile

 

NQ - Powderkeg with profile

Example 1 – with Profile

 

Now that we have the basic elements down let’s talk about a few characteristics which sweeten the quality of the setup:

  • The more times price exits and reenters the balance area the more powerful the break. At least one excursion-and-return on each side is needed to validate the setup.
  • The session VPOC’s included inside the balance area. Even better is when the VPOC’s in another location, you identify a new balance area, and before the balance breaks the VPOC moves into your forming balance area. This means volume’s being expended in this area and (probably) that stop loss orders are accumulating on either side of this balance area. These stops will serve to accelerate the move once it finally breaks the balance area.

 

Defining the Risk and Reward

There are multiple ways to do this, but ultimately your risk will be just over or under the center of your balance area. Preferably the highest-volume price in your balance area. Ideally it’s the session VPOC (point of control). You’ll want to define your reward at at least 100% of the size of your balance area. If for whatever reason it seems implausible that your target will be achieved, forget the setup and move on.

Example: if your balance area is 10 points across, your ideal 1st target will be 10 points on either side of the boundary of the balance area. Since you’re defining your risk as mas o menos the center of balance, if you enter at a break of the balance area that puts your risk:reward at ~1:2, assuming you only trade one contract or lot. It gets more a little more complex (but with a more favorable ratio) if you trade multiple lots or contracts because you can scale out along the way, booking profits and reducing your risk, while still having ammunition to take down further moves.

 

NQ - Powderkeg R-R

Example 1 – Reward Zones

 

Once the reward zones are defined, I like to use a trend line to split the balance area in half. There are many ways to split it in half, but I find this helps keep me focused and in the flow. Use whatever works for you.

I use a bottom or a top trend line depending on which way I think the keg will blow. It really doesn’t matter whether you draw the trend sloping bottom left to bottom right or vice versa as long as it splits the middle of the balance area. If price breaks back through the trend line, no matter which way you draw it, you’ll want to get ready to try in that direction. In this case, based on price action, order flow and internals I think this balance is most likely to break to the upside. So that’s how I draw it.

 

NQ - Powderkeg R-R Trend

Trend/Risk Line

Getting In

Now that our risk and reward is defined, how to you know when to get in? What you’re looking for is an impulsive directional bar. You HAVE to be paying attention here. This means any bar that starts to move unusually fast in a direction, compared to other bars nearby. Remember, you’re in a balance area, which is generally slow, lazy “chop.” So a bar that starts to hustle should grab your attention. Ideally, you’ll have your entry order(s) ready to go and all you have to do is place it and let price trade through and thereby assure a good fill. If you can’t get filled on your entry it’s probably because you hesitated and chose a bad price. The best prices are always ones that you can actually get filled. The best way to assure a fill is to make sure your order is one that gets traded through while price is on its way somewhere else.

This “trade-through” strategy is my preference, is entry option A pictured below, and will give the best risk and reward. A more conservative entry is to let the impulsive move happen and then wait for a back-test of the balance area to hold. This is option B. You still have to act decisively, or you’ll blow your R:R. Be quick or be dead, as I say. So shoot to kill.

 

NQ - Powderkeg ENTRY

Example 1 – Entry Options

One of two things will happen at this point, and neither are in your control. First, price will move toward your target and you get ready to book your profits, or price comes back at you and enters your stop zone (see above). If it does it’s OK. It happens. Look at the risk here… if you got long at the impulse through 4400 and your sell stop was at 4396, your target was around 4415… that was a 1:4 trade. You can afford to try again or flip the other direction even twice and still profit on the trade. But you have to honor your stop.

OK, so, how’d this one turn out? As you can see below, the impulsive bar I thought would be the magic one was a head fake. But that’s OK, because our stop was never touched again. Price re-entered the balance area, giving it even more power, and a few minutes later it launched out in our direction all the way to and past the previous day’s high. If you have enough units to scale out along the way, the max favorable excursion (MFE) would have been about 25 points, while the max adverse excursion (MAE) was just 9 ticks.

 

NQ - Powderkeg COMPLETE

Example 1 – Trade Complete

More Examples

Today gave more than its usual share of #powerkeg opportunities. Generally, there’s one or two a day. But today, thy cup overruneth,… so to speak.

 

NQ - Powderkeg EXAMPLES

More Examples – NQ

 

ES - Powderkeg EXAMPLES

More Examples – ES

Hope this was helpful, amigos. Until next time, trade ’em well…

I Want You to Want… Me

Cowpokes, I think no song better epitomizes the state the US equities market is in as we enter mid April 2015. Here they are, Cheap Trick, live from the Budokan in Tokyo… listen as you read. The opening is the best and pretty much what the SPOOs are saying to you, right now, today, in full-on 70s rock and roll fashion.

S & P 500

Once again, as we have several times in the last few months, we find ourselves at the intersection of Breakout Avenue and Heartbreak Street. We’ve been in the regression channel I’ve posted several times on Twitter recently since December. The SPOOs have tried to breakdown several times and failed. It tried to break out several times and failed also. Now we’ve consolidated our way almost to the bottom of the larger channel,  hit the bottom of the most recent down channel, poked above the top of it on Friday:

ES-Daily

See what I mean? So where do we go now, sweet child o mine? Sorry, couldn’t resist that one.

If I had to guess, based on looking at just this chart, I’d say a test upward is due. I mentioned several times on my daily Twitter homework charts that if buyers could achieve acceptance in the 90s that we’d likely test the ATHs. And I’m sticking to that story.  The chart above shows lots of assertive buying interest in the 30s to 60s the last few weeks. To me, this is clearly OTF activity, and above where we are is where their payday awaits. What’s more, when you zoom out to the weekly, there’s just no denying the massive force of the bull market we’re still clearly in. I mean, look at this thing. It’s a monster:

ES-Weekly

There’s a couple ways that bull trends generally take a larger pause (or end). The first is a “blow off top,” marked by frenzied buying and parabolic candles. In auction theory terms, this is known as excess. Look at the chart above, nothing like that yet. The other way is when, to but it plainly, there’s just no one left to buy. Everyone likes the market (or specific stock), but everyone who wants to own it at a given point in time already does. This kind of thing has happened several times with AAPL over the last few years, for example. A part of me thinks this is kind of the place were in now with US large caps. We’ve had about a dozen attempts in the ES at holding the 2100 zone and each time it failed. Not with a big bloody sell off, but with a push back down to recent value. Each time we bounce up we bounce a little less high, kind of lke a slinky walking down stairs. Look at the daily chart above again and tell me you don’t see what I mean.

So as of Friday we’re in just the right place to test the “Slinky” metaphor, aren’t we? If there’s no one left to buy (for a couple of very practical reasons I won’t bore you with here), then we should see some longs ready to take some profits and the Slinky will start rolling over toward the next step down.

So which is it? Breakup or breakdown? Well, this time it’s complicated. Let me show you a couple things, and you’ll (hopefully) see what I mean. First, not that it’s the be-all-end-all, but SentimenTrader has some pretty good charts which can help with sentiment (duh) and seasonality in particular. So according this this measure, we’re now in extreme territory just like we were a few weeks ago with the so-called “smart money” and “dumb money” viciously at odds over the market direction:

chart (1)

This chart says big players have little interest and are expecting and/or positioning for the market to take a dive while at the same time small players are excessively bullish in outlook. Honestly, I really never pay too much attention to sentiment indicators and measures except when we’re at intermediate term inflection points, like we are now.

The next thing I want to call to your attention, gentle readers, is this week of April 7 Commitment of Trader’s report. Bottom line is that in this report every category of trader which is required to report is net short in the ES now, some by a huge margin, and only one category required to report is net long in the big SPOOs contract. The report is linked there, have a look-see for yourself.

Now if you don’t know already, it’s important to point out that there’s just no way to know why any class of trader is net short or long from the COT. All we know is they are positioned one way or the other on a  net basis. Keep in mind that all futures contracts are both positioning and hedging instruments. So for example, if I run a hedge (or whatever) fund and I have big long equity exposure and I’m not feeling confident about the market’s direction I can hedge off some my market risk by shorting the ES. That way if the market goes down my losses are at least somewhat muted by the gains from my short contracts. The other possible reason to be net short is that you are confident that the market is going down and you want to make a levered directional bet. We don’t know why there’s all this net short exposure now, and that’s the reality. But it’s there for sure.

OK, so let’s get back to the upcoming week. Here’s the thing I am watching like a hawk now. I call it the come-to-Jesus line, and I think it will help us know whether this up-move is for real or just a… wait for it… Cheap Trick:

ES-Range

Basically, I want to see how the ES reacts to this trend top – or whether it fails to get there at all – before I make any big directional bets. Let’s be honest, it’s not like the journey even to the 2090s was smooth and stable, leaving solid structure underneath as a base:

ES-RTH

There are some significant flaws in this move up in my view, and Friday left a pitifully weak and ugly P-shaped (imbalanced selling) profile. So lets see what Monday brings. Speaking of Monday, know that I’m taking this one day at a time now. Given the current location, I think it’s silly to look out any further, so I’m calling the bull/bear zone for Monday around 2091, and watching the 96, 2100, 03 and 05 levels like a hawk to see how we react.

ES2

If sellers are found, we have all kinds of targets from the 90s down to about 2047. Let’s shake this tree and see who falls out, I say. ;-}

West Texas Intermediate Crude

If you’ve been trading this contract the last several weeks then you know this monthly chart is the only one you need to pay attention to for anything other than intraday prices:

www.tradingview

 

Contact with this trend line will either act at a floor for a rally (looking that way at the moment) or if it’s broken it sure seems we’ll head for the depth below with force. Round and round she goes, and where she stops nobody knows…

Trade ’em well this week, amigos…

Dr. Janet Feelgood, I Presume

Last week didn’t really play out like I expected at all. Not that it (the why or my opinion) matters, but ultimately lots of macro things worked out in the markets’ favor. Putin resurfaced, the FOMC effectively pushed federal funds rate changes out on the calendar, Greece didn’t get kicked out of the EU (yet) and middling economic/earnings news was bought fairly furiously. Blah, blah blah.

If I had to sum up the week’s action in a song, this would have to be Dr. Feelgood from Mötley Crüe. Let’s face it – sex, drugs & rock n’ roll are what this market is all about now. Partying like it’s (Nasdaq in) 1999. Hookers and blow for everyone!

S & P 500

Seriously though, this market appears unstoppable. I thought last week there was a good technical case for downside to be made. I know I wasn’t alone in that thesis. But it became pretty clear on Wednesday morning, pre FOMC, that the downside case was just plain wrong. I saw it unfolding and traded accordingly. Since then most of the SPOO short positions were likely crushed. Some SPY and ES option premium sellers probably wish they had hung themselves. There’s a reason why this inspired max pain diagram was first created (source):

 

CAf3E4TVAAAvjLz

 

Anyway, as I looked across the board this weekend at the senior indices, it’s hard to argue it’s not looking constructive for higher:

[one_half first]

SPX

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R2K

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[one_half first]

DOW

[/one_half]

[one_half]

SPMID

 

[/one_half]

[one_half first]

NASD

[/one_half]

[hr_invisible]

That said and shown, way back when I was a kid there was a game they played on Sesame Street called which one of these is not like the other? and the set of charts above is a good candidate for this game too. Cue up the song, give it a play while you look at the charts and I’ll wait.

Done already?

Yep, that’s right. It’s the Nasdaq 100 chart. It had a big gap up which met by some significant afternoon selling pushing it into red territory for the day. This is something to watch for next week. The start of something bigger? Or maybe just profit taking in a couple sectors which have gotten a little frothy (bio-tech names, et al)?

Basically, as I mentioned above in my view we’re in a location in the SPOOs where the weak shorts (and probably all but the strongest ones) have likely been squeezed out. Given this the ES won’t have a free stop ride higher and some initiative buying is needed to push the ES to new highs. The question, of course, is whether this will happen. In the event it does I’m looking at the following target area for the RTH session to complete an intermediate term auction:

 

ES

The 2135 area balances out a remarkably almost balanced composite profile from and 2132 is 127% (a mathematically magic number, 1.27 * 1.27 = the golden ratio) of the range from March 11th to the RTH all time high. When you’re off the map, measured moves of one kind or another all you have to go on. This has proven to be a good yardstick for me in the past so I keep using it.

On the weekly time frame, here’re the ranges I’m looking at:

ES2

My so-called bull/bear area, a.k.a. line in the sand, a.k.a. the zone above which buyers are in control and below which sellers are in control, on the weekly time frame is from around 2082-2075. ETH range targets above include 2118, 2126 and all the way up to 2043. Below I’m looking at 2038 down all the way to the 2-week profile balance target of 2003. 2003 is also a prominent low-volume area on the composite profile shown above. There are many great areas of opportunity in between too, of course.

WTI

For the 3rd consecutive week I’m not covering oil. There’s been more than enough volatility in the indexes to require my full attention. We’ll see if that continues, but with the VIX closing just above 13 on Friday the market’s expecting a lazy trade in the SPOOs.

 Trade ’em well this week amigos…

Going Down Like Disco?

I’ve decided I’m sticking with my cheesy music and movie line/title/pun title theme for a while. It’s entertaining for me. Maybe for you too. TA can be dry stuff. So why not?

This week’s post title is actually a song by the Dandy Warhols, a kooler than cool band from Portland, Oregon who’ve been influencing some of the best indie bands for decades. Have a listen to the song while you read for the full effect. Plus it’s got cowbell which automatically makes it awesome.

 

S & P 500

We had  an interesting week with a nice pickup in volatility, as I was expecting (hoping for) last week. But it was a tough read some days. Friday, many (most?) were expecting a kind of “royal flush” mentioned a few times during the week, but the bulls stepped in, shouted nada! and bid price right back up to the weekly VWAP around 2048. You can never know for sure, but my feeling is that price action this week was warped somewhat by the index futures March-June contract roll, and possibly some jockeying ahead of this coming week’s triple options expiration.

Anyway, I think this one chart sums up the week and also gives us some insight into where we may be headed. Believe it or not, you can read our Evolution charts (or other profile charts, really) a lot like a flow diagram. That’s why the Evolution charts are one of my favorites… they are really great at telling a story day-by-day, week-by-week, etc. Stories put any subject in context, context makes abstract ideas concrete. But I digress…

Start from the upper left, move to the right, follow the arrows:

ES

 

While we’re on the weekly time frame, let’s have a look-see at a couple weekly charts of the SPX.

 

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SPX

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SPX2

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On the left we have a 2 standard deviation regression channel of the recent solid up-trend from mid-November 2012 to now. On the right there’s a closeup of the past few weeks with an ascending triangle drawn. The two things to notice about this very traditional, basic TA chart is that the middle of the channel was rejected 3 weeks ago and we’ve never really looked back since. This is not a pattern the SPX sees very often. In fact, the last couple times it’s made an appearance was in the breakdown of the trend from March of 2009 to 2011 (left) and July of 2002 to January of 2008 (right):

 

[one_half first]

SPX3

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SPX4

[/one_half]

 

Twice this regression line rejection proved to be a precursor to a significant pullback or correction. Before I get all giddy imagining the smell of red candles burning bright tomorrow, notice that on the left chart above, during a similar rejection of the regression line (July of 2010) the index bounced right back into the channel. Which is to say anything can happen and the market is always right. Said another way, we have to prepare for multiple scenarios as traders. Which is a brilliant segue into the week ahead, if I do say so myself. ;-}

First, let’s start with some March seasonality statistics for the S & P 500 and the Nasdaq indexes (via SentimenTrader):

 

seasonal_march_spx

 

seasonal_march_ndx

 

Notice that less than half of the time March 16 is a positive day for both indexes and it’s a crap shoot for St Patrick’s Day. Then following the down days there is a stronger tendency, especially in the Nasdaq, for a bounce. I’ll definitely be watching to see if this is holds true this time. The farther we fall, the more inviting price becomes for buyers, save any macro force majeure. And amigos, I don’t have to tell you there’s plenty of news risk and big economic events on this week’s calendar, any of which (read: FOMC) could create a stir.

I’m actually expecting that we’ll be exploring both sides of the current balance area this week to one degree or another. At this point the HUGE consolidation zone between about 2050 and 1975 has a ton of structure, and save some crazy new events such as the death of Putin and a takeover of the Russian government by extremists or Greece (Spain? Italy?) getting kicked out of the EU, it’s most logical to expect that to be a tough zone to break through. Things just aren’t that bad, honestly, and dip buyers have shown they’re ready, willing and able to buy. So for the week ahead I think the 2040ish composite VPOC is set up as the most logical bull/bear line:

 

ES2

 

Given what I see I think the most likely zones of exploration are from 2040 down to the balance area around 1985 and from 2040 up to the balance area around 2085. Yep, a full 100 point range. Not that we’ll cover it all, but look left on your weekly charts and you’ll see it’s not out of the question. Again, I won’t be shocked at all to see some exploration of both zones, though I’m favoring scenarios in which explore lower first. We’ll see what we get…

The Rude Crude (Oil)

Not covering WTI again this week for the same reasons as last week. Though with a close on the 45 handle, which concluded the week with a huge and solid trend down, there may be a fat pitch to swing at very soon. Charts say lower still from here, with a strong trend in place, but the move is extended enough that it might invite buyers in to trap late sellers for a (short) squeeze play.

Trade ’em well, amigos…

Just Dropped In to See What Condition Our Condition is In

Why yes, the title of this post does refer to the surreal dream sequence in The Big Lebowski. Sort of fits where we’re at in the markets at the moment, doesn’t it?

 

 

The Equity Indices

The big volatility continued, of course, lubricated by global monetary liquidity on the one surface and the picking of multi-billion Euro nits between Germany, Greece and the ECB over Greece’s fiscal woes on the other. All this left many a trader confused and frustrated when sell-side programs took the opportunity to whollop the indexes not once but twice this week, seemingly out of nowhere. These hits came just we were getting comfortable with the idea that no, the SPX’s 6th test of the 150d EMA was not, in fact, indicative of weakness in the equities market and that the bull party may be winding down.

SPXMA

 

It was just the opposite. Turns out the glass was half full and your gracious host was standing over your shoulder, ready to top it off before it even left your lips.

Of course I’m only joking. Fact is that as a short term trader, especially in the futures markets where up is just as good as down, you survive and thrive via adroit use of mind and DOM. Still, I think it’s useful to take stock (get it?) in where we’ve been in order to help visualize where we may be headed. And to help make mental room for possible strikes and gutter balls, maybe even all at once in the same frame.

So let’s look at how we did, starting with the US large caps and working our way down.

[one_half first]

SPX

S&P 500

[/one_half]

[one_half]

SPMidcap

S&P Midcap 400

[/one_half]

[one_half first]

Russell2k

Russel 2000 Small Cap

[/one_half]

[one_half]

Nasdaq

Nasdaq 100

[/one_half]

The thing that I think has to jump right off the screen at you, 3D movie style, is that both the small caps and midcaps were able to at least take a peek above the year to date resistance. The midcaps not only peeked, they were able to bob up out of the deep water and spend a session or so with a dry head. Of everything I see on my charts this weekend, this has to be the strongest argument underpinning the expectation that the SPOOs and NQs have potential to continue higher. On the other side, the fact that none of the indexes were able to close above this same resistance is compelling fodder for a reversal thesis.

So what will it be this week in the SPX? Strike, spare or gutter ball?

At this point, factoring out force majeure, as I’ve been saying for weeks, I believe that the bulls must regain at least intraday acceptance in the 2060s range, and secure that acceptance by pulling the VPOC back up from the 2026 area. This is what’s needed in my view to sufficiently buttress market structure for new all time-highs. Believe it or not, the forceful sell-off on Friday may be just the thing to set that up. Bulls can only build balance (aka fair price acceptance) in the 60s, by buying over some period of time in the 60s area. You can’t do it from higher, like at the Friday highs. Fact is that Friday’s 2053.75 close puts that objective in easy, casual reach, even with a hangover. ;-}

ES

Should the bulls fail to do this, given the volatility we’ve seen, I’d expect us to revisit the 2020s area and possibly even the 1970s area from a week ago. Maybe lower. But again, I think in this environment where we’re on and off the brink every other day, it makes sense to not get ahead of ourselves. All the important levels in the box above are well-known – we’ve tested many of them from both sides, dozens of times in some cases. The only need I think this week is to be ready for responsive or initiative other time frame (OTF) players to step in. Overall, the bulls are in control. Most all the shorts above Friday’s close were likely squeezed out the last several weeks. So bears are the ones who would have to dig in anew. They are side with something to prove, methinks.

 

WTI Crude – The Archetypal Wild Child

Only lightly trading crude oil given volatility in the SPX (my main squeeze) these days, but it’s definitely worth keeping an eye on. On the weekly time frame we’ve finally established a higher POC in the low 51s after endless weeks of driving lower. The profile shows the market out of balance, which means in order to bring itself back into balance and move on we’d need to see a poke up into the 55 area. The fact that we spent Friday at the top of the POC balance area, is constructive for higher prices.

CL

Whether we build acceptance higher is another question, one I’m doubtful of in the short term given the massive oversupply condition we now have. But looking just at the charts this is the most logical course for the auction in my view. I’ll definitely be keeping an eye out for long swing opportunities up into this region this week, via CL as well as the UWTI ETF. Still not much interest in energy sector equity names for the long term. Overall my view is that we’re going to keep bouncing along the 50s and 40s for a time to come. The fundamentals don’t support a v-bounce, at least not yet.

As usual, I’ll post specific levels I’m watching on Twitter as the week unfolds. Trade ’em well, amigos…

The Needle and the Damage Done

Yep, I’m doing my homework out loud again this week. Not sure it’s going to become a habit. I usually don’t have to time it takes to write all this up. But it’s been useful to me given the intricacies and the strange times of late. And I’ve had lots of positive feedback on it too. So I’ll do it again this week.

And yep, the title’s a Neil Young song about heroin addiction. When you think about the relationship we have to oil and kind of damage oil price convulsions can do to the other US markets it fits, no? So let’s start there.

As I tweeted on Friday (and every day last week after the close) in terms of the big-picture numbers Reindeer Air Flight 12-25 from the North Pole is still on theoretical schedule. The S & P 500 finished the seasonal weak week discussed last week down 3.8% at about 2002. This is well within the norm of a 2-5% drop prior to a so-called Santa Claus rally.

In fact, from one point of view there’s a kind of of poetry to the finish of this week. Right at the end of the day Friday the ES closed a weeks-old gap around 1998. Just like the Corleone family from The Godfather, the ES hates leaving family business unfinished. The WTI crude oil contract broke through the $60 dollar mark and bumped its way down to  the high $57s. Lots of loose ends in these two important markets were tied up. Which leads me to ask whether we’re all done and ready to hear Jingle Bell Rock over and over and over in every mall store, xmas tree lot and gas station in the US for the next week and a half?

Well, after another peek under the sleigh tarp I saw a few interesting things happening. Let’s start with the correlation of price action in the ES and CL:

 

ESvCL-Week50

First this is a TPO Evolution chart which assigns a color to each trading day and then builds a profile for the week as the days progress. It tells a story which can’t readily be seen in a regular profile. With the exception of a surprise show of bull strength which caught many traders off guard on Thursday morning (upside erased later in the day), the rest of the time the ES followed the CL contract around as if it were the tanker trailer and CL was the semi tractor. Note the similarity of day by day progress as well as the overall shape. This kind of real-time, short term sympatico is unusual and caught my attention.

Friday I saw many traders looking for an afternoon rally and trading that direction. Normally this is the right thing to do given the circumstances. But not Friday. Friday was a day to react to the chart and not act on your bias. I could see all size-trading ES eyes were clearly focused on CL. Now before you call hindsight bullshit on me, I tweeted this twice when the ES reached critical junctures in the day and said to watch the CL for direction (see my tweet history if you care). The last one was theeee big trade of the day and the move started just moments after that tweet at 11:20 PST. Once the ES returned to the range mid, open, ETH and RTH VWAP near 2014 the table was set for the CL close and I tweeted as much. If CL did puke into the close there would be painful margin calls, just as there had been the prior 2 days. The fact that is was Friday also increased the odds of forced liquidation, amplified by the Russel 2000 as it neared zeroing for the year. And sure enough….

I was kind of flip about it in the tweet, I admit. I was tired and there was little time to get all that in a tweet. Sorry.

Anyway I bring this up to illustrate how I use Twitter. Some people like to tweet entries and exits, etc. Why, I don’t really know. Without having risk/reward, sizing and rationale underlying those entries and exits announcing them is just so much noise in my view. No one’s going to learn a thing from those kind of tweets. I mean, the occasional victory dance tweet can be fun. I do it sometimes. But mainly I tweet at inflection points and when I see unusual real-time correlations and contradictions which may swing the action one way or another. It’s mostly a way for me to crystallize thoughts quickly (see definition: congnative dissonance) about the action as it unfolds. If it’s useful to you too, all the better. There is an element of esprit de corps and a real time sentiment gauge in my stream that I find valuable and to which I try to contribute. I also say funny things from time to time.

By my reckoning, I usually have between 5 and 30 seconds (tops) to make a decision about entry/exit and size of a trade I have anticipated at the best prices. There’s no time to tweet anything like that kind of information anywhere near the point of an actual trade decision, either before or right after. To do so is much the same as texting while driving in my view, a dangerous activity which steals focus from where it should be.

‘Nuff said. Back to the charts.

So given that we’ve taken care of some overdue ES family business, what’s next? For some clues let’s compare the 2014 #weakweek to 2013:

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ESw13

Weak Week 2013

 

[/one_half]

[one_half]

ESw14

Weak Week 2014

[/one_half]

Regardless of the why, the fact is that we have the same pattern of starting off higher and ending far lower. Except this year the magnitude of weakness was far greater – about 2x. If you put your finger over that big selling tail the stories are even more similar. So is that a difference with a distinction? In this case I think it will be, at least early in the week.

The SPX closed just above 2000, an important psychological level. The ES finished much lower, but remember the ES is not the instrument it’s the derivative. That big blue tail above was created by liquidation from positions which had gains in order to offset margin losses (as far as I can tell) and not because of sudden bearish force majeure. That’s how margin investing works. You have to sell things which have gains to offset losses, sometimes when you don’t want to. Friday at the close was a settling of this kind of business. This liquidation created some extra downside momentum and it will no doubt cause a level of short term nervousness for many who suffered this liquidation. And also for the retail crowd who only sees a big red candle and doesn’t really understand the (pretty rational) mechanics of what happened.

So again, what’s next? Believe it or not, my favored scenario is that the Santa Rally Playbook will still be in use, though the execution could be kinda warped. I’ve done tons of macro homework over the last few weeks and I see no reason why there won’t be short term equity bargains to be snapped up as a result of this downside. Longer term, I have some thoughts I’ll save for later. But let’s look at how the post-#weakweek week played out last year (say it 10 times fast):

ESw13+1

In a nutshell, we tested lower but quickly caught a bid for the bargains which lifted the whole ES boat and created range expansion on both sides. Similar dynamics appear to be in play this time around too, albeit with a fair amount more force.  So I am expecting Monday to see some continued early selling, especially with a good chance of market on open (MOO) sell orders from large players squaring and frightened retail investors. There is support in the form of a composite HVA starting around 1987, though it’s not a big area of prior balance (see chart below). I am looking for the potential for the open gap and naked VPOC in the 1981-82 area to be taken out. If the rout in oil continues with ferocity,  I even expect that we could be taking a hard look at – and second-guessing – ourselves all the way down to the notch at 1965. The scorched Earth target would be the cluster of gaps and VPOCs and prominent balance area at about 1950. If oil and the liquidation forces were not asserting themselves so aggressively, I’d say this level of downside is likely beyond the pale. If it does go that far though, I am expecting the big selling tail from about 1990 to 2010 to be a prime target for any upside in the week and also to spend some time balancing there and (re)assessing the circumstances. There is tension building between low(er) equity prices and the (positive economic) effects of lower oil prices, and at some point that tension will be released. As long as the the world remains sanguine on geopolitical situations (again force majeure) this should be a trade-able tension release.

What exactly is this tension I mention? Well at some point the large US equity players have to starting sucking up the bargains. That’s how they make money and the year-end clock is ticking. They can’t make their numbers on the downside or in cash. Plus liquidation may weaken some player’s numbers enough to give other players an opportunity to outperform and enjoy the requisite spoils of war. And that’s a fundamental difference between the equity and oil markets. Oil (or other commodities) can go keep going up or down until liquidity goes away because both sides have the potential to make money by naked exposure or hedging. Then one side just quits. Totally different supply/demand motivation and dynamic in equities. But I digress. Should the equity players stop caring about the oil slick or should there be a cease fire in CL for the time being I’m expecting that we could very plausibly end the week somewhere in the lower volume area between 2031-2057 with the gap at 50.25 being the prime first target.

ES

 

In my view, given what I see right now, this is not a week to take big risk unless you are feeling lucky, punk (a Dirty Harry reference). That may change as the week progresses. It may make sense to press some bets. But don’t forget too there are a couple additional jokers in the deck this week in the form of FOMC and Japanese election news flow which, really, could start at any time now.

As for oil, I’m not going to try to call a bottom. In fact, as I tweeted on Friday I’m starting to think that sellers are going to have to plain run out of willing buyers (liquidity) in order for this to bottom. There’s no structure down here. You’re kidding yourself IMO if you think years-old  low prices and trend lines are a trade-able feature. The situation is so radically different now than it was then. I do expect a character change, however. This week I imagine continued downside to be pool-and-drop, level by choppy level, rather than a mass of water spilling over a broken dam like its been for so many months. My read is that there are more other time frame (OTF) players involved in the market now than even a few days ago. This alone would palpably change the action of such a low-volume contract.

So to sum up, the Russel 2000 state, Japanese politics, crude oil, the Treasury Bond yield curve and options expiration/contract rollover could all have a hand in the large cap equities action this week.Possibly lingering effects too. Save God and the central banks, no one knows for certain what the future holds. But this week we know one of them is talking.

I leave you now with this CL chart. It’s the first interesting cumulative delta divergence I’ve seen in weeks. It’s not huge, but worth mentioning:

CL

 

Trade ’em well this week, amigos.

‘Tis the Season(ality)

How’s your weekend so far?

We had all kinds of chatter this week about the Santa Claus rally. So I thought I’d sneak a quick peek in the back of Santa’s sleigh to see what we might expect, historically, across the US indexes, agricultural commodities and the current red-headed step child of the markets – West Texas Intermediate  (symbol: CL) crude oil.

 

S & P 500

The upcoming week was at least a little weak, prior to  Jingle Bell Rock time,  7 of the last 9 years. The pattern is even more pronounced across the last 50 years.

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SPX Seasonality

Since 2005

[/one_half]

[one_half]

B4L052xIcAAx2Uc

Last 50 Years (via SentimenTrader)

[/one_half]

 

Nasdaq Technology 100

8 of 9 years saw some weakness or 2-way trade in the upcoming week:

QQQ Seasonality

Since 2005

 

Dow Jones Industrial Average

Only 6 of the last 9 years saw some kind of weakness or rotational trade in the upcoming week:

INDU Seasonality

Since 2005

 

Russel 2000

Again 7 or 8 (meh) of 9 years saw some kind of weakness or rotational trade in the upcoming week:

IWM Seasonality

Since 2005

 

Agricultural Commodities – Corn, Cattle, Coffee, Cocoa, etc.

Pretty much a 50/50 proposition on weakness in the harvest basket (symbol: DBA):

DBA Seasonality

Since 2007

 

West Texas Intermediate Crude Oil

8 of the last 9 years were weak or rotational in the upcoming week:

USO Seasonality

Since 2006

 

Will We be Weak this Week?

Of course only God and the central banks know the future for certain and they ain’t tellin’. But it looks like the S & P 500 (symbol: ES, SPY, SPX) is trying to follow the dominant historical pattern. There’s certainly some droopiness in the number of issues above the 200 and 50 day moving averages, as well as in the advance/decline line:

 

sc

 

To me, WTI looks pretty determined to test the much-headlined $60 mark. That’s despite the obvious attempts of buyers to balance out the market (short term) at a few ranges of price last week. There’s lots of profiling jargon happening on this chart, but at the bottom line the oil market is still accepting lower prices. See how the points of control (POCs) are positioned on over the last month:

 

CL Weekly

 

I think we’ll need to see 4 things this week to call it a short term bottom next week: little/no additional capitulation from the long side; a significant balance area broken to the upside with gusto volume or just rocket-to-the-upside action (aka secure/strong low); the short side’s die! die! die! blood-lust bravado turning to fear and loathing in West Texas; and at the end of the week we need a higher POC/VPOC. Probably somewhere between last week’s and the week before’s, should it happen.

We’re at multi-year lows with these prices, so this is one hell of a holiday sale if you’re shopping for crude oil.

Now, strangely enough, a Twain quote comes to mind:

History never repeats itself but it rhymes.  –Mark Twain

When Price and Volume Agree, Part Seven

Starting in part seven of this series, I thought I’d flip the coin over and talk about when price and volume actually agree.

I’ve written a fair bit about the edge that can be gained by watching for a proverbial scuffle to break out between price and volume, Fight Club style. But you can also use price-volume agreement to your advantage to reduce your overall information risk for a trade.

What’s information risk? Well, in a nutshell, there are (at least) two kinds of risk you can incur in deciding whether to act in or around a trade. And it’s hard to talk about information risk without talking about price risk at the same time. Price and information risk are twins conjoined… yin and yang… a zero-sum pairing. The first kind of risk – information risk – is the bigger threat to your P & L over time. Information risk is when you wait too long to take action because you’re seeking confirmation or additional information.

Here’s a scenario. You’ve done your homework, and during that homework you saw 1350 in the ES as an important level. In your plan you noted that this price should be strong support on a test from above sometime during the day. And you think that 1347.50 would be a good stop placement for what could potentially a 10-point trade. That’s a 2.5 points of potential risk for 10 points of potential profit. Nice.

But when price comes to your level, 1350, instead of getting long (or scaling out of your short) you wait. It was in fact a good support level, and buyers step out of nowhere en masse right there at 1350 and price rockets up from that level. Knowing you were right and seeing its a good trade, you decide to take action and by the time you get your orders in price is at 1353.50, and you can’t get filled until 1354. You still have that same potential for a 10 point swing, but there’s just one trouble. You’re stop is not valid at 1351.50 – which is 2.5 points below your actual entry. You can place the stop there but it’s quite possible – likely even – that you’re going to get taken out at a loss during what would be a normal rotation before more upward movement. 1347.5 is still the only “safe” stop for that particular trade. And for your entry as executed (not as you planned!) that means you have to take 6.5 points of risk for only 6 points of potential profit. Not so nice.

And there it is. You’ve sabotaged your risk-reward ratio and your profit potential in this scenario because you took excessive information risk. Price risk, as it turns out, is not really risk at all. In fact it should be called price reward. As you can see above, the actual trade-off is between taking action when you don’t yet know what’s going to happen for sure or waiting for more information. Knowing and/or waiting, in trading at least, can really cost you.

But you can mitigate your information risk. That’s what your price and volume analysis tools are for. It’s not just that they are pretty, cool and even pretty cool (ha), it’s that they can help you mitigate and manage your information risk in real time.

And there was one unusually clear example this week that, not by coincidence, could have aided any trader embroiled in the scenario above. Note the prices in the actual chart below don’t match the scenario above exactly. I used round numbers above to make it easier to explain.

But the idea is this – you expected buyers to step in at your 1350 price. They did. Your tools – the Acme Volume Impression in this case – were giving you clear visual evidence that your hypothesis about the trade was correct. Price is doing want you expected. Volume is very clearly agreeing. So what’s the right thing to do? When? Which kind of risk do you really want to take?

This one picture answers all.

Acme Volume Impression - Test and Reversal

Have a great weekend, amigos. Trade ’em well next week…