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:

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SPX

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R2K

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DOW

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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):

 

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SPX3

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SPX4

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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

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[one_half]

SPMidcap

S&P Midcap 400

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[one_half first]

Russell2k

Russel 2000 Small Cap

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[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

 

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ESw14

Weak Week 2014

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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

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B4L052xIcAAx2Uc

Last 50 Years (via SentimenTrader)

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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…

Trading for Value, Part Four

Today, in part four of the Trading for Value series, we’re going to break it down and lay it out.

We’re going to spread some of the most important pieces out on the workbench and see how they all fit together. It’s going to be a bit technical. Maybe even a little dry by comparison to some of the other installments. But that’s because a lot of information is going to be packed in here. So grab some coffee (or an adult beverage depending on the time of day, of course) and read on.

What’s the “it” being broken down? Well, it’s this concept of the value candle. We’re going to walk through:

  • what they are/are not
  • some of the important visual patterns
  • how those patterns compare to things that might be more familiar

And then lastly we’ll examine several charts in several markets to show the kinds of instruments on which this kind of analysis yields the most and clearest insights. I’ll say right up front that this is not a Swiss Army Knife of an analysis tool. It does not work well on every instrument and trading situation. In fact, it’s pretty specialized and intended to be used on very short time frames. And as great as it is shaping up to be at aiding the trade in certain instruments, it’s only just ho-hum on others.

First, Some Context

Let’s do a little “level setting.” No, this is not a trading pun. It’s a bit of jargon we used to use before a big meeting at a certain monstrously huge software company where I worked. It means we need a little context before we get to the heart of the matter. An informational appetizer, if you will. The most important contextual assumption below is one that is so ingrained in my thinking I often forget to mention it. And that piece of context is that most all patterns are only worth your attention at prices or levels you have previously identified as important.

At other times (or prices), patterns of most all kinds should be considered noise. It’s only at or near real inflection points that action of any trading kind should be taken. And one of the most interesting things about real inflection points is that they are pretty predictable. The exact wrong approach in most any trading method is to act on a trigger or signal at just any old price. Some prices are way, way, way more important than others, and for the purposes of this discussion please pretend that the examples shown are in fact important prices. We could literally be here all week if I went through the entire process of price/level triage, and you’d never make it through to the end. I might not either.

For the sake of expediency I’m just going to pull some charts up from under the counter, ala Ron Popeil, so you can see the finished product.  Besides, level-finding and price triage will be the subject of a future series of posts. ;-}

Pogo Sticks

I am a very visual person and an aficionado of metaphors. So while these things are called value candles, almost every time I see them I think of a pogo stick. Why? Well, in a way, value candles look and function much like an actual pogo stick. Here is an enlarged value candle taken from an actual chart. Now tell me the resemblance is not striking:

Acme-Value-Candle---Pogo-Stick

 

There are really 3 fundamental components to the value candle/pogo stick:

  1. The handle/spine, which is actually the bar range. In this particular case, it’s an OHLC bar. It’s the central support, if you will, for the whole thing.
  2. The spring cylinder. In a real pogo stick, this houses the spring that gives the toy its rebounding energy. So it is with our value candle. It’s the 1-sigma value area of the bar and it’s where the bulk of the bar’s energy is stored.
  3. The foot pegs. In a real pogo stick, the pegs are attached to the internal spring. When compressed by human weight against something solid, they cause the rider to rebound into the air. In this metaphor, the pegs are actually the bar VPOC, or volume point-of-control. The point of control is simply the price at which the most volume is traded for that bar/profile/period, etc.

As we’ll see in a moment, the value candle VPOC very often displays the same rebounding characteristics. The more deeply it is compressed into the value area, the more likely price is to bounce the other direction very shortly thereafter.

Now one very interesting characteristic of this particular pogo stick is that it works both directions. Right side up or upside-down, the spring can be sprung.

Potato, Po-tah-toh

Before we go much further, I want to point out that the value candle concept is not something that we at Acme made up. In fact, it’s something we pared down. You see, the value candle is simply a volume profile, visually streamlined and reduced to its svelte, naked essence.

Let’s have a look to compare. Here is the same 5 minute bar of the same instrument from the same day and time, but “clothed” two different ways: on the right, in a single-bar volume profile; and on the left in a value candle.

Acme Value Candle vs Volume Profile

So you can see same essential/critical/most important information is displayed in both the value candle and the volume profile – the range, the value area and the VPOC. Though by comparison, the value candle is much less visually noisy.

And as we’re about to see, that increased focus on the essential information can render a rotation-in-the-making easier to spot.

On the Rebound

So what are the kinds of pogo patterns we’re looking for? Again, generally speaking, we’re looking for the body of the candle (actually the value area, or the range of most-accepted prices within 1 standard deviation of the VPOC) to be positioned toward the outer extreme of the bar range, and also for the VPOC to be positioned toward the outer range of the value area. The further toward the outer extreme the better. Remember, in this metaphor, the outer extreme is the top of the range if price is in an upward rotation, and the bottom of the range if price is in a downward rotation.

For the examples below, we’re going to use 3 minute candles. The choice of 3 minutes is pretty arbitrary to be honest. It’s just that for fast-moving instruments 5 minute candles may be too long. And for slower-moving instruments 1 minute is too short. So this is the happy medium I’ve chosen just so we can have a kind of apples-to-apples comparison.

Beyond that, each of the charts has 3 studies on it:

  • The Acme Volume Profile VPOC, which actually makes the value candles on the chart
  • 2 instances of the Acme Volume Profile Value Channel, with one value area set at 68.2% (1SD), and it’s the inner gray-shaded channel. The other is set at 95.5% (2SD), and it’s the blue upper and lower channel lines. These are on the chart simply for reference to the session’s value area context. See here for more on standard deviations, if you’re not sure what those really mean. Yes, pun intended that time. ;-}
  • One instance of the simple Acme Volume indicator. This shows relative per-bar volume at the bottom of the chart instead of in a new panel.

One last thing before we get to the annotated charts. I’ve cherry-picked some pretty clear examples. Better to start with an ideal and learn to recognize valid but less ideal examples than the other way ’round, methinks.

From Under the Counter

First up… West Texas Intermediate Crude (CL). This is a prime candidate for this kind of analysis as it has clean, volatile short term swings and is often driven by aggressive price discovery. This means key levels are frequently faded, and that’s exactly the behavior that value candles were conceived to reveal. In this example we have clear pogo stick patterns on a swing high and a swing low:

Acme Value Candles - CL2.14.2012

Next up… gold (GC). Here again we have a swing high and a swing low, though not on in the same session. Pretty similar patterns. A bit trickier to read by comparison, though.

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Acme Value Candles - GC High2.13.2012

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Acme Value Candles - GC Low2.16.2012

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Of all the indexes, by far the one that makes the cleanest pogo patterns is the Russell Small Cap Index (TF). Why? While I can’t be 100% sure, it seems to be the least arbitraged of the index futures. Again I need to highlight that this is speculation, and it has fairly light volume at around 125K contracts per day. So no matter what, it’s much, much easier to move around than, say, the ES (which we’ll see next).

Acme Value Candles - TF High Low2.15.2012

And with that, I’ve saved the worst for last. I think for an instrument like the ES, this really is not the best tool. There is so much volume in the ES with so many players acting on so many time frames with so many purposes all at the same time that it really can’t form clear pogo patterns on most rotations.

Value usually takes so much longer to play out in the ES than with many other instruments. Again, mostly this is because the ES is commonly used as both a position vehicle and a hedging vehicle. Meaning that institutions buy a basket of stocks and sell ES contracts against that basket to hedge the position, for example. Still other traders take outright positions on the S&P 500 with the ES contract. Both could be happening at the exact same time, and thus can tend to “confuse” the price action in the very short term.

These differences of volume and simultaneous intent in the participants cause each of these instruments to have a very different character. How so? Let’s look at a couple value candle examples in the ES:

Acme Value Candles - ES2.14.12

Conclusion

My hope is that this walk-through delivered some clarity on the value candle concept, why it works, what it’s useful for seeing and when it’s not so good too. Again, this is a new concept we’re developing, and so far it’s showing lots of promise. It’s in successful, daily use by a number of Acme traders, a couple of whom you’ve already met, and there are definitely more examples to come.

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

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[iconbox  title=”For Rancho Dinero Members” icon=”emblem-important.png”]The template used to make the charts shown above as been added to the Acme Chart Template Library.[/iconbox]
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Trading for Value, Part Three

In the last episode of our Trading for Value series, we saw a couple very interesting charts from our intrepid oil trader Danny. Not only does Danny trade oil, but he’s pretty damn funny too.

He was looking back over a chart from last week that marked a significant near-term turning point in the price of Light Sweet Crude (CL). He was sort of marveling at how clearly the turn was spotted with the Acme Volume Profile Pack studies (high praise, we know… but that’s the point of all this!), and made a joke that it was like the price was just swimming along and a Great White shark came right up underneath it. More to the point, he could actually see it coming:

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Acme Volume Profile VPOCThe Bait

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JawsThe Shark

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We’ve not heard the last from Danny. One of these days he will show up for an encore presentation, toting more interesting and creative thoughts on trading price and volume.

But today it’s all about Phil. Phil is a Rancho Dinero Pro Member, primarily an ES trader and he’s been using the exact same Acme Volume Profile VPOC study as Danny. Though in a completely different way. The point of this series, after all, is to show some fresh perspectives on using price and volume instead of or in addition to the kind of volume and TPO profiling many of you know so well.

So here’s Phil, ready to show and tell. These are his words and images, essentially verbatim. Without further delay, here is Phil to take it away:

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Anyone that uses profiling in their trading will know that the basic theory behind it is that of price discovery. Profiling is a great aid in helping determine levels of interest as it clears up much of the noise that may be missed by the just looking at the chart. In profiling theory price discovery rotates between balances which can usually be found by looking for the low volume nodes that surround a high volume node in a composite chart. That being said, something I have found to be of use is the application of this same idea down to the micro level.

One of the tools in the Acme suite, the AcmeVolumeProfileVPOC, allows you to see clearly where the majority of volume is being transacted per period in your charts. In my experience I have found that once you have determined your levels of interest (be it through a composite or simple support and resistance) you will want to have as much information as possible for you to make a decision whether to engage or not at those levels. In my trading I use a combination of divergence indicators to determine selling or buying pressure at this point and combine that with the AcmeVolumeProfileVPOC to see where the volume was done. Whether I am looking to fade a move or enter on a pullback, I want to see that a vpoc was created around this level and that the price action is showing clear rejection of the vpoc in the way of continuation or a counter move. Once this happens I look to enter in the desired direction on the retest of this vpoc which usually happens in the next or within few bars after. In some cases the retest is very quick so like anything in trading you have to be ready to jump on the opportunity when it presents itself.

In the example below I use a 5 minute chart to explain what I mean:

1)      Going into this past Friday, prior to the open I determined what levels I would be looking to engage in using a micro composite chart for the month of January along with a range profile for the previous swing that we are currently trading within. As you will see the micro composite for the month (ETH) showed that the highest participated price for the month was 1308, I therefore expected that 1308 would find buyers and sellers and looking at the previous move off of this price and the trend for the month, expected that buyers would be present.

2)      As you can see also from these charts, 1308 and its surrounding volume nodes were bought and rejected the price drop during globex into the RTH open.  In the 5 minute chart with the VPOC indicator you will also see that there was a vpoc on a wick of a clear reversal candle. This in my book means price got to that level and sellers were absorbed by enough buyers to be able to stall this move. As a result we knew saw a small bounce from this level into this open.

3)      Once the RTH session got on the way, we saw a retest of this vpoc at 1307.25 to the tick where buyers came in and a prepared trader could have bought at first sign of stalling or rejection (or however you determine whether or not to engage), with minimal risk (stop below the lows) for a possible bigger pullback of the globex drop to a previous area of resistance which in this case happened to be around 1313.50 where we saw congestion on the way down.

As you will see there are many other examples on this chart and as with anything in trading, it requires you be curious and try it out for yourself however I believe the vpoc tool will help you identify areas which are likely to be retested for a rejection and/or continuation with defined risk/reward parameters.

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ES 03-12 (30 Min)

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ES 03-12 (5 Min)

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Again, amigos, this well is proving to be deep, clear and mighty refreshing. We’ll be raising another bucket before you know it. And if you like what Phil had to say or you have questions, be sure to leave a comment. No doubt he’ll be around to appreciate and answer.

Until next time, trade ’em well…