Tuesday, April 24, 2012

Mature Balance Area on S&P 500

Here is a link to a previous blog post on the S&P 500:  http://scottpluschau.blogspot.com/2012/04/weekend-update-s-500.html

A mature "Balance Area" is forming on the Emini S&P 500 futures.  A balance area shows two sided price action, or a market has found an area of value.  Markets go from value to seeking value.  Two sided price action to one sided price action.  I am patiently waiting for the one sided price action to begin in order for me to aggressively trade the S&P 500 in the smaller degree timeframes on the correct side of that order flow. 

Right now, with the structure of the daily chart, pricing patterns are more prone to failure or false breakouts in the smaller degree timeframes.  The chart in the S&P 500 is currently a picture of "noise" or "randomness".  Outside of opportunities that take place at the "extremes" of this balance area, I know I have to stay on the sideline and preserve my capital, or I will get chopped up.  The upper and lower extremes of a balance area are key reference areas.  Do you know the limits of your trading system?  If you can effectively scalp in noise for ticks, I tip my cap to you.

The good news for day traders like me is that a balance area, also known as "Horizontal Development", leads to "Vertical Development".  Which way it goes from here I don't care.  What I want to do is find a favorable trade location in the smaller degree timeframe that coincides with the larger degree timeframe.  I want the risk of the smaller degree structure with the potential rewards of the larger degree structure. 

Some chart developments to look back and review are the "Triangle" and the "Double Bottom" in the daily timeframe, which both had their "Measured Rule" profit taking targets get fulfilled.  (See chart below)

Notice how on the double bottom the second low was made on lower volume.  When the neckline was broken to the upside it sets up a short squeeze for the current open interest placed on the short side of the contract trapped within this pricing pattern.  This is what makes a double bottom a lethal trading pattern.  The bears did their best to hang on, but a stop placed beneath the valley in the double bottom provided a safe location where the trade idea would have been invalidated.  The trade idea for a double bottom is based on the "probabilities" for an increase in demand.  The initial short covering on the breakout can fuel other traders to move off the sideline which further fuels the reversal.  I never want to be early on a double bottom or anticipate a breakout.  I believe being early on pricing patterns has negative expectancy.  Which means I will go broke eventually doing that often enough.  There are an infinite amount of times a market will look like it is forming a double bottom only to see a new low prior to the proper breakout. 

Next, the triangle shows a picture of consolidation, or two trends of increasing supply and increasing demand with each rally and each selloff, coming to a point where one side is likely to run over the other.  This triangle had a steeper lower rising trendline, showing a greater increase in demand than the supply of the upper descending trendline, which gives it a more bullish probability in my opinion than a typical "Symmetrical Triangle".   The breakout here becomes an ideal situation to add to the prior winning trade of the double bottom, and to be able to trail the initial stop loss.

I touched on this triangle in the very early stages of this blog.  It is in fact the third post since I started to post regularly in December 2011.  It's interesting looking back at that post now.  One thing I have tried to make clear to my readers, is that I take zero pride in pointing out patterns "after the fact" (anyone can do that), but review them for the sole purpose of building up intuition for recognizing patterns early enough as they are developing in order to establish an effective trading strategy or build a trade plan around it.  This previous post is definitely worth another look:  http://scottpluschau.blogspot.com/2011/12/s-futures.html

Measured rule takes the distance between the top and the bottom of the double bottom and adding it onto the breakout point.  The measured rule in the triangle takes the distance from the first reaction point in the triangle to the opposite side and adding it onto the breakout point.  These are in blue dashed trendlines on the chart.  I find measured rule to be effective as a profit taking target because that is about how long it seems to take for the losing traders to unwind their losing positions and for other traders to get involved on the winning side before it meets a stopping price.

(Click on chart to expand)

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