CISCO Futures
A trading model is a plan of action for the trader. It may be explicit as in
a moving average crossover breakout or as intuitive as pattern recognition.
An auction market model is the result of a three step strategy development
process. These are Market Strategy, Trader Strategy and a synthesis of the
two, the Working Strategy.
Learning to Trade
The Steps:
A Trading Plan Case Study
Trading Plan Case Study: A Second Chance
1-303-306-1521 1-800 800 7227 Fax 1-303-306-1598
Internet http//www.cisco-futures.com
Email dljones@cisco-futures.com
Strategies, Models and Auction Market Trading
Donald L. Jones
Copyright CISCO, May 11, 2002, all rights reserved
Market Strategy is determined by the market itself, by the
characterisics that define it. It may be a short timeframe market with
a lot of action packed into minutes or even seconds, like the indexes. Or, it
may be a longer timeframe, more sedate market like the grains.
An auction market study of a market reveals that market's behavior, its
condition, and hence the strategy one must employ trading it.
Secondly, the trader has characteristics and preferences; timeframe, risk,
markets to trade, account size and so forth. These go to make Trader
Strategy. Traders control their Trader Strategy, but Market Strategy
is what the market offers.
Working Strategy is a synthesis of Market Strategy and Trader Strategy.
One's plan, or model comes from the Working Strategy.
Market Strategy
Traders want to catch a trend and ride it to congestion. This happens only
under the right conditions. The market must cooperate, offering opportunity.
The trader must understand the market well enough to know when it is in or
approaching a cooperative mode. A market's condition describes for you it's
reference points. These are the measuring sticks, each telling something
about a particular market feature. Reference points show the phase of the
market (balance, trend or transitional), its current risk, its historic risk,
its value, the volatility (and how it is changing), volume (and how it is
changing), the behavior of the commercial traders and
a number of others. More advanced analysis in the Advice Engine Package
examines the trading potential of the current market in absolute terms.
Reference points are like the pieces of a jig-saw puzzle. Combining the parts
describes the market. Putting the parts together makes the Market Strategy.
A typical Market Strategy for a market in balance would specify entry points,
risk, internal trends, current value and its center, commercial traders behavior,
trading range compared to the norm, shape of the price-volume bell curve,
recent behavior of the market and any trends in volume and volatility. Market
Strategy provides a market-based plan of trade entry, i.e. where the market
offers opportunity.
Examining the same market after it has begun to trend alters the focus.
Many of the same reference points are still important (commercials, volume,
volatility, value and the like). But now congestion governs. Has the
trading range become limited? Is the price-volume curve bunching?. Have
the commercials capped the trend? Is volatility dropping? Is volume easing?
Market Strategy is now the search for clues for a transition to congestion.
Trader Strategy
Trader Strategy is based on the trader's situation and requirements. It may
overrule market startegy. For instance, a market may still be showing trend,
but if the trader meets a target, an exit will be taken anyway. Or a timeframe
may be set (exit no later than 15 minutes before the close). Or a risk
limit may be different from that found in the Market Strategy. Trader
Strategy adds the imprint of the trader to the overall trading methodology.
Working Strategy
Working Strategy is a combination of Market Strategy and Trader Strategy.
Market Strategy undergoes large changes on a daily basis.
Trader Strategy is less
variable. One picks markets to trade, risks to take, hours to work, etc.
That strategy changes when a trader changes (e.g. trade DJ indexes instead
of SP's) or broadens the base of trading from one future to several.
A Working Strategy is unique to the trader. No one else will have the
personal input even if they start with the identical Market Strategy.
Trading Plan/Model
Models arise from the Working Strategy. They are intimately related to the
trader. A model is a codification of procedures the trader has found that work.
It includes the elements of market analysis in the Market Strategy, the
preferences and idiosyncrasies of the trader and the knowledge gained by the
trader from actual trading. As in any successful business, a successful trader
develops a 'feel'. This is not magic. It is experience. Much of it comes
from making mistakes and learning from them. Another part is from observing
markets in many conditions and seeing what follows. While intangible, 'feel'
is a very real part of developing and trading a model.
The path from Market Strategy to Trader Strategy to Working Strategy and
finally to a trading plan/model is the "trading equation". Mathematically it is
Market Strategy + Trader Strategy = Working Strategy ==> Trading Plan/Model.
The trading equation is a strong argument against purchasing a commercially
available trading model. Such a model cannot fulfill the trading equation,
since it cannot include the trader's strategy. A trader is forced to have
a trader strategy because it fits his/her particular situation.
Commentators on technical analysis regularly point out that people who
purchase models do not follow them. The purchased model is only a part
of the equation.
In the Beginning...
Beginners in most professional fields start with a course of instruction.
Following the instruction/introduction phase, there is an apprenticeship.
A successful apprenticeship leads to "journeyman" status, where the individual
becomes a member of the professional community, making a living from his/her
efforts. Some few rise higher, becoming masters; teachers, innovators, gurus.
The standards developed by most professions do not exist for traders.
There are no auction market schools. There are no organized apprenticeship
programs for auction market traders. The beginner, convinced of the potential
benefits of trading, is on his own. He/she reads magazines, books and gets
ideas from the internet and other traders. Inevitably the search for
understanding leads to a perceived need for a "model". There are many models
in books, magazines and explained in weekend seminars. Such models address
the 'Market Strategy' part of the trading equation and at best provide only
a partial answer. Most (all?) of
the 'sure fire' models do not work. Unfortunately, the beginner does not
realize that "a model that works" is worth it's weight in gold and no one would
sell such a valuable commodity.
Technical Analysis: A Bum Steer
The path of least resistance for the beginner is technical analysis. It is
offered and discussed widely. Methods for calculating market 'indicators' are
prevalent. At best, technical analysis deals only with first part of the
'trading equation', i.e., with the Market Strategy, leading to a "model".
Widely used, to little apparent avail, technical analysis plays a prominent
role for many in getting started in trading (see Trading as a Career, on the
CISCO Futures website). Learning to calculate a moving average or oscillator
is hardly the answer when one does not understand the market.
Market Waves and Tech Anal
What Path to Take?
Lacking formal educational facilities, the career path for traders, is not
well defined. It is certainly clear that one must understand markets well
enough to divine the Market Strategy for that market at that point in time.
It is equally clear that one must define one's own strategy, which operates
within what the market offers. Only then can a reasonable trading plan be
developed. How can one find the market's strategy? And then one's own
strategy? And then a plan. One set of steps follow.
1) Learn market structure. Learn the foundation principles of markets.
2) Learn to 'read' markets; which ones offer opportunity and at what risk.
Application of market principles leads to Market Strategy.
3) Define one's strategy: time frame?, activity level?, maximum risk? reward?
This knowledge provides Trader Strategy.
4) Synthesize Market Strategy and Trader Strategy into a Working Strategy.
The Working Strategy is the trader's plan of attack.
5) Find the market details, the current 'reference points'.
Integrating the current reference points into one's Working Strategy
becomes one's trading plan. The strategy now has numbers, a guide
to action.
Step 1. Market Principles: Auction Market Theory
Auction market principles are found in Auction Market Theory. An abbreviated
version of the theory is published in Stocks & Commodities, June/July 2002.
A more complete version is on the CISCO website, under "Whats New". Theory
provides the framework for analysis--those principles to follow. Theory
shows the trader what to look for in a market. Once the market is defined,
theory positions one to find a market based strategy.
Theory guides the trader in dissecting the market. As a result, a trader gains
an understanding of opportunity offered by the market and the risk inherent in
that market at that point (say the end of a market day). These variables
change with time, often within 24 hours or less.
Suggested Reading
Go to http://www.cisco-futures.com. Click on "Whats New" on the left sidebar.
Read 'Trading as a Career'
Trading as a Career
Study 'Auction Market Theory'
Auction Market Value Theory
Step 2. Market Strategy: Applying Auction Market Principles
Market Strategy comes from a market's current condition. For example, if a market is
in balance, the upper and lower breakout prices are known. The balance range
is known. Price exceeding the upper or lower limit is a 'breakout', an alert
for the beginning of a trend. Also known are the balance 'value area' and 'point
of control'. Breakouts from balance give an 'opportunity' measure which
permits a cataloging of that market's potential for trading. The balance
range can be translated into a risk measure. Trading points are developed from
limits and value areas. Overall trading potential comes from the opportunity
/risk ratio (reward-to-risk ratio). Markets can be compared by their reward-to
-risk ratios. Those with a currently too low reward-to-risk ratio would not be
traded.
If the market condition is not balanced, less is specified by the market parameters.
It is generally more risky to trade. If a clear trend is in place the day
trader knows to go with the trend. The long term trader who did not get in
near the breakout has missed the lower risk trade. Playing 'catch up' is a
much higher risk strategy.
Regardless of outlook, the auction market trader has information that
illuminates the market, aiding in action decisions. Still, the trader
must keep in mind that there are only two
goals: get into a trend early, exit when the trend begins congesting.
The market will tell you it's condition, volume path, volatility path,
commercial behavior, congestion, member's intentions, tradeability, etc.
Market information sets a strategy unique to this market at this time:
A balanced market will breakout at some point in time.
A trending market will always come back into congestion.
The market may be distributing (moving) or congesting--Auction market analysis
tells which.
Members intentions (commercial capping) are on the Visual Graphic.
Tradeability overall comes from Advice Engine studies.
Ditto for reward to risk ratios.
Learning to Develop Market Strategy
Becoming familiar with auction markets and the data is a first step
to incorporating these concepts into one's trading. The CISCO website
has a wealth of information at http://www.cisco-futures.com. Data from
these sources are used in the 'Trading Plan Case Study' below.
On left sidebar, scroll down to the section "Background". Click on 'Value
Based Power Trading'. This study introduces you to 'market condition' and how
to find it, as well as several market reference points. Other items in the
section such as 'Visual Graphics', 'TCP Data Intro', 'Overlay Demand Curve',
etc., can be consulted as needed.
To calculate Market Strategy:
On left sidebar, scroll down to the
section on "Data Packages". Click on 'Swing Trader Package'.
At 'End-of-Day Trader Control Package...' click on 'Background'.
Becoming familiar with auction market data and procedures:
On left sidebar, scroll down to "Order Free Trial".
Sign up for a two week
trial. Learn to use the 'Swing Trader Package'. One gains day-to-day
analyses of market condition and market reference points.
Learn about the 'Opportunity' markets offer:
On left sidebar, scroll down to the section "Data Packages".
Click on 'Advice Engine Package'.
Advice Engine Package Page
Click on 'General Background'.
Search out
those parts on opportunity. Use the free trial to study the Advice
Engine data daily reports and research services.
Completion of these tasks give you an understanding of what is involved
in Market Strategy. You will have a good start on reading markets.
To go deeper, click on 'Short HomeStudy Course'. This four month, intensive
application of auction market principles and analysis is well explained
in the background information.
Step 3. Trader Strategy: Investment, Risk Aversion, Timeframe
Trader Strategy reflects the needs of the trader. It must fit within the
guidelines set by the Market Strategy. If the market is in balance, one path
is followed, if not, another. If the overall reward-to-risk ratio is poor,
the market is rejected. Exactly how trades are made depends on the trader's
outlook--day trader, long time-frame trader or anything in between. Included
are the trader's risk preferences, market preferences, times to trade and
any other variable unique to the individual.
Some Restrictions on Trader Strategy
Size of account limits futures traded and time held.
Number of contracts in the entry trade are limited.
Extreme volatility equates to large risk: do you want this?
Holding overnight carries longer term risk: do you want this?
Active day trading requires constant attention: do you want this?
Information on Market Strategy is factored in.
Step 4. The Working Strategy
With Market Strategy and Trader Strategy determined, a Working Strategy
comes from synthesizing the two. Worked out are risk parameters and limits,
state of the market, timing of trades, exit strategy, etc.
This is your contingency plan for a varied set of possibilities.
Step 5. Trading Your Plan: Reference Points
A trader builds trading decisions within the conditions set by the market and
his/her Trader Strategy. It is a 'model' in the sense that the trader has a
plan of action, but not the sort of exact model a beginner has in mind.
The trader takes what the market offers (Market Strategy) and works within that
framework. The basic trading plan is simplicity personified: "get on a trend
early and exit when it is over". Execution of the basic plan, using the
information in the Working Strategy, is the trading model.
Plan/Model Examples
A assumption is that one starts with a Working Strategy, with a plan outline.
The outline includes risk and other determinations one makes before starting
to trade.
The 'Plan For Today' might be "stay out of this market because it is too
volatile or the average opportunity is too low".
Or: as a daytrader, this market is in balance and I will seek to buy bottoms
and sell tops.
Or: as a daytrader, this market is trending up and I will seek to buy pullbacks.
Or: as a swing trader, I will buy upside breakouts and sell downside breakouts.
Or: as a swing trader, the market is trending up and I missed the breakout. I
will stand aside until the trading risk eases.
"Whatever my plan, I will use the appropriate reference points from the Trader
Control Package, The Day Trader Package and the Advice Engine. These reference
points will help determine the start of a trend, congestion during a trend
and trading points used by others (e.g. value support and resistance prices
from the Advice Engine Day Trader Report)."
Some of these reference points, with their sources, are:
Value & change:
from Day Trader Package and Trader Control Package
Location of demand POC:
from Day Trader Package and Liquidity Data Bank
Volume growing/easing:
from Trader Control Package and Liquidity Data Bank
Volatility growing/lessening:
from Day Trader Package and Trader Control Package
Relative size of volatility:
from Trader Control Package and Free Tables of Averages
Initial Balance significant:
from Trader Control Package
Balance/Trend:
from Trader Control Package
Congesting or distributing:
from Day Trader Package
A trader's day starts well before the market opening. The previous day and before if necessary,
is used to build the Market Strategy. This is integrated with Trader Strategy, resulting in
the Working Strategy. The last leads to today's trading plan or model.
The Trader Strategy
The trader's profile will not change radically. Most days it will be the
same as the day before. We set up a particular trader for this example:
The person: Mr. T. A fifty year old male who has had some success in the business world.
Trading Arena: A conservative day-trader, seeking four or five trades per day.
Trades during exchange hours
May computer trade or go through broker
Expects to be out at least 15 minutes before the close
Normally does not trade on the open, watches the first hour
Follows primarily one commodity, the SP Index. Occasionally trades other futures.
Account size: $20,000
Risk per trade: $500 maximum (2.5% of account)
Target gain per trade: $250, not absolute--may hold for larger gains
Data Access: Ticker, CISCO Data
Trading methodology: 15 minute tick bars for timing,
Market Profile/Meta-Profile based data for trading decisions
(Market Profile comes from CBOT LDB data, Meta-Profile is from ticks.)
Elements of Trading Strategy
TS.1 Enter only if trend start is obvious or highly probable. Exit on the first sign of congestion.
TS.2 Trade in low risk markets, either breakouts or buying bottoms or selling tops of balances.
TS.3 Accept no more than $500 in net losses in a day.
TS.4 Remain detached, unexcited, clear headed: Follow value, not price.
TS.5 Understand the markets and patterns, be aware of structures such as short covering rallies.
TS.6 Develop a Market Strategy prior to making trading decisions.
TS.7 Usually does not trade the first hour after open.
TS.8 Trades single contracts.
Consequences of the trader's preferences:
Needs general understanding of Auction Market Theory and market structures.
Primary market traded: emini SP, since volatility in the regular SP is over $500 (averaged $955, last 3 months).
Requires information on yesterday Market Profile/Meta-Profile for value (value area).
Requires information on market condition to set entry strategy for current day (if balance, needs limits, if trending,
needs direction).
Within day information on congestion will guide exits.
The Day's Market Strategy
In this example, market analysis will start with the close of May 3, 2002 for
trading on Monday, May 6.
Analysis will use the regular SP because volume data at price exists for it,
but not for the emini.
CISCO Trader Control Package (TCP) provides information on market condition
and other reference points on an end-of-day basis.
TCP data (reference points) for the close of May 3 shows:
Data is from CISCO Futures Visual Graphic Report (Part of TCP).
1) 5 day market is in balance. Upper limit = 108900, Lower limit = 106400,
risk = 312 ($780).
2) Volatility is 421 ($1052). Average (90 day) volatility is 382 ($955).
3) Value area is 107600 to 107080, with a center at 107250.
4) 1st hour's trading is 96% of the days range.
5) Volume is 109704 vs previous day (May 2) of 108051. 90 day average
volume is 114558.
6) Commercial traders capped the top at 108300, in the first half hour of
trading. Same for May 2 and 1.
Reference points 1) through 6) are all characteristic of a balanced market.
Market Strategy for a day-trader on as of close May 3 for Monday, May 6:
The three regions of interest: inside the balance, outside the balance
and the value area limits.
Inside a balance, price rotates, with the center (107650) being the focal point.
Price too far from the center will return. Price near the center could go
either way with equal probability.
Market activity inside the balance (108900 - 106400) should be traded as if
the balance is permanent. That is, wait until price nears a limit (10890 -
108590 or 106400 - 106720) and then look to sell if near the top, buy
near the bottom.
Trading outside the balance infers a breakout. It is an alert for the start
of a trend.
At the breakout, strategy changes from expecting price to rotate back to the
center of balance, to seeking evidence for start of trend. Now the strategy
is to look only for long trades on upside breakouts and shorts for the downside.
Value areas are a one-day piece of information for the day trader.
Price above or below the value area is an alert for a change in demand.
Modest changes in demand occur most days, even in markets in balance.
These changes often offer trading opportunities for day traders.
In this case the upper value area price is 107600, quite near
the center of the five day balance.
Lower value area is 107080, below the center, but still a distance
from the lower balance limit of 106400.
In addition to the three trading regimes, tradeability should be considered.
That is, does this market offer opportunity commensurate with the risk of
trading it? The one-market trader tends to ignore the question.
Still, with any market there are times it should be avoided; in particular if
it is too risky or if it
offers too little opportunity. Two rule of thumb risk evaluation methods are
the volatility (vs past
volatilities) and exchange margin requirements. Volatility jumps are easy to
understand, but exchange margins?
Exchanges need to protect the contract, to insure that those who trade can
pay the price of losing. A raised
exchange margin is a straightforward sign of increased risk. More
scientifically, CISCO's Advice Engine
research programs evaluate opportunity, risk and risk to opportunity.
The Advice Engine studies are explained
on the CISCO website. They show that the SP is highly tradeable.
Elements of Market Strategy
MS.1 Uptrend mode. Look only for longs above 108900, trade on pullbacks.
MS.2 Downtrend mode. Look only for shorts below 106400, trade on pullbacks.
MS.3 Trading inside the balance:
Below 10672 look for upturns (trading a balance). Below 106400 switch to downtrend mode.
Above 108588 look for downturns (trading a balance). Above 108900 switch uptrend mode.
MS.4 Maintain a preference for the downside, since commercials capped three days in a row.
MS.5 Value area trading: Long above 107600, short below 107080. No trading in between (in value).
MS.6 Directional alert upon breakout of 1st hour range on May 3.
MS.7 Measure congestion threshold by 3 TPO's on the price line.
MS.8 Tradeability and opportunity is adequate.
MS.9 Volatility around $1000
Working Strategy for SP May 6, 2002
WS.1 Meeting criteria TS.1 (enter on trend), map the market data from MS.1, MS.2, Ms.3 and MS.6
Upper Balance Limit 108900
Risk 108580
Balance Center 107650
Upper Value Area 107600
VA Center 107250
Lower Value Area 107080
Risk 106720
Lower Balance Limit 106400
Alert areas for long entry: 108900, 107600 and region 106400 - 106720
Alert areas for short entry: 106400, 107080 and region 108900 - 108580
WS.2 TS.3 specifies maximum risk ($500). MS.9 volatility of about $1000
precludes SP. Switch to emini, UU.
Volatility is now about $200 (1/5 contract size). The trader sets trading
risk at $300, 1.5 times the volatility.
In the emini SP $300 is 600 points.
A single contract is traded with a risk of $300 from entry.
WS.3 TS.2 (low risk markets) is fulfilled by chosing balanced condition and
trading UU instead of SP.
TS.4, TS.5 and TS.6 are supported by the Market Strategy value analysis.
WS.4 TS.5 is fulfilled by trader experience and studies of Auction Market Theory.
WS.5 Following MS.4 gives trader a preference for downside trading.
WS.6 Standing aside the first hour of trading fulfills TS.4 and MS.6.
WS.7 Exit no later than 15 minutes before the close.
The Market of May 6
The first hour of trading defines the Initial Balance. This is the arena
marked out by the professionals as a 'trial balance'. Exchange members
and other professionals like to have a balance within which to trade.
The Initial Balance represents a strong effort to dominate the market.
Mr T stands aside for the first hour. The Initial Balance is 107650 - 106950,
(fifteen minute tick bars in Figure WSF 1.).
His strategy from rule WS.1 suggests a short at the value area lower limit,
107080.
But the lower Initial Balance is 106950. Mr T does not want put on a trend
trade in a balance region. So he modifies his value area short side entry to
a sell below 106950, say at 106925.
He will still take a long at the upper value area
limit 107600. Otherwise, his strategy WS.1 through WS.6 is unchanged.
Referring to figure WSF 1., the value area upper limit of 107600 is touched in
the 9:45 to 10:0 time frame, but there is no breakout.
The next two hours are spent within the Initial Balance. In the 12:15 to 12:30
period Mr T gets his short at 106925. He places a stop at 107525 ($300 risk).
The stop is never threatened. Mr T keeps watching for signs of congestion, a
bunching of TPOs. Figure WSF 2. is a Meta-Profile of May 6. After the entry
at 106925 the market spirals down. There are never more than two TPOs at
any price--so no congestion.
On the way down, at 14:00 to 14:15 the lower balance limit is breached at 106375
(one tick below 106400). This is another selling opportunity for Mr T.
Following rule WS.7, Mr T exits at 15:00 at a price of 105250. Results before
costs and slip:
Trade 1 in short at 106925, out at 105250: gain 1675
Trade 2 in short at 106375, out at 105250: gain 1125
Disclaimer: This theoretical trade is an example to illustrate the auction
market approach to trading. There is no Mr T and this is a paper trading
example. Data used herein is from sources deemed reliable.
8:30: 0 107275 107550 106950 107500 1478
8:45: 0 107500 107650 107350 107375 1376
9: 0: 0 107350 107475 107000 107175 1281
9:15: 0 107225 107550 107125 107425 976
9:30: 0 107425 107575 107250 107475 807
9:45: 0 107450 107600 107325 107425 820
10: 0: 0 107350 107550 107300 107400 537
10:15: 0 107450 107500 107175 107250 502
10:30: 0 107150 107400 107100 107325 594
10:45: 0 107400 107400 107025 107175 481
11: 0: 0 107175 107300 107075 107200 454
11:15: 0 107250 107275 107025 107200 466
11:30: 0 107175 107200 106975 107025 376
11:45: 0 107100 107200 107025 107100 297
12: 0: 0 107100 107250 107075 107200 286
12:15: 0 107250 107325 106825 106875 735
12:30: 0 106875 106950 106675 106700 972
12:45: 0 106775 106850 106600 106775 668
13: 0: 0 106775 106800 106575 106725 825
13:15: 0 106750 106750 106550 106650 519
13:30: 0 106525 106675 106425 106500 832
13:45: 0 106525 106575 106400 106550 639
14: 0: 0 106500 106575 106125 106400 874
14:15: 0 106275 106425 105825 105925 1313
14:30: 0 105975 106025 105600 105675 1104
14:45: 0 105675 105675 105200 105250 1400
15: 0: 0 105250 105300 105000 105150 1090
Figure WSF 1. 15 Minute Tick bars SP emini May 6, 2002
UU DEL-MO/YR 06 02 MO/DY/YR 05 06 02
OPEN,CLOSE 107250 105175
HIGH,LOW 107650 105000
# Ticks 21834
META-PROFILE REPORT FOR 05 06 02
AND SEGMENTED AUCTION
COMMODITY -- Mini S&P 500 (CME-IOM)JUN 02
Price Brackets Segmented Auction
107650 B B
107625 B B
107600 BD B |D | | |
107575 BD B |D | | |
107550 BCDE |B C |D |E | | | | |
107525 BCDE |B |C |D |E | | | | |
107500 BCDE |B |C |D |E | | | | | |
107475 BCDE |B |C |D |E | | | | | | |
107450 BCDE |B |C |D |E | | | | | | | |
107425 BCDE |B |C |D |E | | | | | | | | |
107400 BCDEF |B |C |D |E |F | | | | | | | | |
107375 BCDEF |B |C |D |E |F | | | | | | | | |
107350 BCDEF |B |C |D |E |F | | | | | | | | |
107325 BCDEFI |B |C |D |E |F | | |I | | | | | |
107300 BCDEFGI >B >C >D >E >F >G > |I | | | | | |
107275 BCDEFGI |B |C |D |E |F |G | |I | | | | | |
107250 BCDEFGI |B |C |D |E |F |G | >I | | | | | |
107225 BCEFGI |B |C | |E |F |G | |I | | | | | |
107200 BCEFGHI |B |C | |E |F |G |H |I | | | | | |
107175 BCEFGHI |B |C E |F |G |H |I > > > > > >
107150 BCFGHI |B |C F |G |H |I | | | | | |
107125 BCFGHI |B |C F |G |H |I | | | | | |
107100 BCFGHI |B |C F |G |H |I | | | | | |
107075 BCFGHI |B C F G |H |I | | | | | |
107050 BCFGHI B C F G |H |I | | | | | |
107025 BCFGHI B C F G |H |I | | | | | |
107000 BCHI B C H I | | | | | |
106975 BHI B H I | | |
106950 BIJ B I J | | |
106925 IJ I J | | | <= Short
106900 IJ I J | | | Value Area
106875 IJ I J | | |
106850 IJ I J | | |
106825 IJ I J | | |
106800 JK J K | | |
106775 JK J K | |
106750 JK J K | |
106725 JK J K | |
106700 JK J K | |
106675 JKL J K L | |
106650 JKL J K L | |
106625 JKL J K L | |
106600 JKL J K L | |
106575 KLM K L M | |
106550 KLM K L M |
106525 LM L M |
106500 LM L M |
106475 LM L M |
106450 LM L M
106425 LM L M
106400 LM L M
106375 M M <= Short
106350 M M Balance limit
106325 M M
106300 M M
106275 M M
106250 M M
106225 M M
106200 M M
106175 M M
106150 M M
106125 M M
106100 M M
106075 M M
106050 M M
106025 MN M N
106000 MN M N
105975 MN M N
105950 MN M N
105925 MN M N
105900 MN M N
105875 MN M N
105850 MN M N
105825 MN M N
105800 N N
105775 N N
105750 N N
105725 N N
105700 N N
105675 N N
105650 N N
105625 N N
105600 N N
105575 N N
105550 N N
105525 N N
105500 N N
105475 N N
105450 N N
105425 N N
105400 N N
105375 N N
105350 N N
105325 N N
105300 NP N P
105275 NP N P
105250 NP N P <= Exit
105225 NP N P 15 min
105200 NP N P to close
105175 P P
105150 P P
105125 P P
105100 P P
105075 P P
105050 P P
105025 P P
105000 P P
Figure WSF 2. Meta-Profile for SP emini, May 6, 2002.
In my recent articles on auction market analysis (S&C June, July and November,
2002) I gave examples of making trades with value based information.
Implicitly
these were all first chance, breakout trades. One does the analysis,
the market meets the entry criteria and boom, the trade is initiated.
In the real world we sometimes
miss that first chance. Most of us know better than to chase a trade. But, on
occasion, the market offers us a second chance. Recognizing a valid second
chance opportunity is more difficult and takes more market knowledge than entry
on breakout. Second chances can come in a variety of guises, but they have two
general characteristics: the initial breakout comes out of a congesting market
condition and the second chance occurs during a subsequent congestion.
This article takes you through a second chance trade. The second chance
aspect of this trade is an accidental by-product of research on the BuySell
data base (an end-of-day report from the CBOT
with buy-sell statistics for members and the public). I needed a breakout day
in an active market to get a feel for public trading behavior in the few days
prior to breakout. The example chosen, DJ on July 19, 2002, happened to be a
case where the market experienced an overnight breakout. The swing trader who
is active only during floor hours missed the trade.
Missing a trade is a serious matter for a swing trader who is active
in only a single market.
The dynamics of the market limit the number of breakouts--it takes
five days to develop a five day Overlay, subsequently there comes a breakout
and trend for a few hours or days; a new five day Overlay develops and so
forth.
Even in active markets like the Dow Index discussed here, there are relatively
few breakouts per month.
When the market analysis in a missed opportunity strongly supports the value
change, the trader's natural question is "will the market give me a
second chance to get into that trade?".
Second chances are of great interest to day traders too. The day trader
is actively looking for entries all day long. For both day and swing
traders the rules are deceptively simple: get onto a trend as it begins,
as it is just coming out of congestion. Then
exit when the market goes back into congestion. The time frames are
different; swing traders measure exiting congestion in hours or days,
day traders in minutes. Both
swing and day traders agree on entry from breakout. Both will enter on
a second chance when the market offers. After entry the swing trader will
typically rely on a stop or evidence of congestion for exit while the day
trader will micromanage the trade for a short term gain. After exit, the
swing trader is usually done with
that market for the day, but the day trader is looking for another 'second
chance', i.e. for short timeframe congestion and subsequent breakout.
How can you tell if the market is offering you a second chance?
Market knowledge
is the key whether the specific situation is a breakout, as in this study, or
the continuous market that day traders typically follow. You will track value
and market condition as the market revealed them earlier, or as they are
currently developing. The tools for locating value in auction markets
have been presented in my recent
S&C articles. You are assumed to be conversant auction market nomenclature.
This example starts with the Dow Jones Index at the market close of
July 18, 2002. We assume that the trader:
....Swing trades (larger risk, larger expectation than day trading)
....Is active during floor hours only
....Follows breakout trades only
....Always places a stop on entry
....Does not hold indexes overnight
Conditions at the close July 18, 2002
Market is in a 5 day balance
ULIM = 88300 (resistance)
LLIM = 83200 (support)
Meta-Profile
VAU = 86000 (1 day resistance)
VAL = 85060 (1 day support)
Volatility
VTY = 477 AVG = 358
Trade Facilitation
TFF = 4.04 AVG = 3.5
Volume
VOL = 60254 Yest = 77658 AVG = 54000
BuySell Net Public, Difference (B - S)
7/18 = -594, 7/17 = -453, 7/16 = -152, 7/15 = +330
Net last four days: -869
These auction market data provide us the means to analyze the market for
tomorrow. Then we can formulate a strategy based on auction market theory
and data.
Basic Strategy at close of 7/18, with commentary:
Market Condition = 5 Day Balance: ==> Defines value limits
ULIM = 88300
LLIM = 83200
Comment: The market is balanced with resistance at 88300, support at 83200
Range = 5100 ($5,100)
Octant risk = 638 (1/8 of ULIM - LLIM range)
Meta-Profile: Latest day value
VAU = 86000
VAL = 85050
Comment: Meta-Profile value area is within the 5 day resistance/support
Range = 950, nominal octant risk is 119
Volatility 477
Comment: Volatility is some 33% above average, presaging increased market
activity. Higher volatility equates to enhanced trader interest.
Trade Facilitation (TFF)
Comment: Trade facilitation is adequate, there is public participation
TFF is yes or no. Yes means many opportunities are present (wide range).
BuySell Statistics Last Four Days = -869
Comment: Last three days all negative, public is net selling.
The public drives markets out of balance. Here the drive is down.
Evaluation: Market Analysis as of the close, 7/18
Non-directional reference points
Market appears well balanced: Octant risk = $638
Value area range = $950
Trade Facilitaition weighted toward congestion as is
expected in balanced markets.
Volatility at 477 is 33% above the average.
The high volatility may presage
a market condition change.
Volume is higher than normal--even in balance this market is drawing attention.
Volume is lower on the 7/18 than the day before. Ignore this, since the
7/18 volume is still higher than normal.
Directional information: Public has been net selling for the last three days.
This bearish sentiment argues a downside preference.
Strategy as of the close 7/18:
1) Be prepared to go with a breakout long above 88300, risk $638
2) Be prepared to go with a breakout short below 83200, risk $638
3) Short timeframe: go long a breakout above VAU, 86000, risk $119
4) Short timeframe: go short a breakout below VAL, 85050, risk $119
5) Wait for Initial Balance on 7/19 before taking action
6) Directional expectation is down from bearish public net selling
You, the swing trader, see the market open well below your entry point for
a short. Your emotional take is "rats, I missed a potentially profitable
trade". All your evidence points to a confirmation of your analysis. Yes,
you would have been very comfortable with a short position, taken at breakout.
The next analysis point is the end of the Initial Balance hour. This hour is
the professional trader's time. They are less interested in value and value
change than they are in developing a comfortable trading range to operate within.
You are interested in value. Your analysis tells you to be short or out.
Will the Initial Balance price rotation offer you a second chance?
The Initial Balance (approximately 1st hour) range is:
IBU = 82900
IBL = 82100
IB last = 82350
At the completion of the first hour (IB) you collect your information:
1) A downside breakout occurred prior to the opening
2) Your downside preference from BuySell data is confirmed
3) The high volatility action predictor came to pass.
4) The Initial Balance is within a reasonable distance of the lower limit
5) The Initial Balance has closed above it's low
6) This is a downward moving market.
** All your analyses support the weak market theory
General rule: Only seek shorts in downward trending markets.
Reasons to override the "do not chase missed trades rule"
A) Value considerations: The market has recently broken through
the Lower Balance Limit, the Lower Value Area and is currently well
inside the most recent value defined by the Initial Balance.
B) The dollar risk ($850) is reasonable compared to the octant risk
of $636 that one would take in a regular breakout. The excess risk
of $214 is acceptable in view of the market's pattern and consistency,
i.e. items 1 - 6 above.
C) The IB retracement from it's low may merely be an effect of the way
the IB is formed, e.g. the rotational nature of the IB process, not
evidence that value has bottomed at the IB low. If this is true,
the latest price (82350) is a valid entry point, a second chance.
Risk considerations:
1) Entering short at IB last with a stop at IBU is $550 risk.
IBU is a very recent high price set by the floor processes
and may not be a valid value-based trading point.
2) Entering short at IB last with a stop at LLIM is an $850 risk.
LLIM is a longer term definition of value (support) and
price above that would suggest market is moving back into balance.
You do not want to trade directionally in a balance.
3) Octant risk is $636, so IBL stop ($550) is likely too small.
Stop at LLIM ($850) is preferable.
Trading Decision
1) The market is comfirming the reference points because of:
a. Breakout from the balance condition on the downside.
b. Breakout down from the profile Value Area.
c. Volatility predicted market movement, it happened.
d. Market was facilitating trade, not shutting down.
e. Above average volume indicates trader interest.
f. BuySell data shows the pubilc is bearish.
2) Items 1) a - f are all consistent with downside trading.
3) The risk of $850 is some $200 above that for trading at breakout
This is deemed acceptable, since the analysis is so strong
4) The pullback in the Initial Balance is the opportunity
to follow the "shorts only in downward markets" dictum.
5) Enter short at 82350 (market order at 8:15)
6) Set stop at LLIM = 83200
The reader can map out the trade with the help of the 15 minute tick bars
below. Note that the alternate stop at 82900 would have been hit in
the 9:15 - 9:30 period. The trade, as proposed on the basis of Auction
Market Theory, turns out to be a very good one indeed.
Trading always involves a trade-off between risk and reward. In the
current example the reference points were so strong that you would
take the trade on the first 'second chance' opportunity.
If the data were somewhat less supportive, you have another
possibility. After the Initial Balance period is completed
your strategy could be to take your short position only if the
IB broke it's low at 82100. If that does not happen, you have
saved a loss. If it does, you have given up $250 in opportunity
potential and increased your risk stop to $1100 (the $850 from
IB last + the $250 from IB last to the IB low). The weakness in
this argument is that the IB is not strictly based on value, but
somewhat at least, on the non-value based needs of the professionals.
The Next Day (Monday, July 22) for the Swing Trader:
We assume the day trader would have exited sometime during the day,
according to the trading methodology being followed. But what of
the swing trader? A swing trader who only exited on a non-progressive
stop would be in at the close. Analysis of one's trading methodolology
for holding overnight is the subject of our text, Value Based Power
Trading, free on the CISCO website (www.cisco-futures.com).
An assumption at the beginning is that the swing trader does not hold indexes
overnight. The extremly high risk of holding is mirrored by the high
margins required by the exchanges. If the trader exited 15 minutes prior
to close, the exit price of 80000 gives a profit of $2350 before slip and
other costs. Certainly a good result considering the $850 risk accepted.
But it is not the amount of the result that is important. Auction market
analysis allowed you to recognize the second chance. Auction market analysis
let you analyze the market so that you knew you wanted a second chance. So,
even if the trade had been a loser, your reasons for making the trade were
valid.
Further, it was auction market analysis reasoning that set your stop.
Note that had you used the IBU risk of $550 you would have been stopped
out at 82900 in the 9:05 - 9:20 timeframe. In truth, there was no
auction market (value) reason to set the at stop the the IBU point. It is
just attractive because the amount you put on the line is $300 less.
Using the value related stop dodged that bullet.
Recap
Before the open on 7/19 you knew this was a day that held good trading
potential. The market was in balance (congesting). Volume was up,
volatility was up, the market was facilitating
trade and you even had a directional indicator from the net public
selling. You knew exactly where the 'first chance' trading opportunity
was located; at the five day breakout price. The minute the market
opened you knew your 'first chance' was unavailable. Based on your
auction market analysis, you also knew you would like to have a second
chance.
You know the breakout came out of congestion and a second chance will
also come from congestion. If the market offers a second chance you
can immediately find your risk, based on the most recent value, defined
as the lower limit of the Overlay on 7/18. You know this risk will be
higher than in the first chance entry and by how much. You can then
decide to trade or not, based on solid information and your attitude
toward risk.
DOW JONES FUTURE, 15 Minute Tick Bars
July 19, 2002 September contract
7:20: 0 82800 82900 82550 82550 61
7:35: 0 82600 82650 82100 82300 91
7:50: 0 82350 82500 82250 82500 37
8: 5:00 82460 82500 82300 82450 40
8:20:00 82400 82640 82250 82250 108
8:35:00 82300 82700 81850 82300 183
8:50:00 82350 82500 82100 82300 112
9: 5:00 82350 83000 82200 82700 181
9:20:00 82650 82700 82350 82450 151
9:35:00 82400 82450 82050 82200 121
9:50:00 82150 82350 81650 81850 102
10: 5:00 81800 82050 81650 81800 87
10:20:00 81750 81850 81200 81450 131
10:35:00 81500 81550 81100 81250 92
10:50:00 81200 81450 81150 81450 109
11: 5:00 81490 81800 81400 81550 85
11:20:00 81600 81700 81250 81300 66
11:35:00 81350 81500 81100 81300 87
11:50:00 81260 81400 81100 81300 66
12: 5:00 81330 81400 80850 80950 66
12:20:00 81000 81350 80950 81350 60
12:35:00 81400 81850 81300 81650 101
12:50:00 81700 81880 81250 81350 117
13: 5:00 81400 81500 81200 81260 51
13:20:00 81280 81350 81000 81200 65
13:35:00 81210 81210 80600 81000 126
13:50:00 80950 81400 80900 80950 110
14: 5:00 81000 81100 80700 80900 92
14:20:00 80850 81200 80650 80750 103
14:35:00 80700 80700 79850 79850 191
14:50:00 79900 80150 79450 80000 181
15: 5:00 79950 80200 79950 79950 75
Figure WSF 3. Fifteen minute tickbars for DJ, July 19, 2002.
---------------------------------------------------------------
References
CISCO Homepage http://www.cisco-futures.com
Auction Market Theory, at "Whats New"
Trading as a Career, at "Whats New"
"Swing Trader Package" aka "End-of-Day Trader Control Package"
Background
"Advice Engine Package" for 'Opportunity'
'Advice Engine Report'
'Advice Engine Day Trader Report'
Appendix
Theory provides structure and strategy
General structure of markets intra-day
Prices set by negotiation
Daily MP bell shaped
Some prices accepted, some rejected
Members want balance
Initial balance attempts to set day pattern
Commercials capping of markets
Value area
Volatility
Trade facilitation
Demand measured by volume
Trading range
Special situations, e.g. short covering rally
Market structure longer term concepts
Market condition (balance, trend or between)
Market cycle timing/change
Value migration
Volume change
Volitility change
Day-to-day serial correlation lacking
Exchange determined margins
Risk evaluation
Opportunity evaluation
Strategy is initially set by market conditions plus trader orientation.
1) A trader may be day-trade oriented or longer term.
a. Day traders
Can seek very low risk and be satisfied with very low return per trade
Will trade many times per day
Can accept more risk for higher potential returns
Will trade few times per day
b. Swing/overnight traders accept more risk for larger potential returns
1) A daytrader in a balanced market will be selling tops and buying bottoms.
2) The same individual in a trending market enters on pullbacks,
but does not trade against the trend.
Trading Model: Application of theory and data
Trading is profitable only in moving markets.
A model is designed to enter an emerging trend early in the
the beginning of 'distribution' and exit on evidence of
congestion 'accumulation'.
Market condition is the foundation of analysis
Balanced markets, by definition are accumulating.
Trader relies on internal trends (responsive trading)
or breakouts (alert for start of distribution).
Opportunity tends to be smaller, but so is risk.
Trending markets offer larger opportunity at greater risk.
Model development depends on the trader's risk attitude, field
(day or longer term), financial base and emotional structure.
Some daytraders seek two or three ticks per trade and may trade
many times a day. Other daytraders take larger risks for greater
returns and hence, trade much less often. The same is true for
the less risk averse swing or longer term trader.
* Copyright Donald L. Jones, CISCO Futures 2002