T Tr ra ad di in ng g E Ed du uc ca at ti io on n A Ar rt ti ic cl le es s T Ta ab bl le e o of f C Co on nt te en nt ts s Trading Education Article #1 Protecting Yourself Trading Education Article #2 Structure Trading Education Article #3 Timeframe Tactics Guide: What a difference a Timeframe Makes Trading Education Article #4 Day Timeframe Market Confidence Trading Education Article #5 Knowing What to Look for Trading Education Article #6 Buying and Selling Tails and Trader Development Trading Education Article #7 Initial Balance Trading Education Article #8 Understanding Timeframes Through Example Trading Education Article #9 Understanding the Importance of Two-sided Versus One- sided Trade Trading Education Article #10 Traders and Costco Shoppers Trading Education Article #11 The Auction Process—Incorporating Multiple Observations—All in One Example Trading Education Article #12 Separation and Divorce are Always Difficult Trading Education Article #13 What I Internalized on My Own I Still Use Trading Education Article #14 The Horses are at the Gate and There They Go! Trading Education Article #15 How we View the Market Often Delivers Far Different Perspectives Trading Education Article #16 Does Your Brain Need Defragmenting Trading Education Article #17 A Week of Trading with Jim Part 1 Trading Education Article #18 A Week of Trading with Jim Part 2 Trading Education Article #19 A Week of Trading with Jim Part 3 Trading Education Article #20 References Trading Education Article #21 Keeping the Market Profile in Perspective Trading Education Article #22 Destination trades Trading Education Article #23 Contrasting Symmetry Trading Education Article #24 Day Timeframe Inventory Imbalances Trading Education Article #25 The Learning Process Trading Education Article #26 Stops Trading Education Article #27 A Week of Trading with Jim April 2011 Trading Education Article #28 Reading Structure for Day Timeframe Trading Trading Education Article #29 I Remember When Trading Education Article #30 Resting Orders Trading Education Article #31 A Bad Day in the Life of a Guru Trading Education Article #32 Timeframes: Out of the Abstract Trading Education Article #33 Defense Trading Education Article #34 We Have Met the Enemy and He is Us Trading Education Article #35 The Transition from Bracket to Trend Trading Education Article #36 Trend Days Trading Education Article #37 Where to Get In: A Real-Time Trading Example Trading Education Article #38 Looking Past the Hood Trading Education Article #39 Price Versus Value Trading Education Article #40 Fading Trend Days Trading Education Article #41 Spikes—How to Employ Them in Your Own Trading Trading Education Article #42 If Trading Education Article #43 A Market on the Move Trading Education Article #44 Does the Market Profile Work 45 Trading Landscape – A Recent Example 46 Recap of Dec 2, 2011 Real-time Markets Webinar 47 Understanding How We Really Make Decisions 48 So What Do I Do with This... 49 So What Do I Do with This..Continued 50 Confidence 51 Responsive Trading 52 Odds and Context are Inseparable 53 It’s Too Late I Missed the Trade 54 Circuit Breakers 55 Actionable Nuances from the Pre-Market Updates 56 Shakeout 57 How to Trade a Trend 58 The Fairest Price or POC Migration 59 TPO versus Volume Profiles 60 The Successful Trader’s Mindset 61 At Odds with Market Price 62 & 63 Disappointing Friday; Long Weekend 64 S&P Recap August 24, 2012 65 Poor Highs and Poor Lows and Excessive Buying and Selling Tails 66 Hierarchy of Information 67 Hierarchy of Information Continued 68 Acceptance 69 Taking the Ambiguity Out of Confidence 70 Monitoring for Continuation 1 PROTECTING YOURSELF FROM ME AND ALL OTHERS Successful trading requires that you protect yourself from your own opinions, my opinions, if you are reading our blog, the news services, and anyone else that you may be following. The answer rests in employing market ‐ generated information (MGI): listening to the market versus those referred to above. Quite often we get an opinion riveted into our mind only to see the market doing something entirely different; if you have advanced to the stage of understanding and endorsing MGI yet are unable to act when you clearly see a different opinion expressed by the MGI, you are experiencing cognitive dissonance , the psychological conflict resulting from holding two simultaneous, conflicting thoughts. I never knew a trader who hasn’t constantly had to deal with this issue; the emphasis is ongoing. S&P 500 Dec 2010 as of Thursday, September 23, 2010 for Pre ‐ Market Friday: Let’s make this real and very personal: on Thursday afternoon, Sept 23, 2010, when the S&Ps couldn’t trade and stay above “unchanged”, 1129.60, which is always a day timeframe reference, the market called for a day timeframe short. The market broke and settled below the reference I had previously published (1122.00). But because the POC or fairest price to conduct 2 business remained just slightly below unchanged and did not migrate lower with the price break, the market also called for the day timeframe short to be covered. Our Pre ‐ market blog post on Friday, September 24 th stated that the NASDAQ rally didn’t look complete to the upside while the S&P auction didn’t look completed on the downside; we thought that the better odds for Friday’s S&Ps were for a balancing day. S&P 500 Dec 2010 after Close on Friday, September 24, 2010: As you can see, the market gapped 13 handles higher on the opening; the news stories attributed Friday’s rally to the Durable Goods report. The rally was well under way prior to the news report. The failure of the POC or fairest price to conduct business to migrate lower with price on Thursday alerted us to the possibility of heavy short inventory positions, inventory that was “short in ‐ the ‐ hole”, trader talk for short at bad prices. This is often a setup for a short covering rally. The fairest price to conduct business (POC) on Thursday was substantially higher than Thursday’s close; these late day shorts had very poor trade location—many traders were caught short at poor prices. 3 On the other hand, since the settle was below my reference level at 1122.00, I thought the best case to be made for Friday’s trade was to see the market balance; this was my final opinion to be posted on our blog. Our post also said, “The upper focus is on the market’s ability to trade above and maintain price and value above Thursday’s high; failure to accomplish this keeps the pressure on the downside.” However, I didn’t pay this possible scenario enough respect. On Friday morning, as you watched the overnight trade continue to creep higher with the opening approaching, you should have been on high alert and prepared for, at least, a short covering rally given the traders that got caught ‘short in the hole’ on Thursday’s late downside break. Thursday illustrates one of the more subtle pieces of market ‐ generated information you will deal with. Yet its subtlety also hides it from the majority of traders—an identifiable edge to those traders who do pick up on it. I often say, nuances are important Let’s discuss some of these to understand the subtle market ‐ generated information generated by Thursday’s auction. Below is a split out Profile of the S&P on Thursday, September 23, 2010: We observed eight auctions that stayed around unchanged. The auction did not find acceptance above this day timeframe reference. An important part of trading is 4 recognizing who is dominating in the session: if longer ‐ term money was buying on the move up, the day timeframe reference of unchanged would have been taken out in a shot. The auction rotating around the unchanged level indicated that day timeframe traders were dominating. Wednesday’s ‘b’ shaped Profile indicated liquidation—old business versus new money selling. The laggard longs that had not liquidated on Wednesday were likely getting nervous late Thursday afternoon, as price was unable to probe higher. Day timeframe longs that bought the upside move on Thursday morning were not getting much for staying in their long positions either. As the day wore on and the closing bell approached, these laggard longs and day timeframe longs began to liquidate contributing to the late afternoon break that ended with a close near the lows. This emotional, rapid liquidation break also brought in emotional sellers (weak hands) that got short at poor trade location, as we discussed above. This set up the possibility for a short covering rally. The pieces to the puzzle from Thursday’s auction required independent thinking and a focus on market ‐ generated information. Focusing on price late Thursday afternoon was very misleading. Market Logic: Too often traders make decisions in a vacuum and fail to look at other markets or potential influences. On Friday morning the Dollar Index was at new recent lows and opened about 4 handles lower; this was likely seen as bullish by stock market traders. Whether there is long term data to support this stock market reaction to lower Dollar Index prices is questionable; nonetheless this is what we often see. We are not economists, we are traders. The S&P’s (big contract) gapped higher and failed to back up and fill that gap; the markets said we were out of balance to the upside; MGI quickly told us that prices would auction higher on Friday. This certainly wasn’t what I expected; however, applying MGI allowed traders to get on the trade. 5 S&P December 2010 Big Contract Open September 24, 2010: Market ‐ generated information telegraphed the rally once the market opened and couldn’t fill the gap. Simple right? Yet this market situation on Friday illustrates (once again) the concept of cognitive dissonance. The big downside break on Thursday afternoon followed by an upside gap opening of 13 handles required a huge mental shift in market perspective; a difficult task for most. Yet the market ‐ generated information was there to convey what was happening in the auction. 1 STRUCTURE: THE MARKET PROFILE ® VERSUS A BAR CHART STRUCTURE Bar chart Profile Components: Open High Low Close Components: Open High Low Close Volume at each price Time at each price 2 We start this discussion with a bar chart and the Market Profile graphic side by side to compare a one dimensional versus a two dimensional graphic. In one dimension, the bar chart is not able to show the character of the market; where the majority of business took place, at what prices levels, and for how long. The Profile graphic releases a substantial amount of information to inform the observer of the complexity, as well as the nuances, of the auction process. Market ‐ Generated Information and Structure The Market Profile ® graphic is a time sensitive, evolving database that updates in real ‐ time to reflect the structure of the market’s natural two ‐ way auction process. Market ‐ generated information (MGI) is the byproduct of the natural two ‐ way auction process and it is conveyed through the Profile graphic. Structure is revealed through the market ‐ generated information and provides us a composite view. It is much more than individual data points; it graphically conveys complex information that allows us to see timeframe participation, inventory, completion (or lack thereof), emotional trading, as well as the nuances reflected over various timeframe perspectives. The Profile graphic equally conveys day timeframe structure to enable a trader to formulate a tactical plan inside the day. Similar to the broader perspective, it allows a composite view, and in this light, may prove even more helpful to protect a day timeframe trader from being mesmerized by price. Day timeframe information is relevant to all traders when you consider that everyone is day timeframe trader the day they enter or exit the market. Our objective in this article is to discuss structure through various examples so that those interested to learn more can get a feel for what structure conveys. It is not linear with several reference points listed on a sheet. Because it is a composite, we can draw on the power of the human mind to see several data points in context and get a sense for what is transpiring. After all, the market is where buyers and sellers come together to engage in two ‐ sided trade; people, not numbers, transacting as the auction unfolds over the day, multiple days, weeks, months, and years. Structure enables us to view confidence, emotion, strength, and weakness, along with the more mechanical components, to understand the various participants and the virtually infinite motivations that move the markets. INTERNALIZING THE IMPORTANCE OF STRUCTURE— The best way to begin to appreciate the importance of structure and how you can employ it is through example; let’s begin with day timeframe structure. In a future educational article we will show how you can carry day timeframe structure forward and apply it to longer ‐ term perspective and longer ‐ term trades. 3 AN ALMOST PERFECT DAY Collapsed Extended Chart 1: Treasury bonds September 13, 2010 The Profile on the left represents a relatively strong, healthy day timeframe auction; on the right is the same Profile with each 30 minute time period split out, which allows you a clearer perspective of how the day developed. You see from the expanded Profile that the market auctioned higher, balanced for five periods then departed the balanced range to auction higher again, and then balance again into the close. TREASURY BONDS SEPT 13, 2010 4 There are no perfect standards; however, this Profile will represent our standard for reviewing further examples. Next, let’s go to the opposite extreme and show a very weak two ‐ way auction with no conviction or completion in either direction in an attempt to identify the range of observations. Chart 2: S&P September 24, 2010 REFERENCE— Our example is actually going to be the following day; however, nothing happens in a vacuum; there is a serial relationship between days just as there in a string of Christmas trees lights. It this example we are just using the last two lights; however, the entire series is important. S&P 500 (Large contract) December 2010 SEPT 24, 2010 5 1. Our Profile on the left and the “Almost Perfect Day” Profile we showed to begin with have one thing in common: they both record a market attempting to auction higher. We are always trying to assess what a market is trying to accomplish followed by asking, “What grade would we assign to the effort?” If we assigned a B+ to our 1 st Treasury bond example, the last example might receive a gentleman’s C. The odds of upside continuation are much lower in our 2 nd S&P Profile example. The fatness, reading from left to right, allows us to see how much time was spent at each price level; the widest area represents the fairest price at which business was being conducted, or the point of control (POC). The more prominent the point of control (POC) or fairest price at which business was being conducted, the more volume it will likely require for the point of control to migrate to another sustainable level. 6 2. The daily auction doesn’t look to be complete; when an auction is over, price should drop away quickly. It spent three ½ hour periods here. 3. Review this profile; you should notice that it lacks any symmetry. This statement becomes clearer as your experience with viewing Profiles expands. The lower portion has no symmetry with the upper portion. Over time, the continual two ‐ way auction process, very often, completes the symmetry. 4. Just as we commented about the top of the S&P Sept 24 th profile not appearing to be completed, the same comment is now is applied to the S&P Sept 27 th profile next to it. 5. The market has attempted to auction lower and selling has dried up; it is likely that the market has gotten too short, in the day timeframe, to go any lower. The uncompleted previous high also indicated that the market had gotten too long in the day timeframe to go any higher (these are other concepts that you will explore as you continue your education). Often, markets have to “break before they can rally” or “rally before they can break”; this is how inventory is adjusted. 6. The rally that begins in J period and terminates in L period completes the auction from the previous day, much like a baseball game that was suspended because of rain. You will hear us refer to this as “repair”. Now that there is a completion of the upward auction, our focus should return to the uncompleted lower auction. Remember, markets are continually developing through a natural two ‐ way auction process. 7. The downward auction is completed. Again, this would be considered “repair”. Understanding the complex information visible through the market’s structure allows traders to begin to migrate away from price ‐ based thinking and trading, to move to a more complete appreciation of the continual two ‐ way auction process and the continually unfolding opportunities. Remember, price is simply an advertising opportunity, structure allows us to put price in perspective. 7 On the morning of September 29 th 2010 our blog post identified the trend line in the chart above as our short ‐ term, downside reference; let’s review the Profile from the early morning ‘pit’ session of September 29th to determine the information delivered by the market structure as recorded via the Market Profile®. 8 1. The same trend line shown on the bar chart and the reference we identified in our blog. 2. An uncompleted auction; caution, this is just one data point. Notice the substantial difference between this uncompleted auction and those in our last example, adding another time period to the low would have delivered exponential information. Exponential information, as it used here, simply refers to a rapid increase in importance, a two wide low is not twice as likely to fail as a single print low but multiple times more likely, a three print low is, again, many multiples more likely than a two wide low to fail. 3. The third auction period saw the market auction down and through the trend line; a simple price ‐ based view witnessed the trend line being broken. A structural auction view saw quite different information; the probe below the trend line was quickly rejected and the auction accelerated more than $5 dollars higher over the next three days. 4. We likely would have never projected the magnitude of the auction; however, by identifying the beginning of the auction you are now in a position to monitor for upside continuation with excellent trade location. Structure—not price—contained the most important information. 9 RECAP: The study of structure and timeframes is a lifelong process; however, as a sign says as I enter my health club reads, “A year from now you will be glad you started today”. We provided two extremes to give you a base to illustrate the concept of structure. However, it should be noted that structure is internalized over time, through various observations, as you watch the markets every day and accumulate experience. Do not be hard on yourself as you assimilate these concepts into your market understanding; it is one thing to be introduced to something but quite another to learn it and make it a part of your thinking and your developing market perspective. There is a common thread among the comments from our clients from both the very experienced to those just starting to trade: you cannot hear or see this information enough. This was a driving factor in our decision to create a video. Not only do I feel like the visual medium is the most powerful way to learn the markets, but it also avails a trader the opportunity to review the material as many times as it takes to internalize the various concepts that I employ in my trading. Structure is not linear; it requires context and an understanding of the bigger picture. Yet the rewards of leveraging it in your trading, I believe, far outweigh the effort. Recognize and identify structure, think about what it conveys in the broader perspective. As Benjamin Hoff states in The Tao of Pooh , “much learning does not create understanding”. Structure will help you understand the composite puzzle of the market ‐ generated information pieces and graphically conveys the broader dynamics of the two ‐ way auction process. 1 WHAT A DIFFERENCE A TIMEFRAME MAKES Timeframes Tactics Guide When trading begins to operate beyond the parameters examined in these examples you will begin to sense longer timeframe involvement. Successful traders continually readjust their strategy and tactics depending upon timeframe involvement. Timeframe Trading Behavior: Determining who is dominating in the market on any given day and understanding how their participation will affect the auction process is crucial in determining one’s trading strategy and tactical implementation. For this article we have combined scalpers, day traders, and short-term traders into a single group and classified intermediate and long-term traders into the second group. The three most important aspects to trading are: 1. Understanding the markets natural two-way auction process and organizing that information so that you can interpret it to trade effectively 2. Understanding the auction’s different timeframe participants and each of their traits and behaviors 3. Controlling and employing your emotions in a productive manner. [to trade successfully] The dilemma of learning complex information: The whole is too complex to learn without understanding each of the pieces, and each of the pieces can’t be fully learned and understood without understanding their context within the whole. This is the same issue that scientists continually wrestle with. The global warming analysis is a prime example albeit on a much broader timeline. Scientists must understand recent and current temperature excursions since they started recording this data; yet they must put these observations in context with long term climate changes that have occurred prior to science even recording such information. A note about conflicting information: What is not directly conveyed in the above point but is equally important to traders is that there will always be an element of uncertainty when our analysis is completed. This is probably one reason why many traders continually dissect information, attempting to ‘figure it all out’ before completing their analysis or, executing a trade. As humans we have a propensity to seek certainty; however as traders, accepting uncertainty is a fundamental necessity . To quote Karl Popper as he is cited in The Black Swan by Nassim Nicholas Taleb,”... uncertainty is our discipline, and..understanding how to act under conditions of incomplete information is the highest and most urgent human pursuit.” We highly suggest reading this book listed on our Suggested Reading list. The basic timeframe descriptions are recapped below. Chapter Three of Markets in Profile deals more in depth with the broader topic and the Field of Vision video takes timeframe analysis even deeper as several differing live market examples illustrate this concept. Timeframes: Market activity is influenced by a wide variety of participants operating under a wide 2 variety of timeframes and motivations. The way each of these participants combines and employs information is different. For learning purposes we have segregated the markets into 5 timeframes: 1. Scalpers are very short-term oriented, trades being completed possibly in seconds; they rely primarily on intuition and order flow. Today most scalping is done via computer. 2. Day traders come to market each day flat (no position) and leave the day flat. Their behavior is very short-term and often emotional. They depend almost exclusively on market-generated information because fundamental information is too slow and cumbersome; fundamental information can actually be counterintuitive for the day trading process. 3. Short-term traders’ timeframe is usually 3-5 days or slightly longer under the right contextual conditions. They supplement market-generated information with an awareness of recent fundamental information and the effects this can cause on market movement. They love to trade from the top to the bottom (or bottom to the top) of multiple-day trading ranges—5 to 10 days is ideal 4. Intermediate-term traders’ timeframe covers weeks or months of market activity; they rely on a blanched mix of fundamental and market-generated information. This timeframe prefers to trade from the top to the bottom or vice versa of large trading ranges or balance. When the intermediate-term traders begin to dominate a market, their behavior is aggressive. While they tend to dominate markets far less frequently than the short-term timeframe discussed above, when they are dominant they are usually very aggressive and move the market substantially. Shorter-timeframe traders who are unaware of their entry into the market often suffer substantial losses. 5. Long-term investors/traders may hold positions for months or even years; they are far more attached to the securities and investments they own. They tend to follow fundamental information first, followed by market valuation, and finally market-generated information to supplement their understanding of market activity. When they become dominant, markets can move out of the more traditional contained ranges of the other timeframes. They move markets; and when they do, the other timeframes “pile on”. LEARNING BY EXAMPLE We have chosen Friday October 8, 2010 for our example. The monthly Jobs report, which is often the most important economic report, was released and showed very poor labor conditions. This would normally be expected to create volatility and interest among all of the timeframes. Let’s review the S&P’s on October 8 th in segments: 3 1. Opening— The opening immediately begins to prepare us for tactical trading; is the market in or out of balance. On this day it is in balance; opportunities are likely small unless the market immediately auctions out of balance. Openings are important references for day and short-term traders. 2. The initial auction is up leaving a “local top”. Local top is a carryover term form the old days when floor locals played a more important part in the market. Local tops provided evidence that the floor traders were dominating the market; longer timeframes were absent. The locals could have their way with the market. Now we refer to this non excess high or low (meaning no buying or selling tail) as a poor or unsecured high or low, which communicates that day or short-term traders are in control. These traders are unlikely to