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Market Update Post Fed – Lessons in Price action
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Market Update Post Fed – Lessons in Price action

by ScottMarch 16, 2017

I see an uptrend like the recent one in the indexes and expect to see the reverse happen. This is because recency bias conditions our primitive DNA to expect everything in context with what came just before.

But that doesn’t work with markets. Like with so many things, our hunter gatherer DNA is ill equipped to deal with the modern world.

Burn this into your brains.

The highest probability following any period of smooth, easy to trade, single direction price movement is a period of choppy, two sided, difficult to trade price action. We call this easytime-hardtime, and it is a very good paradigm for viewing the markets.

So we look and see a reversal coming, what is far more likely is for us to have a period of choppy, hard to trade price action like in crude recently.

Al Brooks has this concept, and he has a neat method of dealing with it. When he sees tape he calls “barbed wire” with lots of overlapping bars, few series of directional moves, choppy unpredictable price action, he just stops trading to give it time to sort itself out. Where there is no edge, there is no edge. We see this all the time in our systems, they outperform, and then underperform in maddeningly clustered fashion.

How can we tell that trends are coming to an end? Trends primarily in two ways on any given timeframes. With a bang, and with a whimper. Either 2001, or 2008.

bang whimper

Both of these situations are very different. One has decreasing volatility with an uptick in volatility towards the final phase. The other has increasing volatility to a historic point.

What does this mean in context for the indexes right now? The move since the Trump ascendency clearly is a decreasing volatility melt up. In decreasing vola melt ups technically perfect counter trend setups appear, which don’t work.

This fuels the frustration of the other side, they are sure the market will reverse, but after so many failed attempts at shorting, they don’t have the guts to get long. Until they do. Mostly these trends end when the sideline bulls who “didn’t trust this rally” finally capitulate and get long. This usually happens after a period of historically small candles, or more correctly, unsustainable low volatility.

The evidence here is compelling. We have a low vola melt up, we have a huge spike. We have a choppy fall for 6 trading days and a choppy rally. The market is likely retesting the old highs in anticipation of forming a trading range.

 

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There is a pronounced “vacuum effect” in trading ranges once they become obvious. Why would a short seller get positioned in the middle of a trading range when he knows it will probably retest the highs enabling him to get a better fill?

Short answer – he won’t, he will be standing aside. And short sellers avoid the middle of trading ranges, because they are really really difficult to trade, and you kind of suspect they will get to the highs anyway. So this can have the effect of making one side seem stronger than they really are. That is what happened yesterday in my opinion. In context I still believe the rally is stinky, but we will see more when we reach the old highs.

Take a look in the trading range breakdown off crude. There are a few lessons in this. Trading ranges end SLOWLY. Imagine an epic 12 round prizefight. A trading range is like that, it ends because one side is too weakened to continue, not by one side landing a knockout blow in the first round.

Also, we get clues of buying or selling pressure towards the end of the trading range. When we start to see consecutive runs of 3 or more candles in the one direction, or points where there should be buying activity but isn’t… our spidey sense tingles.

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Back on the system building tomorrow.

Scott

 

 


About The Author
Scott
  • AcoBrasil

    Timely piece. I’m learning a lot from your tape reading experience. Made me look at this week’s action in a different light.

  • Mark Shinnick

    Useful rules of thumb for preservation of financial and mental capital, thanks.

  • Jay Thomas

    Very clear.

  • http://evilspeculator.com Sir Mole III

    How’s my crew? Very quiet here today!

  • http://evilspeculator.com Sir Mole III

    What have you taken away in particular?

  • ZigZag

    That little OPEC rumor pop is having trouble sticking. Options expire today and contract rolls next week so should be some shenanigans.

  • ZigZag

    day after FOMC hangover

  • Ladywandering

    I like your little note on the Zero :)

  • Mark Shinnick

    Short miners, tight stop.

  • http://evilspeculator.com Sir Mole III

    You are the hammer wielding norse god with a fascination of precious metals.

  • Mark Shinnick

    Yeah…3x PM understanding seems more natural to me for some reason.

  • AcoBrasil

    A few points:
    I find it relatively easy to capitulation entry points, but tops confound me.

    I was looking at the several days of sideways action followed by yesterday’s burst higher as a likely continuation of the larger bull trend. Scott’s post really laid out the inherent weakness of the move, which seems to be playing out today.

    I like the use of two blow-off top models (2001 and 2008) to demonstrate how strong and weak volatility patterns play out. What I really like are how both you and Scott explain how the underlying trader emotions are depicted by candles throughout different temporal points in the charts.

    The explanation of ranges is particularly insightful and really nails home the importance of swing traders being extra patient – with entries in particular – when markets get stuck in a range:

    “Trading ranges end SLOWLY. Imagine an epic 12 round prizefight. A trading range is like that, it ends because one side is too weakened to continue, not by one side landing a knockout blow in the first round.”

  • Mark Shinnick

    Its a mental capital drian today (2nd day behavior) so standing aside.

  • Yoda

    I share those points too

  • Scott Phillips

    Tops are difficult to trade by definition. Think about it, you have profit taking the longer a trend goes on at the first sign of weakness. This makes it look like shorts are making a play, but it’s really just longs banking a winner. You have late coming bulls capitulating to the trend, you have top picking bears as well confusing the issue.

    When a nice smooth orderly trend starts “getting weird” you aren’t at the end, but at the “beginning of the end”. For most of us we are better served just noticing this, and standing aside until the cross currents sort themselves out.

  • http://evilspeculator.com Sir Mole III

    I actually like evolving tops – as new context develops you are presented with inflection points which can serve as early entries. I have often used that method to start scaling into early contrarian positions. Doesn’t always work but when it does it pays off handsomely.

  • Yoda
  • Scott Phillips

    Too much thinking there :-) Overcomplication is what we do when we are confused about the price action, and to be honest the price action right now is…. confusing.

    We have two sided price action. The market is rising, but rising is a choppy uninspired fashion. The bears have a chance here. The bulls have a chance.

    Trading ranges are by definition “coin flippy” on a bar to bar basis.

  • Scott Phillips

    Each extra bar gives us more information, exactly. At certain points we can effectively rule out options like you used to do with your “soylents” back in the day.

    I like this also. It is expert level trading though, not for most people.

  • ZigZag

    You’re right – I have no idea which way things are gonna go – I just know there’ll be shenanigans. I pulled my short /cl options strangles two days before the drop because I knew there was a big move coming and had no interest in being on the wrong side of it. Now that oil volatility is back it should be possible to make a little money on the directionless stuff.

  • Scott Phillips

    NEW POST!

  • Scott Phillips

    There are always shenanigans. The idea that the market is somehow more weird than usual on these opex days may or may not be real.

    Until you have quantified the behaviour for yourself (it may be true) you have to assume that your pattern matching brain is just writing a story in your head.

    Our brains literally cannot be trusted about this stuff, none of us. And that includes both Mole and myself. Many times I’ve been sure something was an edge, and found later it was bullshit.