Wednesday 9 January 2013
Here is how we use the markets to find trades:
Developing activity is the best and most reliable source for understanding what the market is doing. The information it provides can also lead to an edge in taking a position, long or short. Natural Gas provided a classic example of how reading the developing market activity can lead to a trading opportunity. The market always
advertises set-ups. It is a matter of constantly searching for them. We should also add that opportunities develop in all markets and over all time frames, regardless of the underlying futures. As always, a chart is a chart
This is what caught our attention, as of 4 January. Price had previously found support in Aug-Sep 2012, noted by extending a horizontal line to the right. On 2 January, there was a sharp break to the downside, on increased volume, as price left behind a small trading range. The down draft did penetrate the lower support line, but by the close there was a recovery to close mid-range the bar, indicating there were buyers present on the lower portion of that day's trade. There was a two-day recovery attempt, immediately following, adding credence for that area as potential support.
The lines drawn between the swing highs and lows, starting at the October high, tell us that the trend is down, and any position should be from the short side, to be in harmony with the market.
If you look at the high of the wide-range bar, it was where the acceleration lower began. Whenever you see such a bar, with increased volume, it usually carries some significance. Observing the smaller ranges on the rally attempt, we knew if the market were to retest the high of that wide-range bar, the range were smaller and volume decreased, sellers would defend that high, and a short position would be indicated.
Here, the market is letting us know of a potential trade in advance of the event. All we need to do is find confirmation that the market would fail at that level, once again. There is no need to guess, no need of moving averages, RSI, MACD, etc, etc. Rather, the informative facts are generated by the market is all that is needed.
We also know that buyers entered the market just under support, causing the close at just above the mid-point of the bar. We cannot know ahead of time if it is simply short-covering, new buying, or a combination. That wide range can possibly form another small trading range, something of which we cannot be certain, in advance, but the potential is noted.
This is the chart we presented the day of the short recommendation. You can see the start of the acceleration lower on 2 January, left side of the chart. We said that sellers would defend that high on a retest. Note how much lower volume is on the retest date of the 7th, right-hand side of the chart.
What we needed to see to confirm that a short position was warranted would be an intra day price reversal on increased volume. This is what occurred, second bar from the right. Price dropped lower; it was the widest bar of the day, and if you look at the volume bar, volume increased. There was the confirmation to make a trade, right then! a stop is placed above the high of the day. If we are correct in reading developing market activity, price should not rally above the day's high.
We knew we had an edge, a strong likelihood for a profitable trade, and one that entailed a small risk. On the day of the trade, Monday the 7th, this was our comment:
"This is a short-term trade in a down trending market." We had a bias.
Having noted the high volume bar of the 2nd as potential support at the bottom of that range, even though the high was identified as potential resistance, we would be content to take the edge offered and turn it into an immediate profit with little risk exposure.
After entry, when price began to drop quickly, heading for the potential support line, half the position was covered at what turned out to be near the low of the decline, pure coincidence. For the remaining position, we were also aware of the high volume rally bar
of the 4th, noted on the chart. We picked 3.230 as an acceptable
number and threw in an overnight buy order, just in case. The
second half position was covered in early morning trade.
The trade was a success, based on a read of short-term market activity. Price did decline further, to the 3.100 area, as of today. Why be so quick to cover the second half position? An excellent question. We were pre-disposed to a short-term trade from the onset, and that colored our thinking on the exit side.
We cannot address what was not done, only what was done. Yes, the trade left more on the table, as it were. The read at resistance was spot on. The read at potential support was not. It happens. In hindsight, it was possible we would have been stopped out, using
a trailing stop, at a higher level than the 3.230 exit, on a fast rally above prior intra day support that occurred briefly after the second exit, but that is not what happened. An almost $1,500 profit with little risk is a good trade. We deal with what is, and then look for the next opportunity.