A Week of Trading with Jim Part 2
Last week we talked about Jim’s landscape approach and the broad perspective this affords him. Here I want to share how I watched Jim employ the human element in his analysis, part of how he develops a ‘feel’ for the market. This perspective is fascinating to me. Not only does it reveal much different information than a strictly technical approach but equally important, it allows us to engage our minds more fully. It enables us to internalize the auction process and gain a more intuitive understanding. There are a lot of moving parts in formulating our analysis and market perspective; incorporating this viewpoint helps us bring them all together.
Jim says trading is a game. There are little games that are played throughout the session and it is advantageous to figure out what the current game is. For example, sometimes the game is to run the stops at the prior pit session high or low or the overnight high or low; the stops are run and the market rotates back down (or up). “Game over, side out,” Jim says. Then we look to see what the next game is. We were ready to publish this article when Jim called to say, “Game playing is more prevalent when the day and short-term traders are dominating the market; the intermediate and longer-term timeframes may even see these games as noise.”
This is more reinforcement of the need to understand timeframes—our competitors in the game. Jim explained that each timeframe plays differently; the short timeframe is more openly competing with us; their play is more direct and intense, somewhat like a tennis volley. The longer timeframe competes much differently but their effect is real; when they are in the market the whole game changes.
Even though I’ve seen Jim’s writings and heard him talk about this many times, I was still caught off guard when he’d say, “Look at this, they’re going for the gap”, or “they’re trying to take out the high” or “Look, it went to exactly halfback” or “the momentum traders are in here”. He found it almost entertaining, as if he was watching some sporting event. It was somewhat transparent to me. I only saw it once he pointed it out. Jim has internalized the game perspective so deeply that as he is viewing price it almost jumps out at him. It takes years to incorporate all the facets of trading and it is not my wish to discourage anyone (including myself). Yet I can’t help but share it because I see how helpful it is to view the auction as a game—not the numbers, the technical data, the Profile necessarily. Just figuring out the game that is being played and cranking it in to add depth to our understanding.
An interesting insight I had after watching Jim trade over the week: I realize that oftentimes we are so busy focusing on ourselves—how we are feeling, if we should put the trade on, or perhaps if we should exit if we are in a trade. Obviously these are necessary considerations but I see how Jim is equally cognizant of his competitors, constantly aware of who—what timeframe—is in the pit session, what their inventory position is likely to be, and how are they feeling as a result. This concept is discussed in Mind over Markets and Markets in Profile; we’re not breaking any new ground here. But I hope to bring it to life so we can more deeply understand how to employ it in our own trading. The following example is from the first trading day of the year, Monday, January 3, 2011:
January 3, 2011: Composite Profiles as several 30 minute periods print
The pit session gapped five plus handles higher to take out the 2010 high. Exuberance started the session and continued. But we did not see elongation; there were no additional longer timeframes in this market taking it higher. There was considerable news coming out throughout the week with the biggest employment number of the month being released on Friday. The longer timeframes were not in this market with size.
The predominant players were the shorter timeframe. If you understood this you could envision what may be happening; the day timeframe inventory was getting excessively long as more traders bought; but the market wasn’t going higher. They could not take out the E period high. It was interesting to me that Jim commented when F period started to print and didn’t take out the E high, he simply said, “They didn’t take the high.” It was as if he could see there, from thousands of hours of observation, that this was significant. Jim doesn’t talk too much as he trades but the comment at the time struck me funny. It’s hard to explain it. As I mentioned last week, Jim often points out that what didn’t happen is often more important than what did occur.
As the day wore on Jim was considering his competitors; they are short-term and likely need to go home flat (remember to think time of day to supplement your analysis). Their inventory is long as evidenced by the Profile shape. Many have bought and they are not getting much for it. Every tick down and every tick that does not go up makes them question their position. The closing bell is imminent and they are hoping against hope for the move up. Jim said to me, “Can you feel them hanging on by their fingernails? Picture someone on the edge of a cliff. What is it going to take to knock them off?”
Each tick down brings in a new sell order, which brings the market lower and brings in more sell orders. The long liquidation break follows. It stutter-stepped an hour or so—remember the diffusion model and the laggards—there was still time before the bell, they hadn’t thrown in the towel just yet. I was hesitant to short this market because it was a considerable gap and everyone seemed to be buying. We have been taught to be very careful of fading a gap, correct? We’ve learned that the market gapped up—it is out of balance to the upside, higher value is clearly evident. Yet as day traders or short-term traders the contextual conditions in the day timeframe presented us with a solid trade.
This example highlights how important it is to keep our analysis in the present tense; I saw Jim do this repeatedly over the days. Did we open out of a balance? Yes. Did Jim have his trading plan prepared for a breakout and a large opportunity day? Yes. But he was fine tuning his pre-market analysis with the most current information and the most up to date information was telling him we are not seeing elongation. Jim had also recorded the anomaly circled. Recognizing your competitor, what their inventory position likely is, how they are feeling as price drips lower, along with the time of day, will give you an edge that, in my opinion, surpasses an indicator or mechanical trading method.
One observation before we move on: Jim was visualizing this scenario a couple of hours before the break—he was not predicting it but it was a possibility that he was aware of in his developing market outlook. Using his imagination he was keyed in to market-generated information that might give him further clues, what he might do, and where he may put a trade on if he felt his analysis and the odds warranted it. We will talk about visualizing—being forward looking—a little later in the article but it is worth noting here. I saw how helpful this was to Jim putting on a solid trade. Visualization and imagination is not a widely discussed topic but I don’t think its value to a trader can be overstated.
When I first started learning this concept in May 2009 Jim may as well have been speaking Chinese. Even if I could grasp its ambiguous nature I had not the slightest idea how I would implement it in my trading. Over time however I see how actionable and important this consideration is in trade decision-making. Jim says that considering the odds is a necessary component to career longevity. In Linda Raschke’s webinar on January 12, 2011, Jim talked about the liquidating break from long overnight inventory that took place in the E-mini S&P while we were trading together during the first week of the year on January 6, 2011:
Jim’s preparation and thought process:
1. Prior pit session high
2. Overnight inventory is long
3. Jim shorts the failure to find acceptance above the prior pit session high. Prices cannot even come close to the overnight high; the tempo slowed and there was low conviction going up.
This is an asymmetric opportunity; trade location is excellent—we will know we are wrong very quickly to exit with minimal risk—if it moves out of balance against us we exit with a small loss. Yet the potential profit is much greater. As day traders, Jim says this is a trade we almost have to do, namely because of the asymmetric opportunity.
4. The liquidation break
5. As Jim is in his short he notes the anomaly. Jim explained that this anomaly suggests hesitation—that the decline lacks conviction and the odds for continuation are decreased. The hesitation is picked up in the structure—we had a four wide anomaly with the long single prints down. I realize this explanation may be obscure to some but the more you recognize anomalies and think of how they affect the odds in context with your observations of the auction, the more you will internalize your recognition of them and understand how to use them in your trade decision making.
6. Jim exits as he recognizes the “take your breath away” push down for what it is—a liquidation break of overnight inventory that reflects panic selling. In previous discussions Jim has stated that this is the trade that misleads the most number of traders. Jim says the question for us to address is: is there simply liquidation or a combination of liquidation and new money selling? The answer is contextual; if you have previously predetermined that inventory is long you are already aware of the possibility of it simply being a liquidation break. Another analogy I’ve heard Jim use is, “trading is a lot like playing blackjack with a single deck; what has been played before has a lot to say about the odds of winning the current hand that has been dealt to you.”
7. We see that prices traded inside the established range the remainder of the session.
At the time Jim covered his short he said to me, “The market may go lower; sometimes it happens and you leave something on the table. But the odds are that this move will not see follow through” (given the contextual conditions of this particular market scenario). “Over a sample size of 100…500 trades, executing this type of trade consistently should increase your bottom line.”
I wanted to stay in the trade but I was watching price; I was not thinking about odds or much else. Big price moves do that to traders. It is tempting to want to go for the home run, and it can be easy to justify in our minds when we see prices break so hard. I have often watched Jim exit while I stay in a similar trade only to give up points and profits; the market often moves very quickly off these lows (or highs) and profit is greatly reduced as you try to exit at a much poorer price. It is worth noting that this style of trading drains emotional capital as well. We only have so much emotional capital in a trading day; this style of execution is a waste of energy. I have grown in my understanding of odds based trading but it is still not fully internalized in me. If it were, it would not be pushed aside so readily as I decide to follow price.
Jim had visualized the potential of the liquidation break as he was developing his perspective. Jim says that as we gain accumulated experience we begin to expand our ability to visualize. This is an edge that doesn’t come from a technical approach nonetheless it is tangible. The research of behavioral finance has found that most traders form their view of what they believe will happen going forward based on what they have seen happen in the most recent past. To separate ourselves from our competition and be one of the estimated 5-10% who have successful long term trading careers we would do well to diverge from the crowd in this area. I see how Jim is continually imagining what may happen and what the Profile may look like when the next auction starts to print. In doing so, when something unexpected happens, he is not caught flat footed, scrambling. He has already envisioned—imagined—the possibility and formulated an idea of what he may decide to do. I see how looking out at the horizon also helps keep him calm and contain his emotions.
Anomalies are market-generated information that help us determine the odds. The chart showing the January 6th liquidation break earlier illustrates how Jim sometimes uses anomalies to determine his willingness to stay in a trade, take a trade, or remain flat. Notice the anomaly of four wide circled in green. As the price was breaking, Jim was cranking this anomaly into his analysis, the odds of continuation, and his subsequent decision to exit. This four wide anomaly with the single prints break increased the odds of prices finding their way back up to this level and the body of the Profile. As we often hear Jim say, “Nuances are important.” The anomaly, in this case, is an alert that the market is struggling to go lower. If there was a good combination of new money shorts being placed along with liquidation the odds are that the decline would have been smoother.
Jim mentioned other anomalies that provide input into the handicapping: for example, declining volume as an auction continues, not enough elongation—the ‘b’ and ‘p’ formation, and too much elongation—everything happened too fast and the market is too stretched out.
Please go back and look at the first chart from January 3, 2011 of the E-mini S&P. Do you see the anomaly and how this affected the odds of upside continuation? It doesn’t always work out so neatly but they are worth recording as you watch the auction.
When we are present to what is, we are right up front with the expansion of time, but when we make a mistake and get frozen in what was, a layer of detachment builds. Time goes on and we stop.
—The Art of Learning, Josh Waitzkin
Traders who have worked with Jim have heard him say, “There is what we want to happen, what we need to happen, and what the market is telling us.” As the Profile develops and the session unfolds we need to constantly readjust our analysis—our perspective. This can be particularly difficult when we are in a trade; we get stubborn or choose to focus on evidence that supports our trade position or market outlook while we may subconsciously disregard information that may be telling us something different. One thing that struck me as I watched Jim trade was how fluid and adaptive he was. See the E-mini S&P chart below from January 5, 2011:
1. Price is trading up with little conviction.
2. Anomaly below is noted as we watch. We are thinking prices may rotate lower. I want to short the high—I don’t want to miss the party. Jim is patient like a predator waiting for the right moment to pounce. He is focused like one too.
3. Next auction prints—a new anomaly develops higher; Jim’s perspective changes. My mind has become fixated on what was. I want the market to go down and think it will—based on my earlier observations. My mental flexibility is compromised. I have now (subconsciously) shifted to gut feel, intuition; I have ceased taking in the market-generated information objectively.
As you can see the market closed near the highs. Our initial sentiment that the market may rotate down needed to be adjusted as the day went on. I watched Jim go with the flow and change his perspective. In hindsight it doesn’t sound so difficult; in the moment I was unable to do this. I am not proud to say that I could not shake my short bias for most of the session. “Me, stubborn? I have an open mind.”…Yeh right. The consequences of this day were marginal but I think we can all agree that on a different type of day this mental lapse could cause some serious pain.
This may sound minor but think about your trades—trades you took, trades you passed on, or when your positions did not work out as planned. You may find that sometimes your flexibility was pushed aside and “gut feel” took precedence. Jim says that sometimes gut feel works but more often it tends to mislead us. There are times when our gut is right; however it can cause us to get overanxious and take the trade early rather than exercise patience and await the auction’s completion.
As Jim was reviewing my article he called to tell me how well he felt I expressed the idea of “want to” or “need to” happen. Jim said that the “need to happen” mental error captures an extremely high percentage of his trading losses. He has a loss—whether a prior loss or in a current position—and he needs the market to bail him out; Jim said that objectivity is gone once this thought goes through his mind.
The first and third examples illustrate the thoughts I wanted to share but it is fitting that they are also two similar Profiles with two different outcomes. Our first example from January 3, 2011 broke lower after no elongation while the last chart example with a similar market situation from January 5, 2011 did not break lower. There were differences we explained, namely the anomaly, but still, they were subtle. Welcome to the reality of trading. We realize it would be comforting to provide neat and tidy examples that made each scenario seem straightforward and easy to understand. But in some way this would be a disservice and only serve to discourage as you found yourself in yet another unique market situation wondering if it is you and you ‘just can’t get it’. Nothing could be further from the truth.
Like so many others, as a retail trader I have read and researched much over the years looking for a system, method or approach that I could execute consistently to a profitable end. But I, like so many other fellow traders, realize that this is a ruse. The observations and insights I have shared I believe refute the whole idea. The good news is that if we can grasp the true nature of trading and do the work we have the potential to separate ourselves and have a shot at a profitable trading career.
How many of us have tried to use systems, indicators and even Jim’s concepts for that matter without bringing in all the factors, and were cast into poor, or less than ideal trading decisions. It can be frustrating to be faced with constantly different market scenarios but the reality is no two situations are alike. The value of Jim’s approach is that it enables us to understand our market observations with a contextual backdrop; this gives us the potential to develop a depth that builds on itself over time. Even using Jim’s approach we get caught focusing on one data point or one concept that we find after the fact we weighted too heavily. There is no silver bullet, no holy grail on which to build a trading career. It is our hope that we can convey the real path to trading success and provide the support that enables traders to excel in the intensely competitive world of trading.
Next week—I will continue with Jim’s ideas and share what I learned about stops, nuances, and other observations that I hope will benefit you in your evolution as a trader.
I will continue to share what I learned about stops, nuances, and some other observations that I hope will add value to your trading education.
Next week—I will continue to share Jim’s thoughts about stops, nuances, and other observations that can benefit you in your evolution as a “Field of Vision” trader.