NOTE: Jim's S&P Report for Monday, May 22, 2017 is available for download at the end of this post.
Interpreting market-generated information is the foundation of J Dalton Trading. Short-term traders were temporarily right during Wednesday’s selloff and systematically wrong. Our Recap and Preparation Report for Thursday, May 18, which is part of the current Mastery Series education for traders, delivered the following cautionary statement Wednesday evening:
“I have an upward bias because of the low volume, mechanical upper references and the failure of the POC to migrate lower than it did.”
That prescience sentence was followed by Friday’s sharp recovery. The economists Daniel Kahneman and Amos Tversky, two of the brightest stars in behavioral economics, helped me understand the mistakes people make. What was most eye-opening was that these mistakes are predictable and systematic.
The simplest trading approach, and by far the most employed, is price-based, momentum trading. Traders who ignore this approach place themselves in harm’s way. Similarly, price-based, momentum traders who fail to recognize the extremes to which momentum players pile on taking this approach to extremes, can’t conceive of the financial danger they are exposed to.
Recap and Preparation Report for Wednesday, May 17. The report, which was distributed on the evening of May 16 for Wednesday, May 17 stated;
“EXCESS HIGH For the first time [since April 26th] we have and all-time high established during pit session trade.” Excess is one of the two most important factors we deal with. Excess marks the end of one auction and the beginning of a new auction. This statement wasn’t calling for Wednesday’s break; however, it identified the possibility.
Wednesday, May 17 trade Let’s review the market-generated information that began to expose the potential for momentum traders being in the process of taking prices too low. When emotions are involved, risk can be greatly underestimated, particularly if you can’t conceive of being wrong or don’t even know how to assess risk.
In the following graphic, we are viewing the Market Profile for Wednesday, May 17. The market gapped sharply lower, rallied slightly, then sold off for the remainder of A, B and C periods. Before we proceed, let’s take a minute to reflect on what a market often does following a large gap opening. We often see a trend day that elongates throughout the session. The elongation results from constant wave-like selling. On Wednesday, you notice that (see circled area) there are five 30-minute highs clustered close together. Finally, the market streaks lower for I, J and K periods.
The exactness of the five circled highs suggested that selling was not widespread but rather the actions of price-based, momentum traders selling on intraday rallies. In other words, there didn’t appear to be institutional-based selling or selling by “sticky” money. We refer to this as “sticky” money because these sellers stick with their positions for extended periods of time. Longer-term, larger sellers do not sell at such exacting levels. Their size is simply too big. If longer-term sellers were dominating the auction it is unlikely prices would rally this many times; we would see a more elongated Market Profile that didn’t print more than 5- or 6-wide.
POC The POC or point of control represents the fairest price at which bids and offers are being distributed through the session. In a more normal trend day to the downside, the POC constantly migrates lower with price. This suggests that lower prices are constantly attracting new sellers. In the following graphic, you see that the POC finally begins to migrate lower; however, the lateness of the migration along with the failure to migrate lower throughout the session is the second alert that the market might not be as weak as price would indicate.
The final alert was that overall NYSE volume was not supportive of the magnitude of the decline. Successive 30 minute periods probing lower were met with lessening NYSE volume.
The perceptive trader The perceptive trader knows what questions to ask and what information to seek. The perceptive trader also appreciates that timing counts, fully understanding that price-based traders can quickly move markets to extreme inventory conditions. The perceptive trader can fully participate alongside price-based traders as prices are being herded to extremes. Yet this trader with market perspective can fade (go against them) when they are exhausted. The key is being trained to know what to look for. In the above example, the market reversed a good portion of Wednesday’s loss by Friday’s close. This was not unexpected.
Download Jim Dalton’s S&P Recap and Preparation Report for Monday, May 22, 2017 here.