Epilogue 8/24/2021

Epilogue 8/24/2021

We started the day at the top of the daily channel, circled in the daily chart of the S&P 500 Futures above. We are at the target unless we are ready to stack a channel on top of this one, perhaps in a blow-off top. I cannot exclude the latter as a possibility. But I think it was reasonable to expect the market to stall today after three trend days. A stall usually manifests as a trading range of some kind. I pointed that out as my bias in the Pre-Market Outlook.

My day trading strategy is based on reversion to the mean. In trading a 5-minute chart, I am always focused on the mean, which I define to be the 21-period EMA line. As well, I also monitor the mean on the daily, hourly, and 15-minute charts. When the price is above the mean on all time frames, those are your best long trades, and you have your bullish bias. When the opposite is true, your best short trades materialize.

But keeping it simple and just sticking to the regular session 5-minute chart, I plan nearly everything around that mean. I have to decide if we will have a trend day, trading range day, or combination each day. Most days are trading range days or some combination.

Where does the mean fit in? On an uptrend day, you initiate long trades at or near the mean. On a downtrend day, you initiate short trades at or near the mean. On most range days, the mean cuts right through the center of the action.

I also like to run a VWAP with standard deviation bands (the VWAP will also serve as the mean) on range days. I like to short at the upper bands and cover at the mean. I like to go long at the lower bands and sell at the mean. You can try to trade from one outer band to the other, but the probabilities of success diminish.

You can also use a volume/market profile and trade the value area high and low on range days. So there are many tools to help you trade a range day once you decide that it has been presented. I also remind traders to plot the open. Range days often trade around the open and revisit the open in the afternoon. Sometimes it is a good proxy for the center of the range, but not always.

So here is how today looked pre-market, at the most basic level:

So what jumps off the page? Today has not started, but I see that the market was in a trading range at the close yesterday. We closed near the mean, though slightly below it. In a sense, the mean is the center of price action that will act as a magnet all day. Another way to look at it is that it is in balance if the market is in a trading range.

The next thing I want to know is what happened overnight and how we will open in relationship to it. That could affect the open.

You see my comments every morning. I don’t give a lot of credence to low-volume, overnight trading. It is not real. Recall that the S&P 500 index is the composite of 500 individual stocks that are trading individually. They don’t trade overnight. So overnight futures index trading is a proxy at best, sometimes impacted by an early morning economic report, perhaps after-hours or pre-market earnings reports, and maybe even a global event. But the action is not sacrosanct by any means. Many a day session will completely ignore what happened overnight.

I simply want to know whether overnight trading is net long or short as the market-makers and traders might take profits at the open. Also, if there is a gap, that might result in an imbalance until the market finds equilibrium again. That is really it.

As you will see from the chart above this morning, we were still in yesterday’s afternoon trading range overnight, with a brief look above the range (also a new all-time high). All I want to do is mark the Globex high and low, yesterday’s high and low, and where the market opens in the regular session. I turn the overnight data off at that point.

While the chart below shows today’s price action, before that even occurred, I projected yesterday afternoon’s trading range based on yesterday’s high and low, as well as the Globex high and low, and now I had my reference points. Due to overnight trading being somewhat calm, and given that we had three trend days in a row, my bias started with expecting a range day. Also, the price was back at the top of the daily trading channel, so I did not see anywhere for the price to go up this morning (see my comments and the first chart above).

The stock market is a continuous auction. That means that prices are always trying to find the level that attracts the most two-sided trading. We call that the point of control. But the market conducts that search in a particular way. It moves to the previous day’s high and low and the overnight high and low (on the futures) to find the path of least resistance. So as price moves away from the mean in either direction, it tests these levels. If the range is going to expand (trend), then the market conquers the level and moves on. If not, the price heads back in the other direction in the same testing process.

Today, we already had a trading range established yesterday (Monday) afternoon. So with all the information above, here is how the day went:

First, the market wedged into the top of the trading range. The wedge was tight and spikey, which is difficult to trade. Those are the telltale signs of limit order traders and increases the likelihood of a trading range day. The wedge reversing just above yesterday’s high was a heads up, but the good short came on the double top breakdown. Rule #1 for shorting a potential range day, make sure you are in the upper 1/3 of the projected range. We were.

The implications from this first run higher were that the market could not find acceptance above yesterday’s high, much less get up to the Globex high. Those are signs of weakness and increases the likelihood of a trip in the other direction. Rarely does the market not take out one of either end of the Globex range on a given day.

The green shaded areas mark the mini-ranges, and then the measured moves on the breakdown or break up from the range. Wedges have their own rules and measured moves, but they frequently appear in day trading. So the target for the first short was the measured move from the range breakdown. Also, it was a test of the base of the morning rising wedge.

Then, we had a micro wedge into the measured move low. So that is where you want to cover your shorts and, if mentally capable, go long. Rule #1, don’t go long on a range day unless you are in the lower 1/3 of the range. We were. Sometimes, it isn’t easy to work on both sides of the market. It is all about what works for you.

Also, wedges and micro-wedges often morph into head and shoulders reversal patterns, and that was the case here. The right shoulder came right in to test a break above the mean. That is also a good place to go long or add to longs. From there, we saw a micro, small pullback bull channel up to the measured move, also the top of the range, and a test of the morning highs. Sitting still on your long trade was the best strategy. Sell at the measured move.

From there, the market almost duplicated the morning lower high, double top reversal. But we knew something else too. Where was the open? What does the market like to do in the afternoon on a range day? It likes to return to the open.

Knowing this, there was a good short from the break below the mean. Rule #1, I was in the top 1/3 of the range, so the short was valid. I covered at the measured move and open, but the price actually went a bit lower. As I repeat often, I don’t like to be in positions during the last 30 minutes into the close, with few exceptions.

Stops are always placed a few ticks above your reversal bar. You can move them to lock in your profits in a variety of different ways. It is somewhat personal, but you are mindful of the range of the bars to your left. Larger range bars and more volatility require wider stops.

Also, note from the charts above that the NYSE open cut right through the center of the range all day. That was the battle. Would there be a red bear or green bull bar for the day? This is based on whether we closed above or below the open.

As mentioned above and as a sign of weakness, the market could not reach the Globex high today. But it could not reach the Globex low or yesterday’s low either. So the market remained rangebound all day, confirming that neither the bulls nor bears had control, and the auction price was just about right at the open for this range today.

Tomorrow, the process begins anew. But we are still at the top of that channel on the daily chart. We could wind around that line higher at a slow pace, almost like a trading range with a slight upward tilt. We saw a lot of this in June and July. Or we blow through the top channel line to form a new, steeper channel that matches the earlier pace of the market before March of this year. I drew that upper line in the first chart above.

Did I forget to mention, we could also take our raft over the waterfall? That is an unpleasant thought. I would rather have a double top into a much wider trading range on the daily chart. But there are many warning signs that the possibility of a sharp decline, perhaps a visit to the 200-day line around 4025, is real.

It does not line up with the cycle data. That would cuddle price at the July 19th low of 4225 or so – posited as the 18-month cycle low. But that might be wrong, and the 18-month low could still be ahead of us.

You know what they say, “decisions, decisions. I say, “one day at a time.”

Maybe the Fed announcements after Jackson Hole Friday will have some influence. I will also check in with my spirit guide. I hope for no nightmares tonight.

We shall see.

A.F. Thornton?

AF Thornton

Website: https://tradingarchimedes.com

A.F. "Arthur" Thornton is an expert in logic, risk/reward quantification, market fractals, pattern recognition and asset class behavioral analysis with 34 years devoted to developing algorithmic and quantitative trading systems. In addition to trading his own capital, Mr. Thornton designs custom algorithmic and quantitative trading systems for a small and exclusive group of exceptionally qualified traders.

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