Intraday Update - Liquidation Breaks | Archimedes Methodologies

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In life, it is said that you get to choose your friends but not your family. In the markets, I would adjust the axiom just slightly. You get to choose your moments but not your company.

On any given day, we encounter all kinds of investors with differing objectives in the markets. There are the Warren Buffet and institutional types, dug in for the very long term. There are swing traders tuned to a more intermediate-term time frame. As an example, we designed the Navigator Core Strategy for swing trading. There are day, hourly, and even 1-minute time frame traders.

For the most part, day traders are usually the weakest hands in the market. Typically, they are less adept, inexperienced, over-leveraged, and undercapitalized. On a low volume today, such as today, you can usually assume that the only players at the table are the day traders or weak hands. The NYSE volume was only 20% of Friday’s volume this morning and about half as I write this.

So what happens next in these circumstances? Take a look at the red bars on the 5-minute chart below:

Day traders get poorly positioned, a few hedge funds decide to have some fun, and the rest is history. This morning, that led to a 60-point sell-off in the S&P 500 for no discernable reason.

Thus, a Liquidation Break is defined as “a sharp downward break in price that often seems to come out of nowhere and is usually short-lived. It is caused primarily by short term traders whose inventory positions are overly long.” The most recent longs with the poorest trade location usually initiate the sell-off then the vultures sweep in. The market typically recovers quickly, leaving behind a lot of frustrated traders.

The risk of Liquidation Breaks, as I have been identifying in the daily narratives this past week, is another reason why I teach traders to “think” as well as use indicators and rules. This is also why, in most cases, we require a stop to be valid at the “close” rather than intraday.

So now take a look at the daily chart below:

While last the candle is somewhat faint, you see a spike tail with the open and close equal at this writing, but comfortably above our stop we discussed this morning at 3825.50.

So unless the market closes below our stop this afternoon, we stay the course in the core, Navigator strategy. Notably, the market is healthier for the process after a liquidation break.

A.F. Thornton

Intraday Update – Liquidation Breaks