You’ve got to strike when the moment is right without thinking

I took a few decent setups this week – I shorted the gap up in European equities on Wednesday but only took 25% of what it offered, getting shaken out at the first sign of strength.

I looked at the range for yesterday. I watched another setups pass me by and I did not trade it and I did not worry. I have a few reasons to trade smaller than usual at present:

1. The supposed light volume in December – not sure this really happened, same with the Santa Rally (more on that below)
2. ES contract rollover confusion and data equalization.
3. ECB interest rate decision.
4. Eurozone news driven market rumours causing market schizophrenia.
5. Today is Friday and a huge move yesterday has to be digested. Maybe something or nothing will happen but I do not want to be stuck in front of the computer at 9pm.

Having said that I did trade small every day this week. Yesterday was pure insanity. It was a test to see if the plate spinning could continue and bring the market to 1300. It crashed down to earth as hopes of a resolution to the EU crisis dissolved.

I took a screenshot of what happened:

I can only say that yesterday reminded me of the day QE2 was announced last year (EURUSD 1 minute chart):

Now. To try to piece together what happened with the “santa claus rally”:

This chart from Rob‘s definition shows Breakdown Volume – (definition from linnsoft):

Volume can be broken down based on either of two methods: – Ask Traded vs Bid Trade Volume – Volume that trades at the ask price is considered buy volume, while volume that trades at the bid is considered sell volume.

It can be seen that the delta did increase from near the 1145 level. (My data is equalised for the front month so this is 1150 on the December Contract).

It increased gradually but it can be seen that sellers were growing stronger and hitting the bids more than buyers were lifting the offers from 1/12 to 7/12. Clearly there is hindsight bias with this but to me it was an important sign of underlying weakness. Long term delta is something I will watch for more carefully in future. Unfortunately I did not use this to to inform any trades I made. I had my doubts about the price being this high but it has proven dangerous to short the market lately so I remained on the sidelines most of the time.

I remembered this sort of analysis when I was re-reading an old book about volume spread analysis by Tom Williams. The name is kind of paranoid conspiracy stuff but it is nothing of the sort. A download pdf is available at therogueinvestor.com

It is a must read to try to give some structure to what you are seeing and if you are trying to trade using volume profiling. It was this book that first confirmed what I needed to see in order to have any chance at trading. At the time I had been using tick data as a proxy for volume data while learning to trade using EURUSD.

There is a summary of some of the phrases on traderslaboratory.

1. Volume is activity. Hence tick volume can be used where actual contract volume is not available.

2. Two ways of looking at volume:
* relative volume: volume in relation to the previous bar or bars.
* actual volume: the amount (size) of volume an individual bar represents.

3. Strength comes in on down-bars and weakness comes in on up-bars.

4. Markets do not like high volume up bars with wide spreads? Why because there is a possibility of Professional Selling into such a bar.

5. Professional Money deals in large amounts and thus sells into up bars so as not to be hurt by their own selling. The converse would also be true.

6. 85% of a volume histogram represents Smart Money activity.

7. Smart Money is active on all time frames. Various time frames are used to hide their actions from those that can read a chart and each other.

Title of the post is from the lyrics of Pink Floyd’s dogs. It is a grim enough song but some of the lyrics remind me of trading.

You’ve got to be crazy, you gotta have a real need
You gotta sleep on your toes when you’re on the street
You’ve got to be able to pick out the easy meat with your eyes closed
Then moving in silently, down wind and out of sight
You’ve got to strike when the moment is right without thinking

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2 thoughts on “You’ve got to strike when the moment is right without thinking

  1. Hey Toast!

    Good post. I have some remarks:

    “The supposed light volume in December – not sure this really happened, same with the Santa Rally (more on that below)”. You said it yourself, and I don’t believe this either. The daily ranges this month are very impressive and certainly above “normal” ranges for december. Also, we know for a fact that volume is highly correlated with range. So, logic says that volume should be above average, too.

    The problem with thess “rules” regarding volume (and all els for that matter” that they totally neglect market realities. On a more general note, I think at least 70% of volume related comments on the internet and in the textbooks are completete and utter nonsense. I think that volume is the single most misunderstood aspect of trading. For example, the floor is littered with corpses of people who kept shorting the historical rally in 2009 because it was on “light volume”, just because the stupid amateur books said that a move on low volume is not sustainable. Most of the people who write these books have no idea either, they just copy this stuff from each other, I guess.

    I like your quote below: “Strength comes in on down-bars and weakness comes in on up-bars.” I agree with this completely. In my experience, leaving context aside, generally an up bar on high volume shows weakness and vice versa. Having said that, you also have the quote about professional money selling into strenght. Personally, I am not a fan of the numeours interpretations on the web which include “professional” or “smart money”. Maybe I just don’t get it but for me these are simply (admittedly catchy) presumpions without actual quantifiable or any other proof. For example, I always read things like: “Smart money is selling to dumb money”. Sounds good and somehow plausible, but is that so? Because if it is, this would mean that this dumb money actually can respond adequately to the selling volume that smart money is throwing at them and at least maintain the price levels for some time without collapsing immediately. Let’s take futures for example. In my head I see all the dentists and lawyers come in after work and gambling away, buying from the hedgefunds or prop guys, 1 contract each, but it just does not makes sense. By far most of the daily volume on the exchanges is created by professional traders (prop guys, hedgers and funds), not the 1 contract guys who sit there scared and clueless. So who exactly is the dumb money? The prop guys? The funds? I have yet to see an explanation to this. The other quote ” 85% of a volume histogram represents Smart Money activity” is another good example of what I mean. If 85% is smart money, would that not mean that they are mostly trading with each other? Maybe I just don’t get it but this does not make sense.

    In my own studies, I prefer simply to think in terms of supply and demand, and I don’t care who creates it. This is absolutely sufficient to explain the phenomenon of weakness on upbars and strenght on downbars. A year ago, when I studied this, I posted this image from TOS which I was using then http://twitpic.com/2rjssn. This is essentially it. High volume means change in the supply/demand ratio and a *potential* change in trend, however you define trend. When used in structural context as provided by the volume profile, this is a powerful tool. It all starts with the fact that the price is going up, which in itself shows that demand is prevailing. However, more often than not, high volume (= high supply) will remove the demand and make price reverse. For how long, and what to do with this information, is a totally different matter.

    Finally, I absolutely agree with the first part of the first quote: “Volume is activity”. Without going into detail, this is the whole basis of my volume profiling approach and also the reason why in my opinion time (as used in TPO based charts) is absolutely redundant, and Dalton’s approach is anachronistic. However, I don’t like the the second part “Hence tick volume can be used where actual contract volume is not available.” The problem with this that if we agree that volume = activity and ticks =/= volume then ticks =/= activity. In ther, less nerdy, words, especially as value traders we use volume (or lack thereof) to recognize value. Ticks can not give us this information. They give us information about how often a price traded but without volume this information is not very helpful. I am not saying that tick chats are useless, I just dont’t agree with the the claim that they be a substitute for volume charts when latter are not available.

    Anyway, these are my 2 or (20 cents) – Eurocents of course, as we are all saved now by Merkozy!

    Have a great weekend!

    Benko

    • wow, that is a huge comment Benko.

      I love your observation about smart money and dumb money, lol. Clearly the hedge funds that are going out of business should be called smart money but are they. The brokerages who take commission are the smart ones. House wins!

      When I said “It was this book that first confirmed what I needed to see in order to have any chance at trading” – I meant that I needed to see volume as ticks were meaningless on their own. As a result I had no idea if a move was real or not without volume confirmation.

      Regarding relative volume, It is easy to look at volume today vs volume yesterday or volume opening hour vs volume yesterday opening hour. If it is higher today the problem is that you have no idea how much higher it can go…

      I cannot take credit for the quotes – they are from the website I mentioned (the same website has a section on market profile also). I would like to hear your thoughts on the Volume Spread Analysis book if you find some time to read it. It was the second time I read it – the first time was in the Spring and I think it is a great resource to help understand what is happening when the market is at extremes.

      Ich wuenche dir auch ein tolles Wochenende

      Toast

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