How to Trade the Market’s Edges Like Exchange Members

Markets will often trend, pause and then trend again as the buying/selling ebbs and flows in the markets. In general markets trend about 25% of the time. If a trader chooses to specialize in one market and only wants to trade that market when it is trending he will greatly limit his profit potential. If a trader is going to maximize the market’s profit potential he will have to learn to trade when the market is in a bracket which is roughly 75% of the time.

While the greatest potential for profit will often come when markets are trending, most of time markets are in consolidation or in a bracket. For traders who know how to work the market’s edges when in a bracket or range, the profit opportunities are greatly increased. It’s easier to trade ranges when one knows that a market will trade within them 75% of the time and that the opportunities are at the edges of the market’s bracket.

Back when trading was conducted by open outcry and on the exchange floors the locals had the all the advantages. They knew exactly where the market was, the strength of the bid and offer and which market element was dominating the current trading. This knowledge gave the locals a trading advantage not seen since the floors closed. Electronic trading has permanently changed the game: no one can know the size of the bid and offer with any degree of certainty anymore. One cannot get long or short instantly, when the market goes from bid to offer and back to bid again, as the locals of old once could.

How can one trade profitably when the market transitions into a bracket? Trading the market’s structure from the outside in and the timing of such are the requirements needed to work the bracket effectively over time. Timing the trades at potential turning points in combination with superior trade location can make bracket trading as profitable as trend trading.

The price levels that offer the trader an advantage come from the market’s structure: selling above value/buying below value, low volume numbers – chart highs/lows, pivot highs/lows, 1st and 2nd standard deviations, value area highs/lows (VAH/VAL) and high volume numbers (Mode/VWAP). The trader’s objective is to enter the market at its edges (support/resistance) when the market turns.

How does one know when the buying/selling is about to stop? The key comes from auction market theory. Markets go up until it is too expensive to buy and down until it is too cheap to sell. With the right software you can read when the buying or selling decelerates or stops enough to reverse the market. The squares, diamonds (above or below the separate bars) and relative buying or selling from Pane #2 (bar Volume Delta) show when the buying or selling is stopping or has reversed. If you enter the market at support or resistance from the structure, when the buying or selling is drying up, you have an advantage similar to that of the locals of yesterday.

In the example below, the stage was set with a market high on Wednesday February 13th of 1522 (not shown). Two days later, as the trading activity approached 1522 on Friday, February 15th (see following chart) would the market breakout or would 1522 hold and the market turn lower? If the buying took out 1522 the market could resume its recent uptrend. If 1522 held as resistance the market could enter a bracket and or even reverse.

On February 15th the market rallied to 1521.75 within 30 minutes after the open; at this level the volume and buying abruptly stopped. The market was at the 2nd Deviation, a tick inside the recent high. The 2nd bar that touched 1521.75 narrowed, indicating lower volume or less buying interest at this level. The two bars that set the high had pink squares on top signaling that the buying had stopped. When the 2nd bar at 1521.75 held the market reversed and traded down to 1518.25, the VWAP (Green Line). The selling then stopped as indicated by the blue squares and the market reversed and then traded back to the Value Area High- VAH (Yellow Line) at 1521. The buying once again dried up as indicated by the pink squares, the market reversed and traded through the VWAP to the VAL (Yellow Line at 1517). The selling stopped as indicated by the blue squares, the market paused and then began to trade around the high volume number at 1517.50.

3/16/2012

The trade setup for the bracketed trade was the retest of the market’s high at 1522 on Wednesday February 13, 2013. If it held the market should move into a bracket and/or trade lower. When the market reached 1521.75 the software showed that the market was at the 2nd Deviation (a potential turning point) above the VAH, that the trading volume was decreasing (bar was narrower) and that the buying (pink squares) had dried up. Conditions were right for the market to reverse. And it did – the market traded back to the high volume number at 1517/1517.50.

To recap the trade the market was approaching resistance at 1522 and if it held the market would transition into a bracketed market or reverse. All of the ingredients necessary for a successful trade were in place. The trader that acted on these two setups (when the buying stopped, caught the market’s edge) would have had the opportunity to book one or two profitable trades by trading from the market’s edge back to the high volume numbers or value.

As previously discussed, markets generally trade within brackets (ranges) 75% of the time. Identifying markets that observe a range can add to one’s bottom line. You might just discover that you like trading bracketed markets better than trending markets because you know when to enter and exit the market.

–> Part 5 of Charles’s Series | –> Part 7 of Charles’s Series

For more from Charles including daily market commentary updates, please visit Cochran Nannis Futures Trading. You can also contact Charles with direct questions regarding his approach.