Whilst it might seem like the blindingly obvious after the event, identifying a trend day as it happens isn’t always as straight forwards as we’d like it to be. But being able to spot trend days early is so important that it could be added to the list of Day Trading Rules. Perhaps the rule would be better described as looking for signs of trend days.
I don’t have a decent statistic to hand, but the fact is that markets tend to trend far less often than not. If you couple this together with trading a mean-reverting market such as the ES, it’s not too difficult to envisage a situation where you are slow to react to a change in the type of activity. If you have strong control of your risk, not spotting a trend day early can be a painful exercise. If you don’t, it can be deadly. It is therefore, very important to be able to recognize the signs early on in a session.
In the beginning…
The thing is, markets don’t tend to randomly start trending. There’s usually something that catalyzes a large repricing. Frequently what you might see happen is that a technical formation coincides with news. So for example, you might see some sort of reversal pattern leading up to a trend day or you might have identified a tightly balanced ranging market that is ready to make a move.
If you combine technicals with a news event, what you get is a market that’s primed for a persistent directional move. So if there’s some major overnight news or pre-market economic figures released, a market such as the ES has the chance to trend when the primary session opens and it’ll likely start to do so fairly swiftly on open if it’s going to be a trend day. Understanding this allows you to be ready for the possibility of a trend day. You’re not assuming it will happen – you’re just aware of the elevated potential for one.
The Cumulative Delta
When big long-term players enter the market (such as banks and funds), the volume delta has to move. Volume delta is the volume transacted at the offer minus the volume transacted at the bid. The more aggressive participant tends to do their business at market and not queue with limit orders – large aggressive players have little reason to worry about a tick or two.
In an uptrend there is more demand than supply and vice versa in a downtrend. So there is competition for prices and inevitably volume delta tends to be directional at the same time as price is directional. If there isn’t delta participation in a trend, then there’s a chance the move will stall.
Higher highs, higher lows
It’s not complicated when you think about it in the cold light of day, but if a market is trending you will probably see directionality in the extremes of each rotation. Simply put, in a downtrend you tend to see lower lows and lower highs and vice versa for an uptrend. Many charting platforms have indicators to label prices for you just in case you forget this.
You also must consider what the level of counter direction activity is and whether it is in line with reversal activity or falls within the bounds of a standard rotation. Relatively small moves against the direction of the perceived trend are what you’d want to see if you were hoping for a continuation. If you see a large counter-trend rotation, something may have changed.
A trending market shouldn’t really need to spend too much time trading in one place before it moves onto the next. If it does, it’s possible that it’s beginning to lose steam. It doesn’t have to be extending the move 100% of the time, but within a certain tempo of the trend, it should continue to put in higher highs for an uptrend or lower lows for a downtrend, without dawdling too much.
The IB (Initial Balance) is the first hour of the primary session. Generally there’s a lot of activity within the IB – especially in a product like the ES. If a trend day is likely to be in the process of forming, then you should see an extension of the IB and not just a big move in the first hour. It may well get to and beyond the 100% extension and it should pretty easily penetrate the 38.2% extension level.
What you’re really trying to see with all of these measures is a persistence of directional activity.
Signs of it being over
“A trend is your friend, except when it’s about to end” goes the saying and failing to recognize that the trend is over can be just as costly as missing the fact that it has begun. Pausing for an extended period of time or a large and heavy volume delta counter-rotation are a couple of early warning signs that a directional move is beginning to falter. Another is a quick rejection of an important price level.
But really, the signs of a trend being over are basically the opposite of what you’re checking for in order to see that it’s started. But it’s very easy in the heat of the moment to not see what’s in front of you.
How to spot trend days early
Sometimes you just “know” something is likely to happen. Conditions are ripe for a sell-off or a rally. What materializes however, may or may not be what you think is going to happen. So you have to read the market as it unfolds. Otherwise, instead of getting run over by a trend day you will get destroyed fighting for one that never appears.
Many traders get to a stage where they do reasonably well on a good proportion of trading sessions only to be stymied by a handful of large losing days. There may be other situations where this can happen, but a reasonable percentage are likely to occur when a market trends. Recognize a trend day as it’s happening and instead of taking a hit to your account equity, profit off a large move.
For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.