- Number of messages : 509
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Date of Entry : 2015-06-28
Year : 35
Residence Country : Russia
on Sat Nov 05, 2016 8:13 pm
THE COUNTER-PARTY TO YOUR TRADE KNOWS MUCH MORE THAN YOU DO
The markets have changed…but they haven’t. Historically, the trading floors of the world’s great stock, futures, bond, options, and forex markets all existed to match buyers with sellers. Today’s trading, or rather the matching of buyers and sellers, no longer occurs in a crowded sweaty trading pit at the Chicago Mercantile Exchange or on the floor of the New York Stock Exchange, it occurs in racks of quietly humming computers in data centers.
THE MORE THINGS CHANGE
“The more things change, the more they become the same.” Jean-Baptiste Alphonse Karr The transition from executions occurring in the pit where traders screamed orders at each other to today’s electronic exchanges which are simply racks and racks of computer servers that are staffed by an army of technicians whose job it is to make sure that the electricity in the data centers are uninterrupted, is the kind of change that Karr was referencing in the first part of his famous quote.
THE MORE THEY STAY THE SAME
Though the laws of supply and demand have remained the same, what fascinates me, is that under the hood of today’s electronic markets are rich sets of order flow data, just waiting to be mined. Under the hood of the market, whether that market is an electronic stock exchange, a crude oil futures trading pit, the real-estate market, the smartphone market, or the restaurant market, there will be good shoppers and bad shoppers.
These good shoppers and bad shoppers are differentiated by the amount of market information they have, and their ability to effectively use this information. There are shoppers who buy the same stuff over and over again. These shoppers become very good at spotting a bargain. These shoppers get very good at knowing when the lines are long and that it is in their best interest to come back a little later.
One distinction between a store and a market is that in a store you buy stuff from the proprietor. In a market, there are multiple people selling the same wares. This allows you to haggle.In a store, you pay the sticker price. In a market, any market, buyers and sellers squeeze each other where they see opportunity to squeeze each other. In the financial markets, retail traders have participated by either investing for the long-term or by trading in the short-term. These retail traders would, frequently unbeknownst to them, be trading against significantly better shoppers - shoppers who knew how to squeeze. We call these shoppers on the other side of your trade, the ‘counter-party’.
HEAD & SHOULDERS | WHY WE TRADE IT
- The Head & Shoulders pattern though very consistent, does not leverage the all of the market information and tools that are available today.
- There are 3 Phases of a Head & Shoulders event. Each phase has its own, known order flow behavior which is documented in detail within this chapter.
- The more that the Head & Shoulders pattern follows the order flow model, the more certainty a trader can have in the ongoing progression of the move.
- The Head & Shoulders model provides the framework for us to take advantage of multiple opportunities.
- Unlike many models, the Head & Shoulders model has maintained is steadiness and prevalence from the early days of yore through to today’s electronic markets.
- The Head & Shoulders pattern provides multiple entry locations. Each entry location has some unique order flow expectations.
- Depending upon a trader’s risk tolerance, experience, capital, and available screen time, some or all of the entry locations can be trades.
THE GOALS OF THIS SECTION IS TO ENABLE YOU TO:
1) KNOW THE PATTERNS & KNOW THE DATA As each phase transpires :
- Right Shoulder, clues found in order flow will provide insights into the likely behavior of the next phase.
2) READILY MONITOR PRICE ACTION & ORDER FLOW IN REAL-TIME
The art and science of 21st Century Tape Reading is the activity of monitoring order flow and its interaction with changes in price while deriving actionable trading insights. By looking at Better Data, you will be exposed to a smorgasbord of insights. Your job, as a Tape Reader, is to interpret the data that will surface. Trader‟s Insight | It‟s All about Context…Price action and order flow must be taken in context with each other.
3) MAKE TRADING DECISIONS BASED ON PRICE ACTION & ORDER FLOW 21st Century Tape Reading of Head & Shoulders patterns is the ongoing process of:
- Reading price action and its concomitant order flow throughout each phase of the Head & Shoulders pattern.
- Proactively anticipating the possible outcomes of the current phase.
- Smartly trading in alignment with the most likely outcomes of each phase.
- ESTABLISHING TERMINOLOGY - HEAD & SHOULDERS:
1. The Left Shoulder
2. The Head
3. The Right Shoulder
- Each phase hasits own unique set of insights
- The Left Shoulder, as the penultimate low sets up the conclusion of the move at the Head.
- The Head, as the Conclusion of the current move, establishes a reversal pattern which plays out by experiencing ending selling, which sets up a state of exhaustion, which creates a temporary vacuum in the order book, this vacuum is eventually filled by new fuel in the opposite direction of the prior move.
- The Right Shoulder takes advantage of this new fuel. Head and Shoulders patterns can be traded on the Long (Buying) side, or the Short (Selling) side. It is not uncommon for Head & Shoulder patterns that provide Long opportunities to be referred to as “Inverted Head & Shoulders” or “Inverse Head & Shoulders” while just “Head & Shoulders” is thought of as a bearish signal for short trades. In this section we will be focusing on long trades and will not be referring to the pattern as Inverse or Inverted, but rather just Head & Shoulders. Though the setups in this section are depicted as Long trades, this approach works equally as well for short trades. When layering order flow over this pattern the percent profitable increases as more concomitant order flow events transpire throughout the lifespan of the pattern.
The most common order flow patterns fall into 3 basic categories:
- Category 1 | Conclusion Buying or Selling - Order Flow Behavioral Traits That Arise at the End of Price Move
- Conclusion (Subcategories)
- Decrementing Rate of Change of Order Flow
- Discrete Surges in Either Buying or Selling
- Late Demand or Supply Panicked Trading When analysis of these 'Conclusion' order flow patterns is integrated with classic technical analysis the results are astounding.
For instance, when a market is oversold, would it be interesting for you to know, in real-time, that when a market is deemed oversold, whether information can be gleaned from the markets concomitant order flow that 1 or more of the Conclusion Selling's subcategories (Decrementing rate of change of order flow, surges in HFT selling, or 'Late' supply) has entered the market?
- Category 2 | Tipping Point - Order Flow Behavioral States That Arise That Are Fertile For A New Trend To Begin
- Tipping Point (Subcategories) Buy Programs Waning \ Sell Programs Waning
- Order Book Having Been Swept When analysis of these 'Tipping Point' patterns is integrated with time-tested price action techniques (Engulfing Bars, Dojis, Known Support & Resistance Levels) the results are astoundingly eye-popping.
- Category 3 | New Fuel - Order Flow Behavioral Traits That Are the Stimulus and the Sustenance That Fuel A Trend
- New Fuel (Subcategories)
- Increase in the Rate of Change of Order Flow
- Discrete Surges in Either Buying or Selling
- New Informed Supply or Demand
- Presumptive Supply or Demand When analysis of these 'New Fuel' patterns arise after a typical sequence of Price & Order Flow evolving from 'Conclusion' through a 'Tipping Point', a trader can infer that a new trend is ensuing and that their trader posture should adapt to fit that new trend. STAGE 1 | „LEFT SHOULDER‟ AKA „3 OF AN ELLIOTT IMPULSE WAVE‟ Price | Sustainable Price Momentum
- Bollinger Band (Standard Deviation Price Moves)
- Price pauses at and extends Bollinger Band
- Price continues in current direction due to inertia
- Order Flow | Diminishing Overall Demand
- MacDaddy (Applied Force)
- Lower High MacDaddy accompanied by Higher High in Price STAGE 2 | „HEAD‟ - OVERBOUGHT\OVERSOLD WITH CONCLUSIONARY ORDER FLOW The Ideal Head
- Occurs at a Known Level
- Is accompanied by Exhaustion
- Closes with new buying fuel
The Head of a Head & Shoulders pattern is a reversal pattern. Trader’s Insight | Conclusion of Buying at a known resistance level is a plus.
„RIGHT SHOULDER‟ - LIFTOFF - THE PRICE DISCOVERY SEARCH FOR LIQUIDITY Right Shoulder Defined The Right Shoulder is the lowest Pivot Low that occurs after the Head is established. A Right Shoulder that is established can be superseded by a new pivot low as long as this pivot low is higher than the Head and lower than the current Right Shoulder. Trader’s Goal The Right Shoulder can be considered an ideal place to enter into a position. The trader’s goal is to leverage both the ideal trade location of the Right Shoulder and also the supporting order flow behavior to position themselves to be in the front of a new leg upward.
By entering in this trade location where there are supporting order flow indications, the trader is in a position where newly arriving order flow will be predominantly to the buy side. This new buying order flow, which is now following the conclusion of selling order flow that occurred at the Head, occurs in an environment where the Supply & Demand curve is vulnerable to illiquidity. At this sweet spot, the Price Discovery process can go into hyper-drive as there is an extreme imbalance between Buyers and Sellers. In a nutshell, this extreme imbalance is why we spend so much time focused on the Right Shoulder as a trade entry location.
Enter at the open of the bar following the bar that formed the Right Shoulder. What to Look For in Order Flow The secret sauce is a recipe composed of key ingredients in the Right Shoulder’s concomitant order flow.
The following are the order flow events that support a Long Right Shoulder:
- Green/Long Order Flow Monitor Events Green/Long Tape Meter Events
- MacDaddy - Surfaced by
- Predominantly demand initiated order flow (Predominantly green MacDaddy bars)
- Red Spike in MacDaddy
- Equities order flow via WIND
- Bonus | Engulfing Bar at Right Shoulder Right Shoulder Core Order Flow & Price Action Concepts Trader‟s Insight | Predominantly demand initiated order flow should lift & support price action.
Substantive market moves are usually supported by a predominance of either overall demand based order flow or supply based order flow. A steady flow of either demand based order flow or supply based order flow is the hidden force that people are referring to when they say, ‘Don’t fight the tape’. We expand on this, and say “Don't fight the Tape – Use Better Data”.
This hidden force can be readily visualized using MacDaddy. Any series of MacDaddy bars that are primarily made of either green (demand) or red (supply) constitute this flowing force. It is our job to stay on the right side of this force. If it is a Long Right Shoulder then there should be an overall trend of buying in order flow. This can be visualized as primarily ongoing green bars in MacDaddy. If it is a Short Right Shoulder then there should be an overall trend of selling in order flow.
- This can be visualized as primarily ongoing red bars in MacDaddy. WHAT PREDOMINANTLY DEMAND INITIATED ORDER FLOW LOOKS LIKE:
- Ongoing Green MacDaddy Infers Supportive Buying Order Flow WHAT PREDOMINANTLY SUPPLY INITIATED ORDER FLOW LOOKS LIKE:
Ongoing Red MacDaddy Infers Supportive Selling Order Flow
After you enter a position, buying should come in right behind you. If you have entered in the ideal spot, then additional buying should come in immediately behind you. If the buying does not come in and move price up, then you have evidence that your entry was not at the ideal spot. This is a crucial distinction. When this happens you can either tighten your stop, or simply get out. You can combine multiple Right Shoulders that possess different ‘Left Strengths’. A few words of Caution If you get in and realize that your entry is fighting the tape, get out. If you get in and the tape turns against you, tighten your stops, or get out. If you don’t get in and the buying comes in and the market moves up, stay out of the market.There will be another, better trade along shortly.
STOP LOSS STRATEGY APPROACHES
Set # of Ticks | Standardize on a set number of ticks away from your entry price. Anywhere from 4 – 10 ticks in the ES is reasonable for day traders. 1 tick below the most recent pivot | If you are trading a 4 tick range bar and your entry practice is to limit your entry price to the open of the range bar that followed the Right Shoulder bar, then you would place your stop loss 6 ticks below your entry price.
4 Tick Right Shoulder Bar | Low = 1,000; Close = 1001 Entry Bar | Open = 1,001.25 Stop | 1 Tick Below The Low of Right Shoulder Bar = 999.75 e.g | 6 Ticks = Entry Bar Open 1,001.25 - 1 Tick below the Low of Right Shoulder Bar = 999.75 TIGHTENING YOUR STOPS There are a few different approaches to tightening your stops. Each trader must create a stop tightening strategy that is in harmony with risk tolerance, account size, available time to trade, experience, and ‘pristineness’ of the current setup. Move your stop to break-even once price has moved 8 profitable ticks. Move your stop to break-even + 1 tick once price has moved 8 profitable ticks. This will allow you to cover your commission.
Trail your stop by 8 ticks from the high of the trade. Trail your stop by 1 tick below the most recent pivot low for long trades (1 tick above the most recent pivot high for short trades). This approach carries with it the risk of being stopped out by an elliott wave abc corrective wave that retraces into the trend.
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