Break From Balance
Sequential days in balance (chart courtesy of WindoTrader)
Markets trend, Markets balance, Markets trend some more. Understanding balance is a very important aspect of understanding market activity.
What is balance? How is it recognized? What does it mean?
These are all pertinent questions that every trader needs to understand. First let us start with this premise. Markets do not go from bull to bear. Markets go from bull to balance to bear,...... or from bear, to balance to bull. To understand why, you simply have to recognize balance for what it is. Balance is a trading range which develops because the cummulative opinion of those investing /trading, in the market at the time is not decisive. Instead it is variable, first leaning in one direction, then the other. Bull markets don't last forever. The way they change (most often, not including 9/11, assasinations or the like) is that the cummulative opion of all those investing, slowly begins to change. This change usually is subtle. Initially some investors simply begin to view the risks of staying with the trend as too high. The trend may continue, but not with the same velocity. Then some time after that a second group of investors sees reasons to view the trend's end as imminent. They exit too. Neither of these two groups goes the opposite way, they simply get out. By now the trend is losing steam and more and more investors begin to get nervous. The remaining trend participants may not get out until the turn is clear, and by then it may be harsh. But in the meantime the trend is ending and balance has begun, since there are more and more investors with contrary opinions. This happens for many reasons. Traders and investors become unsure of how to interpret new information for example, or perhaps there is an enormous amount of information digest, or maybe there are large news items soon to come (like Fed releases), but whatever the reasons, they cause uncertainty, that leads to balance. The balance range can happen in any time period...intraday, daily, weekly, etc. The longer the balance area, the greater the move as price breaks free from balance.
My favorite trade is recognizing this type of balance, and then going with a break. It sounds easy. Sometimes it is. Other times it can be quite difficult to know whether a break is for real, or a retracement into the balance is soon to come. Volume, time, previous attempts, and the context of where the market is when this occurs can all help in making a determination. Nonetheless, sometimes a trader is correct, and sometimes not, so once a trade is placed, you must establish your stop. New traders often want to make that stop the top of the previous balance area. Don't do that. You are giving away your money. In most instances that level will be tested again, and usually broken, if only for a brief time. Whether or not it is tested, and by how much, may give clues as to the strength of the break.
One stop that seems to work reasonably often is by placing your stop loss at the halfway point of the prior range. If this is tested, you don't want to be in the trade anyway. But this can sometimes be a harsh loss. You therefore simply have to weigh all the factors as you consider your stop. But you must have a stop.
Look at the profile chart above. I love using profile to deliniate balance because the value areas are so clear, and overlapping value can clearly distinguish balance, as can buying and selling tails at the extremes. The chart above shows four inside days, all well in balance. The last expanded profile is simply the same data as the contracted profile immediately prior. This is a good setup for a break out trade.
Break from balance can happen in any time frame. Take a look at look at the chart to your left. This is an intraday profile chart showing balance, and break. The product is the thirty year bond. The context is that bond prices had been in balance for four days prior, then a break lower had occurred. Price had opened out of balance lower (than the day prior). Early trading had been within a range as traders decided what to do.
The chart shows both an expanded profile chart and a candlestick chart, both depicting the same time period. NOTICE HOW THE MARKET PROFILE CHART SEEMS TO CONVERY BALANCE BETTER THAN THE CANDLESTICK CHART. Each trader has to choose what works for him or her, but this is one of the reasons that I like profile charting. To me it seems to make balance more obvious. It also filters out some of the "noise" in shorter term bar and candlestick charts. In any case, the balance is obvious. No one knows what price will do, but then it breaks lower. This is a good break from balance INTRADAY trade. A stop could have been set 7 ticks back into the balance (or wherever you thought appropriate based on context). This was a good trade.
Whatever charting method you like, pay attention to balance. A break can be a great trade, and the balance can be used as a reference as well.
Please review our excess trade and our across the box trade as well.