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Your watching the bond market. The day begins in balance with an open within the range of yesterday's trade. Over the last few weeks the market has traded higher and higher, and has now come to a longer term resistance level, where it begins the day today. The question on the mind of all traders is will the bond price breakout through resistance and go higher......or will it be pushed back down? What do you do? How do you trade this type of situation?
BONDS, OIL, EQUITIES, GOLD, COPPER, CORN,.....the product does not matter. This same trading situation happens in all these markets. Every trader who has been around for any length of time is well aware of these types of positions, and the difficulty in interpreting trading, and initiating your own trades, at such levels.
Read a book, go to a lecture, listen to a webcast and look at the charts RETROSPECTIVELY, and it all looks so easy. Of course that was a breakthrough, we say! Sure....can't you see the test and failure? You should have gone short here at resistance! Of course, we think, we can see that. Retrospection is such a blessing. It makes life so easy and trading no problem.
But guess what? Real time is not quite the same. Real time volume, price movement, oscillation, causes our brains to question, our minds to freeze. Is price going through
resistance? Will price be rejected lower? Should I go long? Maybe I should go short? Has enough volume traded to make me comfortable?
Can I be sure where price will go from here? Is it too early to get in? Did I make a mistake?
HOW CAN WE KNOW?
Bottom line.....you can never KNOW, and the sooner you learn that the better!
But you can increase your odds of success if you simply understand a little bit about market behavior, and what happens in these situations.
The primary aspect of making better decisions in these situations is to be prepared. That means keeping up with market action on a daily basis. Understanding not only what the market did, but hopefully why it did what it did and whether that suggest a bullish or bearish sentiment. Context is invaluable. It also means understanding and keeping up with sympathetic markets, and absolutely being aware of the economic calendar and knowing what news items could affect trading. Finally, it is of absolute importance to understand the different timeframes of traders and investors, and how those timeframes might come into play as price meets resistance. I believe that there are some technological aspects to making better assessments as well, and these will be addressed at the end of the discussion.
What does that mean? How can a trader be best prepared to interpret trading as he comes into any given trading day?
A trader must understand the context of the market he is preparing to trade. This means knowing where that market is in terms of short term trend,
intermediate, and long term perspective. It means knowing how the market has traded in the recent past....was it up, down, balanced....and whether
price movement suggests a bullish or bearish sentiment. For example if one is watching the S+P and price was up sharply over the past two days, but that
only happened after a selloff and price testing a low that was rejected, the interpretation might be that the short term rise is short covering, and the intermediate
trend down is likely to continue. Same scenario with price up two days, but in this case trading has been range bound and recent earnings have been
better than expected and congress has reached some budget agreements, then the interpretation might be much more bullish longer term. Context is of utmost importance.
It is not enough to know what the market did, you must learn to assess how it did it, and then be better prepared to interpret why. (I must comment here
that you should dismiss commentaries on TV and in newspapers about why a market moved the way it did. That can only confuse you. You are the trader. You
must make the interpretations. When the trade goes bad, you are the one who will be there and must decide where to go from there.)
Be aware of sympathetic, or actually of linked markets. Even markets that trade inversely to the one you are watching, could affect price movement. An example of sympathetic markets might be the ten year bond future, when you are trading the long bond. The two are closely related, but certainly not exact replicas. The Yield curve changes over time, and this will change the relationship. Another example might be the relationship that we have seen in 2011 between Oil and equities. The two have, for the most part, trading sympathetically. The likely reason for this is the relationship of equity price to projected GDP, and the effect that projected GDP would have on the demand for oil. And an example of markets that affect each other in an inverse manner would be the long bond and equities in 2011, particularly since August. As equities fall, and the safety of those investments looks less desirable, then investors will look for alternatives. Historically the safety of Government bonds has been where this money will go. So in sharply down equity markets, one would expect to see rising bond prices. A trader should be aware of this, and know how other markets affect the one he is trading, and pay attention to them.
The situation we are discussing is what happens to price at resistance levels and how can we decide what it will do? A major factor with such an analysis is understanding the way differing timeframes become involved at such price levels. For the newer trader, this might be difficult to grasp, but it is of primary importance. If you have not done so yet, this may be a good place to review the discussion on the auction process and how it relates to trading. You can do so here.
Traders vary in perspective. They also vary in timeframe. The same is true for investors. The important thing to remember is how this will relate to price meeting resistance at signifcant levels. Take a moment to think about this and what it means. It is absolutely of the utmost importance. We as traders have flaws. We think we will be correct in our assessment (always). Were that not the case, we would not put on the trade. We also tend to be terribly biased. Once a trade is on, or once we are committed, we tend to filter information. We see what we want to see. We cannot help having this tendancy, as we are human. It is who we are. It is in our nature. And yet, we must recognize these aspects of ourselves and work diligently to control them, or at least to recognize their existence. When it comes to timeframes, we must recognize that not all traders are thinking the way we do. We must overcome our natural tendancy to focus ONLY on our trade, and our timeframe, and we must consider that others are in the market for differing reasons and for differing times. The things that affect their trading may be quite different from the things that we consider as we place our own trade. Nonetheless, those traders and their actions can have extreme and severe impact on our trades, our interpretations, and most importantly price movement. We must make ourselves understand the context of those other traders, and the things might make them enter or leave the market, and how that will affect our trade.
Let's look at timeframes a little more closely, and talk about how they might affect price movement at significant resistance levels. I use the term "timeframe", because that is how the concept was taught to me, by Jim Dalton and Terry Lieberman. Jim describes this in his books Markets in Profile and Mind Over Markets. Jim goes into detail describing the Auction Process. This is an invaluable tool in understanding price oscillation in markets, and why it occurs. The auction process occurs whether a trader is looking at a daily chart, weekly or monthly. It applies to all timeframes. The concept of differning timeframes simply refers to the idea that investors and traders have differing horizons within which they expect their trade to work. A scalper, focused on the ultra short term might not allow a trade to go against him by more than a tick or two before liquidating with the idea that he has been wrong on his assessment. A Day trader who trades off of a fifteen minute profile chart may initiate a trade at the same place, but he may allow several ticks or more against his trade before exiting, discounting a single tick or two as "noise". A short term trader seeing the same trade, might expect it to work only if given a few days. He will allow price to move against him to a greater extent than the scalper or day trader. An intermediate term trader may take the same trade as well. He however is looking for much more profit, and a longer time horizon expecting it may take weeks for his trade to be successful. He may allow several multiples of the day traders loss before even considering that his assessment may be incorrect. Again, anything less could be discounted as noise. And of course some traders have much longer time horizons in mind when they place a trade. A long term trader may again initiate his trade at exactly the same spot as the shortest term trader. The long term trader will not be looking for a tick, or two or ten. He will be looking for several points. He will allow his trade "room", to move knowing that short term oscillations may occur without affecting the longer term prognosis. Each trader looks for profit. Each hopes that his trade was placed at precisely the correct point. Yet each has differing profit motives, differing risk allowances, and vastly differing strategies for managing their trades. In the end, they may all be correct, all wrong, or somewhere in between. But it will take differing price action and time horizons for these outcomes to make themselves known.
The reason that we have brought up timeframes in this discussion is secondary to how they relate to price action at signficant resistance levels. These price levels may provoke action from all of the market participants, regardless of timeframe. Unless you understand that, why it may happen, and how it can affect price, you could be terribly dismayed about the outcome of your own trade.
Lets take for example the scalper. What resistance levels will he be looking at in the course of his trading? They will be ridiculously short term of course. He may care primarily about the high price of the last five minutes. The day trader we described may be looking at high and low of the day, and the day prior. The short term trader sees resistance levels that developed over a week or more, while the intermediate and longer term trader are focusing on levels that have been established for weeks and months respectively. But what happens when price reaches a resistance level that the long term trader recognizes as important? That level which the long term trader is viewing, is also being viewed by all other market participants. Whereas the level that a scalper most often addresses will not apply to any other timeframe, the important day trading levels will be important to the scalper. And the weekly levels of the intermediate trader are important to the day trader and the scalper as well. So when looking at price at these signficant resistance levels you must be prepared for the entry of new participants, and you must anticipate how that will affect price. When price bumps up against the long term levels, the intermediate trader may be thinking there will be a breakthrough and going long, but he may be forgetting that the long term trader may be selling at these levels, expecting price to retreat. On the contrary if price does break through, the short term trader may expect a slow and steady rise, but entry of the longer term participants may cause a much more rapid movement higher.
Price moves relative to fundamental information. The efficient market hypothesis would say that at any given moment, price will properly represent the true value of the underlying because at that moment all market participants have been exposed to the information available at that time, have interpreted it relative to their situation, and have acted upon those interpretations in a rational manner. Whether that is true or not is up for debate. Information is provided round the clock and it is up to individuals to gather and interpret that information, and then act on it accordingly.
The important thing to remember is that new information is constantly coming into the market. CONSTANTLY.
Much of that is noise, but much is not. You cannot afford NOT to know when important information is coming. Jobs reports, GDP, bond auctions, Oil reserves,
you must be aware of these news releases. Price may move relative to fundamentals over the longer term, but many times it will balance in an area as market
participants try to digest the information and make decisions. It may only take a small catalyst to propel price in one direction or the other. You simply cannot
allow yourself to be unprepared for that type of information. It is not enough to know that such information is coming, you must think out what it might be, what is expected,
and what your course of action will be for various scenarios. Barring this preparation, you must stay out.
Now we understand timeframes, what should we specifically pay attention to as we watch the market approach a significant resistance level?
Price is the primary answer. Every trader knows that. But we need to look at a lot more than price. We need to pay close attention to volume, particularly relative volume. And we need to consider time. How does price move relative to time? How does volume change, relative to time?
Suppose that the bond market is trading near 3 month highs. Price has moved steadily higher over the last two weeks and the past three days it has balanced at the upper realm of a range just below the three month highs. You are trading. You expect the price to go higher, and if it does, you plan to go long. You are excited at the possibility of a longer term trade that might push your profits to new highs. You know that a news release is coming that will detail Gross Domestic product, and it is scheduled to be released at the same time as the jobs report. You know that these will affect the bond market and you expect GDP to be poor and the jobs report to show unemployment has increased. This may be the catalyst you need to propel bond prices higher. The early morning trading has been dull. Five minutes to go until the news release and the bond market is essentially at a standstill. You see orders above and below the current price being pulled, and you see more volatility as the market thins out. Professional traders know to stay away from uncertainty.
The news is released. GDP is poor, and jobless claims have in fact risen. You watch the market, but you KNOW what will happen. (you can never know ). Bond prices rocket up 8 ticks. Then pause. Then rocket 6 more ticks, now just above the previous resistance. "This is it" you think. Prices move higher. You watch contract volume. 500/1200/400/1100, the numbers print and print and the price rises. Now you are no longer uncertain. You know this is you chance. You are thinking about how many contracts to buy as you watch price go up, up, and markedly UP more quickly. Anxious, you know you must get in. You are missing the move. You simply buy. You are in. Price pushes up a little more, but you are dismayed to see a pause. You had hoped that the surge would push on and on quickly. But price is still rising, simply the rate of rise has decreased markedly.
But the contracts soon print less and less, and then price ticks back a bit. This is normal of course, and now, NOW, price is already above the breakout resistance level, so you feel comfortable that this trade will work. But price falls a bit more. Now the contracts print more volume...1500/2000/1200, but unfortunately the price is going the wrong way. You are now underwater in your trade; not by much, but a loser nonetheless. You become nervous. But price is still up from pre news levels and you know this will work. But price falls. Little by little it falls. The volume falls off, but still price is slightly lower, then lower still, and now it is beginning to approach the levels of the pre news release. Half a point. You are down half a point; $500/contract. You are angry. You waited for price to go through resistance. It did. You watched volume and saw big numbers. You waited until you were SURE. But now the loser is clearly a loser and you are sick. You aren't quite sure what to do until price falls all the way back to the new report level. You get out. 24 ticks. You lost 24 ticks. You leave for the day sick, disgusted, knowing that the markets are totally unfair and somehow rigged. You simply cannot watch anymore.
While you are now out in the yard working off your disgust, the bond market steadies itself. Price does not go up much, but it slowly does go up. It moves slowly and steadily higher, but only a tick or two at the time and by the end of the trading session is now 10 ticks above the resistance level. You come back in that night, still angry, mean to your children, but you take a moment to look at what happened after you left. DAMN. Now you are really mad. You KNEW that you should have stayed in that trade. If you had just stayed in that trade, you would have not only not lost money, but you would be profitable. You go criticize your wife......for something.
Over the next three days the bond market goes up three points.
You did the right thing by not trading in front of the news. A trader simply afford to do that. Most of you reading this do not trade bonds, but those who do know that news releases like GDP and jobs reports can move the market drastically. In addition, during that period, the smart traders have removed their standing orders and the bid ask may change dramatically, and the normally incredibly liquid market becomes incredibly thin! You cannot afford to trade in front of the news.
So you waited. But after the news came out, you saw price move higher. You waited still, you wanted to be sure. It was only after you were sure, only after you saw a large volume get much larger, only after price went well above the resistance........ONLY then did you buy. So how could you be wrong?
What happened in this situation, as has happened to me before, was that the trader misunderstood who was buying and why. He waited as he should have.
But then he only acted when he saw buying, and was pushed into market participation by the fear of missing the trade (ever had that?).
He only acted when the volume of contracts/ per minute AND rate of price change (price increase/per minute) was so large and so rapid that he felt he had
to act. He saw a large volume of contracts, and increase in the rate of buying and price rise and he concluded that new buyers were here.
They were not.
Who was there? Old Sellers;not new buyers. When the old sellers were done, the move stalled.
There were traders short the bond market prior to the news. They heard the news and interpreted that it was bad for their trade. At first only a few got out. This was the initial short burst of up price. Then that burst made a few other shorts rethink and they too got out. Then, slowly first, then much more rapidly in the end, ALL the shorts were piling out.....AT ANY PRICE. It is painful, but it happens all the time. When you are wrong and price goes against you that move can be tolerated, but only to a limit. Then, as the rate of price move against you increases, you simply want out. OUT. That is about where the trader got in. IN.
Price then fell not because there were no more buyers, but because there were no more buyers at that time. Price fell, and fell, and as it fell those long, short, and considering involvment were all weighing the risks and benefits. Price fell until it reached a point where some traders thought it might be a buy. Then price stabilized and a few more got in, then slowly more. By the end of the day price was higher. Then, at the end of the day, the intermediate and longer term traders came home, looked at their charts, saw price up through the resistance, and they began to buy. Large Corporate buyers were doing the same. Price moved higher.
So how could our hypothetical (if only it were so) trader have made a better decision? There is no perfect answer, but let me list a few ways:
In the end there are, unfortunately, no easy answers. But there are are tips that a move will be pushing higher, or that it might be rejected.
A trader must be familiar with these tips. He or she must look for them. He or she must know how to interpret them.
They are as follows:
IT is not always TOO LATE
Please review our excess trade and our across the box trades on this site.