Unresolved Issues
Early last week the market looked as though it was poised to break out of the triangle formation - highlighted in last week's article - but alas, this was not to be. The rally that had been in full force until Wednesday (3 days and 500 Dow points) was derailed on Valentine's Day by Mr. Bernanke's downbeat testimony to Congress. In addition, Friday was options expiry and the fact that we were headed into a three-day weekend set the tone for an uninspiring trading session. Monday saw an early morning rally fade all day with most of the major averages finishing little changed. This leaves the market mired in indecision, thus making it a challenge - in the intermediate term - to gain traction in any direction.
This lack of trendiness transcends all time frames. Day traders, swing traders, as well as investors are facing the same frustration. In last week's newsletter, I touched on the issue of defining the current environment before choosing to engage in the markets. Since then, I've received numerous emails asking me how I define a "choppy market". I would answer this by saying that a choppy or trendless market is one in which the market looks as though it will begin a directional move and fails to follow-through after numerous tries. Consequently, we end up with back and forth movement that leads nowhere.
This type of trading environment is difficult for the inexperienced trader in that he/she feels most comfortable entering the market when the trend is fully underway. Furthermore, a good number of traders have been conditioned to short when the market makes a new low, or buy new highs. As I've written many times in the past, trading is counterintuitive. What feels good is usually the wrong thing to do. Conversely, the trades that yield the highest reward commensurate to their risk usually are the ones that don't feel good when it comes time to pull the trigger. After all, courage is needed if one is to achieve above average returns.
In the chart below, I've highlighted with circles, the levels that would be looked at by some traders as "comfort zones" before entering the market. This is due to the positioning of the prior large green or large red candles.
In circle #1, the ER2 is making an intra-day low after a gap lower opening and a subsequent failed attempt to fill the gap. The intra-day low probably attracts many traders to short. While this was happening, the pros were looking at this level as either a value area, or a point where the market became overextended and overdue for a retracement. In example #2, the same traders shorting the new low, now see three consecutive large green candles, giving them the perception that it's okay to buy (this sequence is repeated in example #4). By contrast, the professional trader sees the resistance area (the bottom of the gap) as a low-risk, high-reward opportunity to put on a short position. The unsuccessful try at breaking above resistance at #2 results in a reversal that brings the market back down to the earlier support; it holds temporarily, but then breaks to new lows (Circle #3). And guess who's shorting the new low? Finally, in the #5 example, the last low of the day serves the same fate to those that chose to sell weakness.
Traders may have a better chance at being profitable in a trending market (shown below). This backdrop can be a bit more forgiving, as long as the trading is done in harmony with the market's dominant direction.
Overall, the vast majority of futures traders lose money. Most do exactly what I've outlined in the choppy market examples. The small minority of successful traders systematically extract money from the market, by simply fading what the rest of the trading population is doing. If you find yourself in the majority, it's incumbent upon you to learn the ways of a real professional trader. Read books, attend classes, do everything you can to seek knowledge, because at the end of the day, this will be much cheaper than the tuition you will pay the market as you learn to trade properly.
If you're interested in learning some of my trading techniques, I'll be at Online Trading Academy Los Angeles beginning March 10, teaching the E-mini 5 day course. I hope to see you there!
The Bottom line: The technical picture of the ER2 (E-mini Russell 2000) has changed very little since last week. The triangle shown in the chart above has not been resolved in either direction. Maybe this week's Fed minutes and inflation numbers will provide the catalyst needed to clear up this technical pattern. In any event, keep those stops tight and lock those profits in when you get them.
Until next time, I hope everyone has a profitable week.
If you have questions, comments or maybe you'd like a specific topic covered, please email me at gvelazquez@tradingacademy.com
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the