One axiom that has stuck with is the one used when traders are on a losing streak and they refer to engaging the market as “picking daisies in a minefield.” This saying references the notion that when the market looks very good, this is usually when it blows up. This is not limited to going long; shorts also find huge reversals to the upside just when the market looks as though it’s ready to fall off the abyss. We see this time and again as the markets are full of traps that the unsuspecting novice trader is prone to falling prey to.
One of these traps is the idea that when prices trade above or below prominent price points, the particular investment vehicle is bullish or bearish. These price points can be a variety of technical levels. Some are what are commonly referred to as support or resistance. Others can be a prior day’s high or low (pivots). Also, the overnight peaks and troughs (known as the Globex) are seen in this fashion as well.
In the two charts below you can see what those traps like.
In the last E-mini class I taught two weeks ago, we spotted a possible trap in the ES (Emini S&P) and some students bought the “new low” in the S&P mini at 1340 (shown in the top chart). This worked very nicely as the ES rallied 20 points. In the chart above we can see that a few days later the Nasdaq mini futures contract had a similar trap, this was a new high, and as we can see it proceeded to fall 50 points in quick succession.
For traders wishing not to fall into this trap it is important to know what causes this to happen. Going back to the class I was teaching two weeks ago, the first session in the morning was devoted to trading and analysis. On the particular day when the trap occurred, the S&P was down sharply and I made the comment that I would love to see yesterday’s low get taken out – as that would provide a good buying opportunity. I got a few puzzled looks from students after making that statement as they didn’t understand why we would buy when the market was making lower lows.
The first point I made to them is that many traders are “conditioned” by all the books on conventional technical analysis to buy new highs or lows. As I mentioned earlier, this tends to make them bullish or bearish depending on where prices trade. There are many instances where the new highs actually act as pull back areas in a trade. In other words, a higher high in the context of an uptrend quite frequently acts as the high point before a retracement, thus stopping out those that chase the trend.
The next and most important point is that often times right above or below these new highs and lows are supply and demand levels which act as repellants to those new buyers or sellers. This is exactly what happened in the two examples shown above. If you look closely inside those larger time frame candles you will discover those pockets of buy and sell orders just waiting to get filled.
Since many of you have been reading these articles for a while, I suspect you probably don’t buy new highs or sell new lows in your own trading. For the rest of you, making sure you don’t fall prey to this particular trap means learning how to identify quality supply and demand levels, as well as learning that conventional thinking is a trap in itself.
Until next time, I hope everyone has a great week.