Wednesday, June 15, 2011

6/15/2011 Initial Balance Revisited

Good evening traders,

This week I have been discussing the initial balance and how I trade it. Although today's action was dominated by the headlines in Greece, the initial balance still provided a great trading opportunity!

The market had a large gap down off the open. Almost ten points. The expectation on a day like this is for responsive buyers to be active off the open. That expectation proved to be correct and price rallied to fill 50% of the gap. Traders call that the "half gap" trade and I will discuss it in future posts, for now let's focus on the initial balance.

After the rally into the half gap, price quickly reversed and punctured the opening swing high. This was the first clue that the initial balance was likely to break lower. While price drifted higher over the next few bars, cumulative delta showed that traders were not committed to the long side. A perfect short setup. This trade was a little trickier than normal because the initial balance was wider than my previous examples. In this case 7 points. That still puts it well within the average range of 4-11 points I highlighted in my previous study.

When the market is in a headline driven mode, you can expect more volatility. As the Greece news hit the wire just before 11, ES took a dive. The sell off lasted until quarter after 3, finally coming to a rest near a previous composite low volume node. Generally the summer trading is slow, boring, grinding price action. With all the great headlines and debt crises around the world its going to be a fun season!

Check back again soon. I will be providing more examples of this week's trade. The initial balance. Good luck, and good trading. As always thanks for reading!


Tuesday, June 14, 2011

6/14/2011 The Initial Balance

Hello Traders!

Welcome back, and Welcome new readers! A lot has chanced in the world of futures trading this year. Many new sites are popping up and many more professionals that were former traders on the street have begun to trade their own accounts. Some of the best traders I have seen since I started are now offering their insights and advice on Twitter, Blogs, and forums. FOR FREE! This is great news for the little guys out there struggling to make their way in the financial markets. I have been at this for over two years now. During this time I have picked up some high probably trades that occur nearly on a daily basis. I want to highlight these different trading ideas in their own separate blog posts. I hope you find them interesting and of course PROFITABLE! So lets get started..

The first trade I'm going to highlight is based on the initial balance. If you don't know, the initial balance is defined as the first hour of trading during the cash session. For US markets and equity futures that time frame is 9:30 AM EST - 10:30 AM EST. The initial balance will set the stage for the day's trading. Its also important to keep in mind that the high or low of the day usually occurs in the first 90 minutes of trading. On days when the market has a wide gap off the open and begins to drive hard in that direction there is no initial balance. This trading idea works best on low conviction rotational days. Usually when there is little or no econ news, or the market is expecting a major catalyst later in the day or week. Before I show you the setup I want to point out that it is important to know the average initial balance for the product that you are trading. I trade the S&P's E-mini futures. The initial balance for S&P's is between 4 and 11 points 65% of the time (the sample period goes back to January 2008). The more narrow the initial balance, the easier it is to knock it over. That is an important concept to keep in mind.

The Setup:

It is a very rare occurrence for the initial balance to contain both the high and low of the day. This is a key concept in this trading idea. As you watch the opening unfold you want to get a feeling for the direction of the market. A good question to ask yourself (I have this on a post-it note on my monitor) is "Which direction is the market trying to go and is it doing a good job attempting to go that direction?". Lets say the market gaps up off the open and retraces 50% of the gap (this is another trade I will review in a later post). The market then continues to surpass it's opening swing high and around 10:15-10:25 sellers begin to pull price down to the middle of the range. If at this point price is above the opening swing high, odds are good the initial balance will break to the upside. If the market cannot hold it's opening swing low however the reverse is true and the market is likely to fall lower out of the initial balance. Keep in mind that a narrow initial balance is easier to overcome! I don't have to look far back to find a good example, because this trade works almost daily!

First lets look at an upside breakout:

Notice the narrow initial balance (5 1/2 points). Also note that the market has gaped up off the open. Price was able to hold it's opening swing highs and the expectation is now for the initial balance to break to the upside. Enter long before the breakout and keep your stop below the opening price. Monitor order-flow and conviction to determine if the trade is heading your intended direction. First scale out should be on the break to new highs, then you may hold the remainder of your position until initial resistance (assuming you did your homework and know where to expect initial resistance!).

Now I will examine the opposite. This one is a little trickier so pay attention!

Notice the gap up and again the narrow initial balance (4 points). At first glance you may expect the initial balance to break to the upside, but the fact that price could not hold the opening swing high in the 10:15 bar is a good clue that long conviction is fading. An astute trader would also notice the divergence in the cumulative delta. I would place my short on the close of the 10:35 bar with a stop above the IB high. As you can see the breakdown occurred shortly after! Again your first scale is on the breakdown and the second should be at a predetermined initial support level. On a day like this I would shoot for the gap fill at 1264.50.

That wraps up this trade for now. I will provide a few more examples this week and then next week we will move on to a new trading idea. Once I have posted all my little "tricks" I'll start tying them together with annotated charts so my readers can develop a high probability trading plan of their own!

I hope you found this post informative. Remember to follow me on Twitter, check out my Facebook, LinkedIn, and feel free to Skype me too! I would love to hear what you have to say, and how you use the initial balance in your trading. Please leave your comments below, and as always thanks for reading!