From the February 01, 2008 issue of Futures Magazine • Subscribe!

It's the close, stupid

A simple daily bar chart can be a powerful predictive tool. As traders, we all have, at one time or another, been guilty of making our analysis more difficult than it needs to be. On the one hand, we work to make our analysis rich enough to be effective. On the other hand, we work to make it simple enough to be usable.

Some times, as we will do here, it’s helpful to focus on simple. In this case, we’ll study six ways to read a closing price. This demonstration will rely on a handful of New York Mercantile Exchange energy markets for examples. The energy markets are extremely volatile these days, and they might not come to mind as a good arena for demonstrating a relatively basic approach. Quite the contrary, often the markets with the most noise are the ones that benefit most from a simple viewpoint.

TRIED AND TRUE

A simple daily bar chart is a graphic representation of a price range on a given trading day. The highest part of the bar indicates the intraday high. The lowest part of the bar indicates the intraday low. A dash to the left of the bar indicates the open. A dash to the right indicates the close.

You can argue that bar charts are an anachronism. They are tools of a floor-trading world, a time when trading opened and closed according to hours that let traders (and liquidity) go home at the end of a trading day. The future of trading is an electronic world. In this futuristic environment, we might imagine autonomous programs trading against autonomous programs in a 24-hour highly-liquid, global, linked world with humans as periodic participants. In many ways, we are already there.

Do bar charts have a place in this future world? Yes, because even a 24-hour day has to end. There still will be a place for the dash to the left and the dash to right. One reason why bar charts work is that trading is a competition. A price at any given moment is a result of this competition. Some days, buyers and sellers seesaw for dominance. Some days buyers dominate and some days sellers dominate. It’s not uncommon for the market to go long periods of time when prices tend to close on or near their intraday high or low on four out of five days. If price doesn’t close at or near one extreme, it tends to close near its mid-range. This phenomenon is not readily apparent on a continuous price chart but is vivid on a daily bar chart. You can use this knowledge of up days and down days to your advantage.

REQUIRED READING

Say price is uptrending. Namely, the highs and lows over the past two or more days have been steadily rising. Say that today looks like a high close day, and you decide to go long. Would you buy minutes before today’s close or wait until tomorrow? The correct answer is to wait. Tomorrow, the price will probably open at today’s close or retrace below today’s close before continuing higher. Today’s close is telling you to buy. Experience is telling you to wait and buy tomorrow at possibly a better price. The reverse is true if the price is downtrending.

Now, suppose the price has been running higher (the highs and lows have been steadily rising), but today the price closes low. This is called an opposing low. The “opposing” refers to price closing in the opposite direction. The close is telling you that tomorrow’s session is facing an opposing (low) close test.

Following an opposing low, if the price opens lower the next day or moves lower during the first half of the next day’s regular session, then the price will probably test for support at a lower level. If the price opens higher or moves higher during the first half of the next day’s regular session then the price will probably resume its uptrend.

The low close is telling you to be on alert. If the price moves lower the next day, then a short position may be in order. If the price moves higher, then a long position may be in order. If you are open to risk and see an opposing low close in the making, then wait until minutes before the close and go long. Consider a tight stop loss below the close. Otherwise, wait. Decide what to do tomorrow. The opposite pattern works in a downtrend, as well.

If the price opens higher or moves higher during the first half of the next day’s regular session, then the price will probably test for resistance at a higher level. If the price opens lower or moves lower during the first half of the next day’s session, then the price will probably resume its downtrend.

The high close is telling you to be on alert. If the price moves higher the next day then a long position may be in order. If the price moves lower, then a short position may be in order. If you are open to risk and see an opposing high close in the making, then wait until minutes before the close and go short. Consider a tight stop loss above the close. Otherwise, wait. Decide what to do tomorrow.

HIGH ENERGY

“Off to the races” is a 30-day chart with one-day price bars. The contract month is January 2008, and the last bar is Dec. 4, 2007.

The channel lines are linear regression channel lines. These are no more than price channel lines with a centerline or mean placed equidistant between the upper sell-line and the lower buy-line. The channel lines are a way to guide your eye. While these channel lines are important, let’s first consider the one-day price bars.

Starting with the last day, Dec. 4, count back six days. Notice how six trading days prior the price sharply undercut the preceding day’s low. The closing price was a bearish indicator. If you trade crude oil, you probably went short that day when the price penetrated the preceding day’s low.

Now see where crude oil moved on the following day. The price retraced slightly, presenting a good entry point for a short position, then broke lower and closed low again. The next day, the price retraced to the previous day’s high and closed low once again. The following day, crude oil retraced slightly then closed low yet again. The price retraced three days in a row before pushing lower.

Next, price pushed lower, but this time it closed high. The price set up an opposing (high) close test for the following day’s trade. A run will frequently, but not necessarily, exhaust itself on or about the fifth day (this chart is a good example). Now we are up to Dec. 4. The price was resisted by its Dec. 3 high, supported by its Dec. 3 low, and closed near its intraday low. A study of the Dec. 4 bar shows price closed low following an opposing (high) close test. What should you do: Go short overnight, long or stand aside?

For the answer, look at “And the winner is” (above). The day is Dec. 5. The price churned sharply. It moved above its Dec. 4 high and closed below its Dec. 4 low. The price range has expanded. Again, what should you do: Go short overnight, long or stand aside?

“Punch drunk” (below) moves us forward. Again, price churned, this time violently. It moved below its Dec. 5 low and closed near its Dec. 5 high. The price set up an opposing (high) close test. The price continued its expanding pattern. The incremental move below and above the preceding day’s range was orderly. Bulls were willing to submit but only to an increment below the preceding day’s low. Bears were willing to submit but only to an increment above the preceding day’s high.

Now, what’s your next move: Go short overnight, long or stand aside? “The plot thickens” (below) shows how the previous day’s high held the price in check. The price closed just below the mid-range level. In charting parlance, when a daily bar chart shows narrowing highs and lows it is said to be forming a symmetrical triangle: Bulls and bears coil toward the expectation of a breakout, usually in the direction of the preceding trend. When a daily bar chart shows expanding highs and lows, you have exhaustion: Bulls and bears are confused.

So far, we have seen a lot. On Nov. 27, when crude oil undercut its low, the price was vulnerable to the downside. The next day, there was a good shorting opportunity when the price retraced above the preceding day’s low. On Dec. 3 and 6, an opposing (high) close set up a test for the following day’s trade. Price’s expanding range also was a sign of exhaustion, which presented opportunities to trade within the range.

OTHER MARKETS

Two other energy markets are represented in “Good buddies”

Both heating oil and natural gas show a rough pattern over the last four days. This is where complexity reappears. Following related contracts is another way to pick up clues. Related charts often move in synch. Crude oil could have helped you to trade heating oil and natural gas. In turn, the linear regression channel for natural gas could have helped you to trade crude oil. Now add moving averages, stochastic analysis or whatever other tools you like to follow. A simple bar chart can quickly turn into a sophisticated mix of analytical studies.

Just remember the simple bar chart. In its simplicity, a bar chart is a good place to start your analysis and a good tool for double-checking your trading decisions. Whether you follow open-high-low-close price bars or high-low-close price bars or candlesticks, the point is to keep in touch with the basics. Each trading day, read the close for each market you follow. Ask yourself what the close is telling you. You might be surprised with the answer.

Richard L. Muehlberg uses linear regression channels and intermarket analysis to day -trade his own account. He publishes a day-trading diary on his Web site: www.DayTradingWithLinesInTheSky.com. E-mail: richardmue@yahoo.com.

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