Traders are constantly analyzing whether a market is trending or not. Knowing the state of a market is vital for traders. Nothing damages an account like trading on the wrong side of a trend, such as buying before a sell-off has been exhausted or selling a rally early. Just as bad is getting chopped up in market whipsaws while believing a new trend is imminent. Whether a long-term, swing or short-term trader, every practitioner in the markets faces the same dilemma.
For the day-trader who is speculating in E-mini S&P 500 futures, it is essential to make the correct call as to day type: trending, rotational or reversal. The leverage used when trading futures combined with the market’s inherent intra-day volatility requires the trader be on the right side of the market. Otherwise, the day ends with a series of losing trades.
Fortunately, when trading is based on stock indexes, there is an abundance of internal data produced by the exchanges that can be used in trade strategies. This is a reason many traders gravitate to stock index futures. One of the purest data items available from the stock exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq, is exchange-wide tick data, referred to as ticks.
TRADE BY NUMBERS
Ticks are not the up- and down-tick values of individual stocks, but a periodic count of the number of stocks that have traded up (the ask price lifted) minus the number of stocks that have traded down (the bid price hit). For the NYSE, tick values typically range between 1,000 and -1,000.
Some day-trading systems make use of the ticks to fade the market on a short-term, scalping basis. For example, if the ticks value is suddenly above 1,000 or below -1,000, then scalpers will fade the market (1,000, they sell; -1,000, they buy), assuming a short-term over-bought or over-sold condition is occurring.
Tick data are delivered continuously and periodically, up to a frequency of one reading per second. When used as the basis for an indicator, it is necessary to determine how to process ticks. Interestingly, testing shows that these statistics all give the same relative measure of stock market activity:
• one-minute period sums of all received ticks.
• one-minute period means of all received ticks.
• one-minute period means of high, low and close ticks.
Because of this, easy-to-work-with one- minute open-high-low-close (OHLC) bar charts of ticks are sufficient for an analysis. While the tick fade strategy is a viable scalping technique, the data can be put to use to classify day type. Knowing how to determine day type is invaluable with a variety of intraday trade strategies
It is possible to estimate day type, even as the session is unfolding, by using ticks not as an instantaneous value but by accumulating tick values and comparing the accumulation with historical averages. The accumulation of ticks is referred to as cumulative ticks, or CTs.
“My kind of day” shows the cumulative tick indicator on Feb. 11, 2009. This is based on the NYSE ticks. In the chart, one-minute averaged CTs are shown as a dotted line that overlays the one-minute E-mini S&P chart. During the session, the CTs’ line meanders to the downside, which might imply a rotational market with a selling bias. As a result, the trader looks to short the market on an upward spike. The second chart shows a short entry from the day’s previous high. This trade was supported because the equivocal nature of the CTs’ indicated we were not in the midst of a rally.
A histogram at the bottom of the CTs’ chart gives the one-minute OHLC values of the ticks that are accumulated by the indicator. In the main area of the chart, there are nine horizontal lines. The middle horizontal line is the CTs’ zero, or open, line and used as a reference level. The lines above and below the zero line are time-of-day pivots where the CTs are averaged over the last 50 trading days (the number of trading days and the specific time-of-day pivots are input parameters to the indicator).
The time-of-day pivots shown are (Eastern time zone):
• 10:30 a.m. (completion of first hour)
• 1:30 p.m. (afternoon pivot)
• 3 p.m. (beginning of the last hour)
There are reference pivots for bullish days — the pivot time-of-day lines above the zero line when the CTs’ accumulation finished above zero, and reference pivots for bearish days — the pivot time-of-day lines below the zero line when the CTs’ accumulation finished below zero. The CTs are collected over the averaging period and counters are maintained to track values at the pivots. As the day’s CTs are collected, they can be compared with the historical averages. By comparing the current session CTs behavior with the time-of-day pivot averages, the trader is able to estimate day type.
“Going long” from Jan. 2, 2009, shows “unequivocal CTs.” There is little doubt that this is a strong trend day up. In this case, the trader never goes short, but looks to get long through some retracement. For example, retracement to a 20-period exponential moving average (EMA) line on a three-minute chart. This is shown in the second chart.
CTs PRICE DIVERGENCE
When watching CTs and futures prices together, there is a relationship that the day-trader can exploit. It is referred to as a CTs price divergence. Divergence refers to a discrepancy from normal market behavior that may create a trading opportunity. In the case of a CTs price divergence, there is a discrepancy between NYSE ticks and an E-mini futures price. As before, a picture is worth a thousand words.
Referring to “Break from the norm” (right), the CTs’ chart from March 9, 2009, we see an equivocally bearish day in progress, and then between 10:15 and 11:15 a.m. (Pacific time) a CTs’ price
• CTs are flat; and
• ES price rises nine points from 676 to 685.
This is highlighted with a rectangle surrounding the flat CTs period and a trendline under the ES price rise. The divergence is not short-term by intraday standards, lasting more than 30 minutes.
The divergence points to one of two possible market conditions: We are in the midst of a reversal, or the ES price rise is divergent from underlying stock market activity and cannot be supported.
Market reversals are typically accompanied with a clear change in the CTs’ orientation (the CTs’ histogram bias changes, for example), so it’s determined that the first possibility is not accurate. We appear to be in the midst of a CTs’ price divergence, which represents a trading opportunity.
An obvious question probably presents itself: How can such a divergence even be possible, because there never are wide fluctuations between the cash and futures markets? The answer is that the ES price is not divergent from its underlying index value but from the recent sum of the broader NYSE ticks. This discrepancy cannot continue for long. Referring again to the March 9 chart, because the CTs have remained equivocally bearish, a short position is preferred. A short entry on retracement the previous 682-684 support area (previous support has become resistance) makes for a successful trade.
You can imagine an indicator that compares CTs and E-mini futures price action to give signals based on a CTs’ price divergence. An early attempt at such an indicator is shown in the last chart from March 30. The large dot (circled) shows a 0.67% swing retracement in price. The enclosed dark dot identifies a concurrent divergent CTs’ reading.
CTs help answer the trend question, and are an important tool to help stay on the right side of the market. Significantly, CTs also tell us how not to trade — they help keep the trader from executing against a strong trend. The trader should not be positioned on the wrong side of unequivocal CT. Equivocal CTs will indicate that market rotation is expected and we might look at key price levels to set limit orders. Equivocal CTs also indicate it is unlikely we will see an extraordinarily strong trend develop and profit targets can be adjusted accordingly.
For 20 years Michael Gutmann was a software engineer and manager at Intel Corp. He is the co-author of 10 patents in areas of video conferencing and computer architecture technology. A commodity trading advisor, he trades his system daily. His recent book is “The Very Latest E-Mini Trading.” Contact him at firstname.lastname@example.org