From the August 01, 2009 issue of Futures Magazine • Subscribe!

For safe profits, trade narrow intraday channels

If you ever get an opportunity to visit Chicago and watch S&P 500 futures floor trading in person, grab that opportunity. You should pay particular attention to the sounds of trading. Close your eyes and listen to the action.

Electronic trading, which is probably how most readers access the markets, is silent. There is no inherent sound. There are silent symbols. Sit in front of your computer screen. Close your eyes. Now ask yourself whether the active E-mini S&P 500 futures contract is moving sharply higher, sharply lower, churning sharply or barely moving. You can’t tell.

An S&P 500 futures floor trader can make sense of price action with his ears. In the S&P 500 futures trading pit, a fast market makes one type of sound, just as a churning market makes another. On the floor trading, there are audio clues that indicate mood and speed. This is so important that software programs have been developed to try and replicate these sounds. In an electronic world, equivalent clues are presented by the angle and width of an intraday price channel.

PUMP OR DUMP

Look at a daily E-mini S&P 500 chart. Mark how many days price closed on or near its intraday high or low. You may be surprised at how often this happens. One reason for a bulls-take-all or bears-take-all close is the play between dominance and submission among traders. Each trading day produces a distinct mix of fundamental and technical factors. At some point, the day’s dominant traders may deduce the path of least resistance is up. These traders then bid aggressively. Opposing traders submit, and the buyers smell blood. Buyers pump the S&P higher until they are stopped by the close of that day’s regular trading.

A strong day lets buyers exaggerate (pump) price higher into the close. The inverse is true on a weak day. A weak day lets sellers exaggerate (dump) price lower into the close. From one day to the next, price can alternately rally sharply or break sharply. Each day is played against the factors affecting that day.

“Exaggeration,” in this context, means an intraday run may be unsustainable in terms of the next day’s trade. Exaggeration is not a bad thing. It is simply in the nature of markets. The challenge for an E-mini S&P 500 trader is to appreciate where price might close on a given day and position accordingly.

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