From the April 01, 2011 issue of Futures Magazine • Subscribe!

E-mini S&P 500 five-minute breakout solution

The market usually moves up in a series of bull trend bars where there is little overlap between the bars and the tails are small. The bars open near their lows and close near their highs. The breakout spike ends with the first pause, which can be a sideways bar or a bear bar. The spike immediately might resume after a one- or two-bar pause, but usually the trend will have less momentum, and it will be in a bull channel instead of a nearly vertical spike. A channel is just a sloping trading range, which means that there is two-sided trading taking place, but the bulls are stronger and that is why the channel is sloping up.

The channel ends at some mathematical target like a measured move projection, a trendline or a trend channel line. The bulls will see this area as a good place to take profits. If there is enough shorting by the bears and profit-taking by the bulls, the market will start to pull back. The bulls usually still want to buy a pullback, expecting that there will be at least one more push up. The bears also believe that the bull trend might resume, so they will take profits once the market has pulled back to some support level, which usually is near the bottom of the channel. The bulls will see the same level, and they will buy there once again.

The buying by the bulls and the profit-taking by the bears will cause the market to rally and it usually will test the bull-trend high. When the trend is starting out, the bulls buy constantly, including at the high of every bar and above the high of the prior bar and above prior swing highs. Once they believe that a bigger pullback is likely, the bulls will instead take profits at new highs and only buy again after a significant pullback, usually lasting at least 10 bars and having at least a couple of legs down. Also, the bears will short again near the trend high, and the market will fall once again. The up and down swings will continue and create a trading range, and at some point the market will break out again in either direction. Then the process will start once more.

Fool’s news

Whenever there is any big price move, market pundits will ascribe it to a news item. However, this is foolish because there are news items all day that do not move the market, and the market usually moves in the absence of the news. Because there are always news stories, the analysts always will point to one as the cause of the breakout, but they almost always are wrong. It makes for good television, but it has nothing to do with reality. They also could point to a boy eating ice cream in Miami as the cause because that certainly was happening at the moment the move began.

There usually are many signs of an impending breakout long before the news is reported, and the breakout occurs when enough large firms begin to place trades in the same direction. They do so for countless and unknown reasons, and the reasons rarely have anything to do with the news.

In the E-mini markets, at least half and maybe 70% of the volume is generated by computer algorithms, and most of those programs have nothing to do with the news. Many of the moves are based entirely on statistical testing and are not related to fundamentals. Because the news is a fundamental, the move is rarely caused by the news.

Traders should ignore television analysts and only listen to what the charts are telling them. The big moves are determined by fundamentals, but most of the intraday swings are created by computer programs and are based on mathematics that have little to do with fundamentals. If the numbers say that the market should go up and enough firms have programs that are running in the same direction, there will be a successful breakout. If not, there might be a trend bar or two and then the breakout attempt will fail. The market either will reverse or just go sideways.

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