From the February 01, 2012 issue of Futures Magazine • Subscribe!

Trading off the prior bar

During the E-mini S&P 500 day session, there are 81 bars on the five-minute chart, and most go above the high or below the low of the prior bar. Each instance is a breakout and, as with all breakouts, there is an opportunity to make money.

In a market as large as the E-mini, the market virtually never can move, even one tick, unless one or more institutions are willing to buy at one tick above or sell at one tick below the current price. We, as individual traders, make up only 5% of the volume and are simply too small to move the market, and the market does not care whether or not we exist.

Because of this balance of power, the market is never out to steal our money by stopping us into losing positions or stopping out of winning trades. The market cannot move above the high of the prior bar unless one or more institutions are willing to buy higher. The buying can be to initiate a new long or to exit a short position. The exit can be with either a profit, if it was initiated at a higher price, or with a loss. For an institution to be able to buy, there has to be another institution willing to sell at that same price. If there are more institutional dollars eager to buy above the high of the prior bar than willing to sell, the market will have to move up at least one more tick to find enough sellers to fill the buy orders.

If the imbalance is great enough, the move can last for many ticks, and any trader who bought as the market moved above the high of the prior bar will be able to make a profit. On the other hand, if there were more institutional dollars willing to sell at one tick above the high of the prior bar than willing to buy, the market will have to fall one tick to find enough buyers to fill those orders. If the selling intensifies as the breakout above the high of the prior bar continues to fail, the market will fall far enough for an individual trader who is short to make a profit.

High-frequency trading firms can make a profit if the market moves only a tick or two up or down, but individual traders realistically need the market to move at least a couple of points to be able to make enough of a consistent profit to earn a living. If a trader becomes good at assessing whether there likely will be more institutional dollars buying or selling as the market moves above the high of the prior bar, he will be in a position to trade profitably.

Similarly, the market cannot fall below the low of the prior bar unless one or more institutions are willing to sell lower.

The key to being a successful trader is being able to determine when there likely will be an imbalance in the buy or sell orders, and whether the imbalance is great enough to move the market far enough to make a profitable trade.

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