"The greatest point of market opportunity is when you feel alone."-James Dalton
With the S&P at life of contract highs, I suppose its only natural that I've seen a ton of traders trying to fade the new highs (or what really looks to my eyes as pure & simple guessing/dart throwing). Look, nobody wants to be the last solider killed in a war just to see it end the next day (think about the poor soul of James Arwood at White Sulphur Springs, North Carolina....the last solider (Union to boot) killed east of the Mississippi during the Civil War, on May, 6 1865, almost a full month AFTER Lee surrendered; nobody also wants to buy the all time high of any market to realize they also just bought a market top. These are very logical & primal human emotions & thought processes.
So w/ that said, I thought this would be a very timely two part post to: 1. Review how tops are formed & what to look for, & 2. How to stay out of your own head. If your looking for an actual top call, well, this post is not for you. Leave the top calling to guys like Doug Kass who called a market top some 200 S&P points ago (hope that gun isnt still to his head :)
A lot of what I'm about to write is pulled straight from James Dalton 2nd book, Markets in Profile. You can find tons of other great stuff on his website, JamesDaltonTrading.com.
So basically market structure is the key to assessing risk of any position, long or short. Balance areas & their relationship to each other are probably the #1 way I evaluate market structure. For those unversed in Market Profile, balance areas are simply trading ranges, brackets, consolidation, congestion areas/ranges. They define price ranges in the market that are containing trade (also sometimes referred to as channels), simple enough right? The S&P's had a very nice example of what I would call a balance area on the daily & hourly chart right before we got NFP on May 3rd.
So as you can see from the above chart, the S&P had formed a really picture perfect balance area between 1530-1593ish (noted by the red lines). On May 3rd, we got a positive NFP report & finally broke higher out of balance above 1593ish (circled in white). So one of two things was going to happen on the breakout above 1593 & I intended to make one of the following trades: 1. The market breaks out higher & is met by aggressive sellers, & prices fail to be accepted above the breakout. In this case I would have faded the probe failure, & looked for a target around the opposite end of the balance area at 1530. 2. The market explores to the upside, not only are higher prices not bringing in sellers, its actually bringing in even more buyers. Higher prices are being accepted & the breakout is successful. In this case (the one that played out) we went w/ the price acceptance in the direction of the breakout. The actual way I played it was to sell /ES 1600 & 1610 puts.
So this brings me to a point I seem to always be preaching about fading breakouts & how to guard you, from your "bad" trading self. Just because a product is moving higher DOES NOT mean "Its just a better price to short it at." This was the disconnect that I saw TONS of traders making after May 3rds breakout to new all time highs. What these traders were failing to realize is that the higher prices were bringing in MORE BUYERS, not cutting them off. So your brain is telling you the higher price is a better short then it was pre-breakout of 1593, but in reality, its the exact opposite....its really one of the worst trades you can take.
This is part 1 of 2, part 2 will discuss what to look for when market structure is becoming weak & clues to look for when a trend is coming to an end.
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