It is important for all stock traders to be aware of broad market tendencies, since they can have  a dramatic impact on individual stocks.  In fact, most of us who hold a large number of stocks intraday soon discover that you don’t actually have 8 different positions… it’s more like 1 big one, tightly correlated to the S&P.  As goes the market, so will go your basket of stocks more days than not, so it pays to understand the behavior of the broad market as well as you possibly can.

Today, I want to get you started thinking about some times of the trading day that tend to be inflection points.  A few of them are very obviously event-driven, but there are a couple others that don’t have a clear cause.  I would encourage you to use this as a departure point for your own research, with one (serious) caution.  If you are going to do research to try to understand how the market works, you need to look at A LOT of data.  In fact, one of the newer traders probably still remembers the time I couple weeks ago when I bit his head off for his idle speculation that today “kind of reminded” him of a previous trading day.  I was too harsh on him at the time, but my point was that any casual observation or anecdotal connection you draw is likely to do you more harm than good.  The right way to do this is to sit down and go through at least a year of ES days, bar by 5 minute bar, taking notes on each day.  Yes, that is roughly 260 trading days, but the really bad news is that this is only a start!  Really you need to look at several years, and if we’re honest about it, no one really develops market feel without living through at least a complete bull – bear cycle, which takes exposure to over a decade of price data.  You can dramatically shorten the learning curve by focused study, but above all, please avoid casual observations until you’ve really examined a lot of data (or lived through it firsthand.)

There is a high degree of random noise in the market, which makes any kind of analysis more difficult, but there also are some significant patterns that occur with regularity.  I’m not sure how to put this into blog form (and I’ve certainly been guilty of trying to write 1,500+ word blogs which has turned out to be too much for me to handle with regularity), but let me just start today with some high-level thoughts about the times of the trading day.  I will probably expand on some of these ideas in a future post:

3AM (New York time):  Yes, that’s right, 3AM.  One reason we need to use futures and not SPY is that Europe actually trades our futures fairly actively when their markets open.  Most major European markets open around 3AM so the first thing I look at in the morning is the price action around 3AM.  This often sets a key inflection point for the day, as our futures will tend to lock into European market direction and follow them in our overnight session.

I will also look at the rest of the overnight for significant levels, but the key word is significant.  If you have to really look and think about it, it’s not significant.  If you see a level that is hit 6 times and holds with only a 1 tick drop in the futures, that level just might be important later today, no?

8:30 AM – sometimes an inflection point but purely driven by economic numbers.  If no report, then this is probably not a significant time.  There are releases at other times, but they have enough of an impact to make those typical inflection points.  At any rate, this is a minor inflection point.  (Note that pit sessions for US Bond futures open at 8:20AM.  This used to be more of an inflection point, but I don’t see it so much in recent years.)

9:30AM – obvious inflection point and the study of patterns around the opening is a whole book in itself.

10:00AM – same as 8:30.  This has been an inflection point, but primarily because of the number of significant economic reports released around this time.

11:30AM – European markets close.  If our markets have staged a major reversal to the European session (eg. Europe was up overnight, we trade up on the open and then collapse into downtrend), this time of day can be very interesting as European traders scramble to cover a lot of their positions on their close.  This is more of an influence than it was 5 years ago, but do not expect it to be significant if our markets are relatively quiet on the day.  Also, this inflection can be a bit of a climax, temporarily capping the morning drive at exactly the point where naive traders are expecting the start of a major move.

12:00 – 1:30PM – Lunchtime.  This is traditionally a dead time for the markets, and it continues to be true.  Much less followthrough in broad indexes, and you really have to pick your spots.  Depending on the kind of trading day (more on that later), we are on breakout watch near the end of this period.

2:00 – 2:45PM – Ideal breakout time.  If the market has been rangebound, we are looking for a breakout to carry into close.  If that breakout comes much before 2:00, your thought should be “this is early, maybe too early to carry into the close.”  After 2:45, it’s getting a little late, but still possible.  A breakout of a rangebound market that occurs in this timeframe deserves your respect — best to go with it or if you must fade, so so with the utmost care.

3:00 – 3:10 – Countertrend inflection.  This used to be related to the bond pits closing (and maybe it still is), but if we are in a good trend there will often be a pretty dramatic countertrend inflection right around 3:00 PM.  This move will be big enough to shake out weak trend followers, so you need a plan.

3:00 – close.  Simple rule:  Do not fade a last hour trend, especially if confirmed by NYSE ticks and multiple broad indexes.  There is a lot of latitude for different trading styles, but I believe anyone looking to fade a strong last hour trend is making a critical mistake because some of the best market tendencies are for last hour followthrough.  If you have been trading for a while and weren’t aware of that you probably need to re-think your market study process.  At any rate, one of my very few hard and fast trading rules is “do not fade a last hour trend.”

4:00 – 4:15.  This is a very interesting time when indexes are open, futures are open, but the cash market is closed.  Sometimes you can see a real resolution of moves as pressure comes off the market and you get good trends in this time.  Be careful because many ETF products are not as liquid as you might think in this time.

That’s pretty much it… we do not (yet) see the kind of inflection points around the Asian opens that we do around Europe.

I hope this helps some of you begin a process for your own study of these time of day inflections.  They are messy (not nearly as neat as this blog post leads you to believe), but they are very real, recurring influences that you MUST be aware of if you trade stocks or index products.

(If you do nothing else, pull up today’s SPY chart (8/23/10) and look at the turning points on that chart against this list of times of day.  Interesting, huh?)

I was trading FCX this morning.  I noticed a clear buyer at 60.90 during the Open.  In the late morning the buyer dropped and I got short.  FCX traded down about 30 cents over the next ten minutes.  It then did a bit of a short squeeze up to 61 before trading down to its opening price of 60.20

From my perspective by far the best trading opportunity that occurred in FCX was one hour later when it clawed its way all the way back to 60.90.  What an amazing opportunity to get short and risk only 10 cents with 2+ points of upside.

Here is why I think this was the best opportunity presented in the stock today.

1. The 60.90 level is not at price such as a whole number where HFTs would be focused on pushing the stock above and below the level, in order to take money from the silly day traders who would be focused on such a level for no other reason than it is at the “fig”.
2. The stock has already proven it can have a significant move off of this price based on the earlier 70 cent down move
3. The risk was clearly defined by the earlier squeeze that couldn’t get FCX to trade above 61
4. The entry price was far enough away from the opening low that even if FCX didn’t break down today the risk/reward was better than 1:5 on the trade
5. There was a clearly defined downside target of almost two points based on Friday’s afternoon resistance of 59

US equity markets are completed dominated by HFTs.  I believe in peaceful co-existence and therefore will focus on trades where I know they are least interested.  They are faster than me so I find trades where speed is not determinative.

Damien Hoffman of Wall St. Cheat Sheet recently interviewed SMB’s Steve Spencer on hot topics in proprietary trading. Steve discusses the things which are affecting traders in today’s market such as financial reform, market transparency, and the transition to a less volatile market. He talks about the importance of being in the right stocks and which set-ups are working well for the current environment. Listen to the audio interview to hear more on what Steve has to say.

I was trading V today for the third consecutive day. My initial bias was short based on the weakness on the tape I had seen during the prior two days. During yesterday’s two point pop in the SPYs I found it to be very telling That V barely bounced. So I came in today ready to get short again. The futures were higher this morning so V offered a very nice entry point at the 76 level.

My initial short in V on the Open worked very quickly dropping from 76 to 75 in a heartbeat. Then over the next twenty minutes V continued to press up against the 76 level with shallower pullbacks. It was very easy to see on the tape the buyer stepping higher. First, 75.40, then 75.50, then 75.70 and eventually buying at 75.90 on the bid. This was “short term” strength on the tape. When V was dropping in price there were no aggressive sellers holding offers at lower prices. In isolation it appeared that V would eventually trade higher because buyers were being more aggressive than sellers.

But if you were to take a step back and think about V’s price action going back to its five point gap down on Friday the tape has been showing great weakness on a larger time frame.

1) On Friday after a large gap down from 85 V failed to hold above the longer term level of 79.50 and then trended down to 76 the next long term support level.

2) On Monday V trended down for the entire day touching 73.67 which is right above its next long term support area. They SPYs bounced from 112 to 114 and all V managed to do was trade up to 74.70.

3) And this morning it was being sold at the 76 level which is the long term support it dropped on Monday.

This is a stock that seemed set to head lower over the coming days. If things were to really start to get panicky a move to 65 was not out of the question.

Yet as I was trading it at 9:45AM this morning I allowed the short term strength in the tape to almost wipe my memory clean of the short bias I had entering the trading session. In my mind the big picture in the stock was running up against the tape in the stock. But that was the incorrect analysis.

Almost universally when we refer to “the tape” at SMB we mean the order fly that is occurring in a stock from minute to minute. But the reality is that traders on different time frames view “the tape” in different time frames as well. It is essential if you are making a longer time frame trade to give the highest weight to the tape in a longer time frame. That is where I momentarily went astray.

If I were attempting some type of scalp play then the momentary strength I was seeing on the tape would have been useful to establish a scalp long. But its only purpose for the trade I put on this morning was to indicate to me that I should take some risk off on my short and not add to my position until I found short term weakness on the tape to match the long term weakness I had identified during the preceding trading days.

In fact that is eventually what I did when I finally saw an aggressive seller at 75.12 put the kibosh on the 75.10 buyer. And I did this a second time when V was being sold at 74 and the large buyer at 73.89 got hit out for 94K shares. The weakness on the tape in the short term was matching the weakness of the tape in the longer term, which was my signal to be more aggressive.

Conclusion:

1) If you have a big picture trade idea use the short term alignment of the tape to press your advantage
2) If you have a big picture trade idea and the short term misalignment of the tape to take some risk off BUT don’t change your bias

Trading Setups That Are Working In Today’s Market

Please join us on May 15th at our training room in NYC for an interactive seminar on which trading setups are working best in today’s market.

The partners of SMB will discuss in detail the setups that have been offering the greatest risk/reward for the past two months in US equity markets.

They will discuss entries/exits, managing open positions, identifying the most likely candidates for these setups in advance.

The seminar will begin at 11:00AM and last for approximately for 90 minutes.

Please RSVP to seminars@smbcap.com

A very talented experienced trader joined our desk about five months ago. Let’s call him Trader Dan. He decided SMB was a better fit for his personality than his original trading firm. His first trading job entailed shorting very strong stocks intraday and getting long very weak stocks intraday. Somehow he was able to earn a living with that strategy for many years but it was slowly eating away at his sanity.

He has done a nice job of learning what we teach and putting his stamp on his own brand new trading style. Despite his many strengths he has one area in particular with which he has struggled. Based on the many emails we receive I know that he is not alone. He has been unable to figure out a way to get back into a trade once he closes his initial position.

Let’s discuss the stock he was trading today. He was long 2K AIG from 40.60. He thought there was potential for AIG to trade at least up to 42. There was definitely evidence on the tape to support the idea that AIG would eventually make a nice move above 41. In fact, midday I was giving a lecture to our most recent trainees and one of them had a question about AIG. He observed that “it seems like recently AIG has spiked above 41 intraday but it always fails. How do you know if today is the day it will follow through?” My response was that based on the volume spikes both before and after 11:00am there was strong evidence that AIG could close higher today but it would need one more spike in volume to pull it off.

Back to Trader Dan. After AIG failed to hold above 41 for the second time Trader D hit out of his 2K shares. I think he made around forty cents on the trade but never got back in for the move that pushed AIG up to 42.

How To Get Back In

Tip #1: Don’t hit out your entire position if it is a trade that is working for you. Now this isn’t technically giving you a way to get back in but the truth is that most times you should have never been flat in the first place. If a trade is not working then it makes perfect sense to me to get flat the whole thing. But if a trade is working for you then scaling out is appropriate 95% of the time. Almost never will you be able to pick tops and reversals. Scaling out of a position ensures that you will still be involved for the entire move on most occasions.

Tip #2: If you get flat a position and the price you sold begins to act as support bid to get the stock back. In other words you sold the stock because you believed it was going to trade lower but its NOT TRADING LOWER. So buy it back as close to the price you just exited and keep your stop tight.

Tip #3: Generally, a position that trades in your favor has large institutional orders pushing the stock in the direction that you are risking your capital. The large buyers/sellers quite often will continue to accumulate/distribute at similar prices thereby giving you a perfect opportunity to re-enter your position when it touches one of those prices again. Check out the chart below. Three times AIG pulled back close to 40.70 and each time did not drop the 40.70 bid. Third time was the charm as it led to the final up move to 42.

Tip #4: Set an alert for the trend high or low from the first half of the day. When a stock breaches this price later in the day there is a good chance for follow through. ESPECIALLY if there were large volume spikes earlier in the day in the direction of the stock’s intraday trend.

Tip #5: If a stock consolidates in a tight range very close to a previous support/resistance level when it breaches that key level it is more likely that there will be follow through so should be used as a place to re-enter a position.

Hopefully these tips will give you an idea of how you can develop detailed plans on how best to take advantage of the opportunities you have identified each day. It only takes one good stock per day to be a consistently profitable trader. Just ask all the future traders who focus on a single contract each and every day

Steven Spencer, partner at SMB Capital, was cited earlier today in an article on TheStreet.com regarding the price action in MON and what traders are expecting if it trades below the 70.00 level on heavy volume. You can read the full article here.

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Holy mac and cheese what a move yesterday! I have had a long bias for the last four or five sessions and can legitimately say that I hit the bottom yesterday. And wait for it… also got short down there for a good ripperoni round trip sandwich.

I missed the initial point up move from just having to deal with my overnights, in addition to hitting the bottom on LVS, MGM, BRK.B and SPYs all at once. Oh boy was that a rough morning. The market is so resilient it makes me sick. We were setup to actually have a down day but the buyers took control early in the session cleanly after trapping a lot of shorts…including me. Ripper.

But the day wasn’t over at 11am. I knew I was starting to lose my cool when I gracefully smacked my keyboard with a couple of fingers. I focused on my breathing to get back in the zone and bang. LVS gives me a trade. The sucker showed its strength and rested for about 20 minutes around 20.20 which was last Thursday’s key inflection point. I saw my trade and I loaded the boat.

The stock broke its long term resistance on the daily and weekly charts with some descent volume during yesterday’s session. Think we may still have 1-2 more bucks of upside before resting. Keeping an eye on MGM and WYNN to play catch up. Long MGM and LVS overnight. Interested in buying pullbacks on open on entire sector but will be aggressive to play continued strength.