This article was originally written by Scott Hoffman on December 18, 2009.
In my opinion, George Douglas Taylor was one of the greatest trading thinkers, and luckily he left behind one book on trading: The Taylor Trading Technique. This book lays out his “Taylor Book Method” for swing trading in futures.
Taylor postulated that the markets had patterns based on “market engineering” from the “powers that be” in the grain markets. These insiders would frequently cause prices to decline to set up a buying opportunity for themselves. Then, after the market rallied sufficiently to yield profit for these insiders, a short-term top was created to give them a selling opportunity. The market would sell off, and the cycle would start again.
The effect of this engineering was to amplify the natural rhythm of the market, creating false moves that would fool traders into buying when they should be selling, and vice versa. The thrust of the Taylor Technique is to identify this rhythm and take advantage of the “false moves”. I have long maintained that if an individual could identify moves in the market that would serve to inflict the most pain on unwary traders then they would have a great trading system. I believe the Taylor Technique does that.
Taylor created this method for the grain futures markets, but I find it equally applicable in the financial futures markets today. Hedging programs in financial futures create self-correcting markets. Buying will create an advance for a few days while hedging takes place to lock in gains and to sell options against a profitable position to earn premium. Straight selling adds to the hedge sales, and a short-term top is created. This yields a repeating pattern of a 2-4 day cycle of buying, followed by a 1-3 day cycle of selling (markets tend to fall faster than they rally).
Taylor labeled each trading day using 3 primary classifications: ‘Buy Day,’ ‘Sell Day,’ and ‘Sell Short Day’. These labels were used to identify where the market was in the cycle and to align entries and exits with the market’s rhythm. If you read Taylor’s book, however, things become murkier. He describes situations in which you sell on buying days or go long on selling days. In some sections it is hard to tell what he means or whether he is contradicting himself. Additionally, he puts a lot of stock into measuring and recording previous swings, then using past measurements to predict how far future swings may go. In my opinion, I have found these examples to be of limited value.
This does not mean that his ideas are not useful; they are brilliant insights. The key is to think in Taylor “concepts” rather than to follow it mechanically. I have found the Taylor technique to be much like Market Profile when using his concepts to analyze markets in an anticipatory way. By anticipating upcoming market structure, you are armed with a plan as to how a market may unfold, and how you can trade it.
Taylor sought to avoid intraday market noise and focus on a core play for the day. This is the same principle of Market Profile’s emphasis on ‘trade location’. As Jim Dalton–one of the best minds in MP’s–wrote: “The end of an auction offers the moment of greatest opportunity…risk and return are asymmetric at this point. Good trade location is the key to managing risk.”
This is the core premise of the Taylor technique, locating the end of a buying or selling “auction” and the beginning of another. When you identify this correctly, potential rewards can be large as you enter at the start of a multi-day move.
There are five core “Taylor Concepts” that form the basis for the Taylor Technique. They are:
- A ‘high-to-low’ or ‘low-to-high’ rhythm: Most of the time, markets generally alternate in a 2-3 day high-to-low or low-to-high intraday rhythm. We compare the open to the close for this observation.
- Swing Highs and Swing Lows: These are made one of two ways, either with a ‘Violation’ (a test above/below the previous day high/low) or a ‘Good Gap’ (the market gaps the other way, trapping the previous day’s players). A Swing High or Swing Low is marked by ‘excess’ as the market ‘overshoots.’ This is the false move the Taylor Technique seeks to identify.
- Residual Momentum: Markets tend to exceed the previous day‘s high or low in the majority of days.
- Inside Days/2-Day ‘Balance’: I expanded this to a broader range of ‘breakout’ setups; days to forget the ‘Taylor count’ and ‘go with’ a move out of close in support or resistance.
- Key Reference Point: The use of a price for a ‘reference point’ helps you interpret the market’s action. It is usually the previous day’s high or low, depending on whether you anticipate buying or selling. These five concepts help you identify where the market is by the Taylor cycle, and gives you price levels to identify places of opportunity.
These five concepts help you identify where the market is by the Taylor cycle, and gives you price levels to identify places of opportunity. As I said above, the Taylor Technique classifies days according to one of three labels; ‘Buy Day,’ ‘Sell Day,’ or ‘Sell Short Day.’ We use these labels to anticipate what our core play will be that day, and to use that structure to identify and execute trade opportunities.
The first type of day is the Buy Day. We look for a Buy Day after 1-3 days of high-to-low trading action. On the Buy Day we anticipate the end of a decline (a selling auction in Market Profile) as the last sellers get in. We generally use the previous day’s low as the reference price. A move below the previous day’s low creates the excess low that marks the end of the decline and we seek to buy as the market rejects lower prices and begins to rally. On a classic Buy Day we look to buy when the market trades back above the previous day’s low, thus trapping the last sellers. This rally continues, and the resulting low-to-high action is evidence of Buy Day action (and a successful long entry).
On a successful Buy Day, we have established profitable long positions that we took home, anticipating upside follow-through on the Sell Day. The Sell Day can be confusing because, in spite of its name, it is generally not a day to establish short positions (although there are exceptions). On a Sell Day, we anticipate residual momentum to rally the market to the high of the previous Buy Day session. This rally to the ‘Buy Day’ high is used to liquidate the long positions purchased in the previous session.
The final day of the Taylor Technique cycle is the Sell Short Day. A Sell Short Day is incredibly similar to a Buy Day. We look for residual momentum to produce a move above the previous day’s high to create the excess high that traps the last of the bulls. At this point, the rally (a ‘Buying Auction’ in Market Profile) terminates, and a decline ensues. On a classic Sell Short Day we use a move back below the reference price–usually the previous session high–as a trigger to enter a short position.
We generally use the previous session high or low as our reference price, but an Inside Day poses a different situation, as there is no violation to create an excess high or low. Taylor viewed Inside Days as a sign that the market was at a short term balance point. For this reason, Taylor would view both the previous session’s high and low as reference prices. We anticipate a move above the previous day’s high to be a‘go with’ move to buy, anticipating the start of a rally. A move below the previous day’s low would be the same ‘go with’ move.
The Taylor Technique, combined with a trader’s tape reading skills, gives a trader the powerful conceptual framework to categorize and understand market activity. This framework improves a trader’s ability to anticipate market movement as well as to allow him or her to trade with the rhythm of the market.
© 2011 Scott Hoffman
The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.
Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.