This originally appeared as a blog post in Scott Hoffman’s Futures Insight Blog on Friday, January 18, 2013.
I think it’s human nature to be a contrarian, especially among traders. Sometimes that’s a good thing—life would be boring if we all thought the same thing and there wouldn’t be any markets if everyone agreed on a “fair price”.
However, it is healthy for your trading health to know when not to be a contrarian and money can be made by going with the flow. Some of the most hair raising experiences I’ve had servicing my futures brokerage clients have come when I’ve tried to help out clients who have ended up on the wrong side of a strong trend. These experiences have taught me valuable lessons about survival as a trader.
Below is the daily chart for the eMini S&P futures. It had been working higher for much of the New Year; last week it made a high at 1471.50 and then it traded sideways for a few days-the past three days closes had been within three points of each other. Yesterday it really never tested either end of Tuesday’s range and it closed with the narrowest range of the previous four days.
These patterns told us that the market had reached short term equilibrium; a move out of this equilibrium would likely see positive feedback and a trend day-it would open on one end of the range and close on the other.
On a day when we anticipate a trend day is likely (I call them breakout setups), given that we anticipate the market will open on one extreme and close on the other, we want to avoid trading against the trend, as it’s likely to be strong and not give countertrend traders much of a chance to get out with small losses. What’s more, it’s likely that the longer a trader stays in a countertrend trade, the large the trading loss will become and the losses often grow with startling speed.
So how do we know which way a breakout will go-how do we avoid getting on the wrong side of the market and how can we position ourselves to take advantage of trending moves?
We do this by monitoring the bounds of the recent trading range. Our trading actions are the opposite of what we would otherwise do at support or resistance. Rather than looking to short a market after it has moved higher and reached resistance, instead we look to go long after the market breaks above resistance – we use this as our evidence that the market is resolving itself to the upside. Likely we would look for a break below support as the trigger for a short sale.
This type of trading frees you from the difficult task of predicting which way a market will move. We let the market decide where it wants to go and we enter a trade when it “makes up its mind&rdquo. Why try to make a (difficult) decision if you don’t have to?
Today’s intraday chart for the March eMini S&P futures is below. Last night we didn’t know which way the market was going to go, however, by the pattern of the past few days we knew to anticipate that a breakout move was likely. We would start by looking for a rally over yesterday’s high or below yesterday’s low.
Yesterday’s high of 1469.00 was taken out around 7:20 this morning. From here we would look for 1469.00 to be support and clearing last week’s high of 1471.50 would be further proof (and long entry) that the market was heading higher.
1471.50 was taken out after the 7:30 AM data dump and it rallied to a session high of 1476.00. It then retraced into the 8:30 AM stock market open, dipping slightly below the 1471.50 level.
This premarket correction is a great example of the kind of move that sucks in the unwary countertrend trader- “It took out the old high and failed! Time to pick a top and short it!&rdquo By the time that correction ended it had fallen 1.25 points below the breakout price; and it’s hard to catch much of a move that small. However, if you went long after it regained the old high you had a steady (it’s been kind of small so far) move in your favor, and the trend day means we should continue to anticipate higher prices later into the session.
Remember, it often pays to be an independent thinker and trader. Just don’t let your independence blind you to times when it’s smart to think like a sheep and be a follower.
© Scott Hoffman