The EMini S&P futures had a breakout setup today, as Friday was an NR7 day (narrowest trading range of the previous seven days). The breakout setup meant we should anticipate a directional move today- a strong move in on direction – and we should look to trade accordingly.
For breakout trades I normally start with the previous day high and low. We look to go long if the market trades above the previous day high or go short if it breaks below the previous day low, looking for this to be a springboard to a larger move in that direction.
The concept behind this is that the range contraction / breakout trade pattern indicates a market has reached a short term equilibrium point. This equilibrium point is a result of market participants unwillingness to buy at higher prices or sell at lower prices, which is needed for a market to trend.
When market conditions change (data release, surprise news, weather change, etc.) traders have a new idea as to what is the market’s “fair value” is and they begin to buy higher or sell lower to move the market toward the new fair value. This often sets up a positive feedback loop where the market gains momentum in the direction of the move the farther it moves from the initial equilibrium point.
For the EMini S&Ps today, the big fundamental development was yesterday’s letter by FBI Director Comey reiterating that no charges were likely coming against Hillary Clinton over her emails. This caused stock index futures to gap higher on the open last night, and they held on to those gains throughout the night.
Last night’s action meant we would have to look for a different trade opportunity today, as the session open was well above the Friday high (our normal reference price) and the gap remained open this morning.
In this morning’s Swing Traders’ Insight Futures Watch List I laid out a different setup for today’s trade. I suggested we essentially us the overnight trade as a discrete trading session and in turn use the overnight high (2112.00) and low (2102.75) as reference prices, buying a move above the high or selling a break below the low. (The idea with this trade is that that the overnight move either didn’t take the market “high enough” or it “overshot fair value” to the upside.)
The market moved above the 2112.00 high about six minutes into the session, triggering our long entry. The initial stop loss could go below the day session low of 2108.00, or below a lower low if you wanted to give the trade more room. Regardless, with breakout trades we can generally use a relatively tight stop as momentum should carry the market in our direction.
By 11 AM the market reached 2123.25 within a point of the session high (which was eventually exceeded just before the close). You were likely out of the trade somewhere between this 11 AM high and 1:40 PM, when it fell out of the bottom of the midday channel. The end of the day rally to new highs is a not-uncommon occurrence for breakout days, which tend to squeeze “wrong way” traders throughout the session.
Essential Guide for Futures Swing Trading
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