T2W Trading Community

Capturing Trend Days

Trend days occur when there is an expansion in the daily trading range and the open and close are near opposite extremes. The first half-hour of trading often comprises less than 10% of the day's total range; there is usually very little intraday price retracement. Typically, price action picks up momentum going into the last hour -- and the trend accelerates.

Classic Trend Day - A large opening gap created a vacuum on the buy side. The market opened at one extreme and closed on the other. Note how it made higher highs and higher lows all day. Also, volatility increased in the latter part of the day--another characteristic of trend days.

A trend day can occur in either the same or the opposite direction to the prevailing trend on daily charts. The critical point is that the increased spread between the high and low of the daily range offers a trading opportunity from which large profits can be made in a short time.

Traders must understand the characteristics of a trend day, even if interested only in intraday scalping. A trader anticipating a trend day should change strategies, from trading off support/resistance and looking at overbought/oversold indicators to using a breakout methodology and being flexible enough to buy strength or sell weakness. A trader caught off guard will often experience his largest losses on a trend day as he tries to sell strength or buy weakness prematurely. Because there are few intraday retracements, small losses can easily get out of hand. The worst catastrophes come from trying to average losing trades on trend days.

Fortunately, it is possible to identify specific conditions that tend to precede a trend day. Because this can easily be done at night when the markets are closed, a trader can adjust his game plan for the next day and be prepared to place resting buy or sell stops at appropriate levels.

The Principle of Range Contraction/Expansion

Several types of conditions lead to trend days, but most involve some type of contraction in volatility or daily range. In general, price expansion tends to follow periods of price contraction, the phenomenon being cyclical. The market alternates between periods of rest or consolidation and periods of movement, or markup/markdown. Volatility is actually more cyclical than is price.

When a market consolidates, buyers and sellers reach an equilibrium price level -- and the trading range tends to narrow. When new information enters the marketplace, the market moves away from this equilibrium point and tries to find a new price, or "value" area. Either longs or shorts will be "trapped" on the wrong side and eventually forced to cover, aggravating the existing supply/demand imbalance.

In turn, the increase in price momentum attracts new market participants, and pretty soon a vicious cycle is created. Local pit traders, recognizing the one-way order flow, scramble to cover contracts. Instead of price reacting back as in normally trading markets, "positive feedback" is created -- a condition in which and no one can predict how far the price will go. The market tends to gain momentum rather than to check back and forth.

Tick Readings for Short-term day trading - Volatility conditions are important to quantify even if you are a short term day trader. In a normal consolidation market, overbought/oversold type indicators, such as intraday tick readings, can work well for S&P scalps.

We can tell when the market is approaching the end of contraction or congestion because the average daily ranges narrow. We know a potential breakout is at hand. However, it is difficult to predict the direction of the breakout because buyers and sellers appear to be in perfect balance. All we can do is prepare for increased volatility or range expansion!

Most breakout trading strategies let the market tip its hand as to which way it wants to go before entering. This technique sacrifices initial trade location in exchange for greater confidence that the market will continue to move in the direction of trade entry.

The good news is that breakout strategies have a high win/loss ratio. The bad news is that whipsaws can be brutal!