When Does Context Trump Bias?

Charts, Commentary

No, not that Trump…

I thought I would start the week with one more example from Friday as I think it punctuates a few topics which come up over and over again to consider in your model development. The first is how you develop your process for handicapping the relative importance of key market structures and frame your actions around them contextually. The second is your stance, perhaps also on a case by case basis, on whether you will stalk continuation trades which seek to trade through a major line in the sand or will only look to trade pullbacks to them from the other side. As an aside, even when your directional bias is strong, will the context of relative strength of the structure line influence whether to trade at all in that direction at any given time? In other words when does context negate bias?

So with those considerations in mind, consider the action on Friday which tested the super important 79-80’s structure as shown. As always, we suggest taking a very zoomed out view of the ‘shape’ of the market over many weeks or even months as part of your analysis process – yes, even as a day trader. The reason isn’t to draw any hard conclusions for predicting direction, but simply to be aware of areas in the market which are likely to be attracting longer term swing and position trading participants. No doubt in our mind the line based on the prior 79.75 case price from 3/26 as marked was the most important price overhead coming into the session Friday for the bears to hold or the bulls to retake. It was the highest high over several weeks since the last sustained selloff in the first two weeks in March. Hopefully it jumps right out at you with your zoomed out view as a day trader regardless of what your chart setting is. And again, removal of time from the process is always something our members are seeking to do. The idea being to identify key market structures which are likely to attract both buyers and sellers and used to frame entry/exit decisions, stops, hedges, etc. which show up the same on any chart periodicity setting. As you will see the 79.75 swing definitely fits that bill and then some…

Often super major lines in the sand like this will early reject initially and have rotation auctions a bit inside them before being legit tested and/or crushed, but that wasn’t the case here. The market rallied hard in Globex with hardly more than fleeting shallow pullbacks and went right to the legit test in this case. Point being that had it not quite made it there initally and instead rotated around the 75’s structure or a bit above for a good while, the perception of many who chose to play it in one direction or another might have been different. As always, most every decision will be wrapped with various contextual considerations to ponder. So with that said, the first question would obviously be asking yourself what your directional bias was at the time, if any. From the conversations we had in the room and elsewhere, most seemed to agree that there was strong upside pressure in the market and that sustained right through the cash open shown in the chart above. But given that this was such a super major line in the sand, were you willing to bet that the bulls would be able to crash right through it without a serious effort from the bears to fade it? In other words, even if you had a strong long bias, could the context surrounding such a major level keep you flat or even have you betting the other way? Trading straight through such a major level would be a pretty tall order for the bulls especially given there wasn’t any immediate news hitting the wire at the time driving prices higher. Not to mention likely profit taking from earlier bulls who had entered far below slowing the momentum down. And finally, another question which I poised at the outset is regardless of a long bias, do your process rules permit you to buy “under” a major line in the sand price like this and trade through it from below? Or do your rules require price to break firmly beyond and then pullback to the line holding from the other side before considering entry? As you can see here the answers to these questions would have absolutely determined whether you traded at all at this level and if so, in which direction…

Note the strong aggressive and passive bull pressure in pink coming in to test the case high followed by more of the same in red, which ended in a strong seller response to the buyer absorption into the high via short finish led by the largest size. The stage was definitely set at that point for those wanting to make short bets on the merit of the large number of late trapped longs into the highs there. But from there you can also see that the bulls didn’t give up and continued to absorb aggressive sellers through shallow pullbacks, especially the ones in blue and purple. But as I said earlier, if you were still a bull from there bias-wise, would you be willing to trade through the line above from below it? At that point it would be fair to say that the stage for likely mass ‘puking if wrong’ was set on both sides. Plenty of new buyers betting the current top would break higher, and plenty of sellers betting we would at least rotate back to test the prior day high 75’s area below before moving higher. And remember, though it is a broken record by now around here, any and all analysis is only an analysis of what IS happening right now. It can never predict the future relative to every risk/reward objective trade by trade. But what DOES tend to be quite predictable trade by trade is the psychological pressure of immediate fear and greed on most participants. In other words, we “knew” where a lot of traders entered in both directions, and we also “knew” that a good deal of them would be short term outrights traders who would get out if it didn’t go their way. Whether your bias, process rules and contextual reads at the time had you betting long or short there, it didn’t cost you very much to find out if you were “right” due to the likely puking of whoever was wrong once it did move out of the current range…

As it turned out it was the sellers who ultimately won the initial battle, obviously. The trapped longs got more and more nervous as time marched on and price didn’t make new highs. And back down to test the Thursday RTH high former R turned S structure 75’s from above we went. Those members with ‘structure to structure’ type risk/reward overlays no doubt had that area on their radar as a first scale or flatten spot. And as you can see there was plenty of seller absorbing relative volume to scale into on the initial early reject in light green and the legit test in dark green areas there as would be likely. Congrats to those who bet the short side here and won of course, but as always it doesn’t mean those who bet the long side above were ‘wrong’ either. Either way, hopefully it will spark some thought about your implementation of process rules and contextual considerations for your models. And remember, edge is only found over many events in a series, and from many contributing factors. .02

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