Posted 7:01 a.m.
The day began with a gap below yesterday’s close and 4 consecutive bear trend bars. However, the tails were prominent and there was a lot of overlap, and limit order bulls were able to make money twice in the 1st 5 bars. This increases the chances that this is a bear leg in a trading range, and it increases the chances that today will have a lot of trading range price action. It reduces the chances that today will be a strong trend day up or down. The odds are that the Emini will trade down for 30 or more points in the next few days, and that might have started yesterday, but this weak selling probably will result in a trading range open, and today still might be a small inside day. This might simply be a test of yesterday’s low that will be followed by a weak rally and a test of yesterday’s high, forming an inside day, or at least a day that mostly overlaps the past several days.
While it is possible that today will be a big trend day, this trading range open makes that unlikely. Traders are scalping mostly with limit orders. Until there is a strong breakout up or down, or at least a double top or bottom, the odds favor more trading range price action, and it might last all day.
Pre-Open Market Analysis
S&P 500 Emini: Learn how to trade a topping candlestick pattern
The Emini daily chart had consecutive outside bars, which is usually an expanding triangle on a lower time frame. It was on the 60 minute chart. What usually happens next is an inside bar, which then creates a ioi (inside-outside-inside, but with consecutive outside bars, it is an iioi) breakout mode pattern The Emini is also unusually overbought. Yesterday was an outside bar, which means that Monday was inside yesterday’s range.
Monday was an outside bar, which means that Friday was inside Monday’s range. An outside outside pattern therefore is also an iio and an ioo. It is a type of tight trading range, which is an intensely balance market. If today is inside yesterday, the pattern would be an iioi and an iooi. It does not matter what you call it. It is a tight trading range, which is a breakout mode pattern. Since it is forming in an overbought market, the odds favor the bear breakout.
The daily chart has had 8 consecutive bull bodies, which is rare. The month-long rally also is composed of a series of buy climaxes and attempts at tops. This increases the chances of a transition into a trading range and reduces the chances of the rally continuing for several months in a small pullback bull trend. The odds favor a trading range developing within a week or so, and it will probably last a month or more.
The weekly chart has had 7 consecutive bull trend bars, which is also rare. The week has not yet closed, and the range so far is small. There is about a 70% chance that Friday will close below Monday’s open and create a bear body on the weekly chart. This is especially true because of the topping pattern on the daily chart, which will probably create a sell signal bar today and then trigger tomorrow by trading below today’s low.
When a market is as overbought as the Emini is, it can get more overbought, but it is at unusual extremes right now. This makes it more likely that it will pull back over the next few ways. Most of the buyers over the past couple of weeks were momentum traders. They were not buying this late in a bull trend because they think the Emini is cheap. They are buying because they see every day higher than the day before and expect it to be higher again tomorrow. These are traders, not investors.
What happens when they no longer believe the Emini will be higher? They will sell out of their longs, and the Emini will probably quickly fall 30 – 50 points over 2 – 3 days. This should happen over the next few days.
The investors have big profits, but their stops are now far below. Their computer models require them to not exceed a certain risk. When the risk is big, they have to do something to reduce it. The easiest thing to do is to reduce their position size. Their profit taking creates a pullback. Once the pullback stops growing and the selling dries up, the bulls buy again, and they then have a tighter stop (below the pullback) and less risk.
The Globex range has been small and the Emini is down about a point. This is consistent with the outside-outside pattern on the daily chart.
Forex: Best trading strategies
The EURUSD had a strong rally in March, but the rally had three legs up, which is a wedge, and it failed to get above the February high. It has now traded down for 4 days. I wrote several times over the past 6 days that the daily chart was forming a wedge top, and that the bulls needed to begin to breakout above prior highs if the yearlong trading range was going to break out into a trend. I also said that my 80% rule made it unlikely to do so. Eighty percent of breakout attempts in a trading range fail, and 80% of reversal attempts in a trend fail. The odds are always against a successful breakout into a trend, no matter how strong a rally or selloff in a trading range is.
The selloff on the 60 minute chart is in a tight bear channel, but the slope is not steep, and the pullback is still above the low of the March 16 rally. This is a big down – big up – big confusion candlestick pattern. Confusion is the hallmark of a trading range. which means that the EURUSD will probably be in a trading range for several days, approximately within the range of the past 2 weeks.
Because the EURUSD has been in a tight bear channel on the 60 minute chart for 4 days, bears have been selling every rally, betting on a lower high. Every new low has tested back above the prior low. This means that the bears are taking at least partial profits, and that bull scalpers are buying below prior lows, looking for a scalp up above the prior low. They then take profits. When the bulls are unwilling to hold onto positions and are selling rallies, the odds are that the trend down continues.
When a tight bear channel lasts for 50 or more bars, there is a risk that the bulls decide that it is no longer a bull flag and instead has become a bear trend. A sign that the transition has occurred is a big bear breakout with a follow-through bear bar. If the bear breakout below the bear channel is big enough, the scale in bulls decide that they are in trouble. Instead of holding for a profit, they look for any small bounce to exit with a smaller loss. The result is that the bounce no longer goes above the last low, and instead is followed by a new low. The space between that high of the bounce and the breakout point is a gap, and this measuring gap is often the middle of the new bear trend.
The bears tried to create a measuring gap yesterday, but failed. They are trying again over the past hour. If they fail again, they will probably give up selling on the lows, and instead will wait to sell a rally. This means that the selloff over the last hour is important. If the bears again fail to create a gap and the EURUSD trades back above the 5 hour trading range of the European session (its low is around 1.1180), the 4 day selloff will probably end and the EURUSD will begin to form a trading range on the 60 minute chart.
A bear trend usually does not reverse into a bull trend. It usually first has to form a trading range. If the bears fail to create that 60 minute gap, then today will probably be a trading range day. The EURUSD is currently forming the follow-through bar on the 60 minute chart. If it is a big bear trend bar closing on its low, the odds favor a measuring gap. If it is not, the odds favor an exhaustion gap and a rally above the overnight trading range low, and the conversion into a trading range on the 60 minute chart.
The breakout was not especially big. This reduces the odds for the bears, but we need another hour to know if the bears will succeed, which they still might.
Summary of today’s S&P Emini futures price action and what to expect tomorrow
The Emini was in a narrow trading range for most of the day, and had a late sell vacuum test below the December 31 close, putting the market briefly in the red on the year.
The Emini tested the close of 2015 briefly today and bounced. However, the odds still favor a down week, which means Friday’s close will probably be below Monday’s open. The odds also favor a 30 – 50 point pullback over the next week, which means that the Emini might go sideways to down to the daily moving average.
See the weekly update for a discussion of the price action on the weekly candlestick chart and for what to expect going into next week.
Traders can see the end of the day bar-by-bar price action report by signing up for free at BrooksPriceAction.com. I talk about the detailed S&P Emini futures price action real-time throughout the day in the BrooksPriceAction.com trading room, and a 2 day free trial is available.
When I mention time, it is USA Pacific Standard Time (the Emini day session opens at 6:30 am PST, and closes at 1:15 pm PST). You can read background information on the intraday market reports on the Intraday Market Update page.
Thanks Al for your lucid response to a question that I realize might seem a bit naive, a question that springs from the surface-level counter-intuitivenes sensed so often in trading. One must always realize that it’s the aggregate market that decides, not any particular set of participants, who are only, at best, making probability-based decisions about what the aggregate decision will be.
Best, Charles
I think an implication of what you say about the non-importance of the specific algo is that price action is not the only way to attempt to be in sync with markets — a logical use of ATR can work just as well as looking at pivot clusters, to determine probable locations of support and resistance. Each of our own gene sets determines, in part, which of these approaches each of us find most workable.
Hello Al,
I have recently heard several in-depth interviews with systems traders, most of whom are almost entirely technical. None of them mention support and resistance, even when talking about risk mgt, usually discussed in terms of ATR.
You often mention the machines that do most of the trading, so most trading is system trading. Is support/resistance enforced by other groups of traders, or do would you guess that systems traders just don’t like to talk about programming S/R ?
I don’t care about what terms anyone uses. All markets are controlled by tests of support and resistance. That is basic market logic and it is programmed into our genes.
Just look at buying a house or a car, or watch an auction. Markets constantly probe for the best price at the moment. They have to probe up and down. When they go too high, the market turns down. That means there is resistance at that price.
All of those traders are trading primarily using support and resistance, but they might use other terms to describe what they are doing. They are looking for the best price and have to be conscious of what is too high and what is too low if they have any chance of making money. Everyone needs a sense of value, or they will quickly go out of business. For example, they might say an oscillator has a divergence. Why would it have a divergence? Because it is forming a double top test of resistance or a double bottom test of support.
The same is true of risk management. They have stops that are logical. For example, they want a stop on a long to be far enough down so that they do not get stopped out, but not so far down that the risk is too big. What they are saying is that they put their stop just below a price that they believe will be supportive.
It does not matter what algorithm a system uses. It ultimately will default to buying near support and selling near resistance, even if it is not using a chart. This is true on all time frames. When you put them all in a pot and stir them, you get the chart patterns that we see, which show what turns out the be the most popular support and resistance levels created by the dollars of all of the participants, whether or not all of the participants think in terms of support and resistance. Their behavior helps create support and resistance. If enough buy around a certain price, the market goes up, and that price becomes support. So, they bought at support, even though they were not thinking about that when they bought.