How I Track the XOP: Developing Intuition with Consistent Metrics
Nov 24, 2018 Trading Blog
I’m not one of those traders who lives by the theory that trading must consist of an absolute set of rules and indicators which must never be deviated from. Over 19 years I’ve become mostly a discretionary trader, a combination of art and science. I still have general rules and guidelines (science), but since I trade the same instruments everyday, I have also developed a sense of intuition (art) and a sense of how the rules must be altered to fit the situation at hand. Developing that intuition is not easy.
To develop intuition, you must first develop a standardized way of viewing the market. A simple, consistent, and focused set of metrics that will act as your focal point. There is no ‘one true set’ of metrics. Everyone chooses their own way to view the market. The key is to keep it simple, manageable and useful. Do not fall into the trap of using too much information. More information doesn’t necessarily increase certainty. Once you develop your set of relevant metrics, next comes repetition. A lot of repetition. Apply the metric set continuously and then notice when the metrics change. Notice outliers. I call these outlier situations distinctions. If you can draw distinctions from a consistent set of metrics, you will find opportunities for trades. Standardization produces repetition, which then produces distinctions, and those distinctions produce situational expertise. There can be no expertise without standardization, consistent focus and repetition.
I track the XOP using 30 minute bars with the following metrics:
- Low/High/Close of each bar
- Net Change of each bar
- Range of each bar
- Intraday VWAP
- Max distance of each bar from Intraday VWAP
- Average price of each bar
- Max positive distance and max negative distance from average price of the bar
- Volume of each bar
- Cumulative volume of all bars for the day
This list is really just a measure three things: Sentiment, Momentum and Effort/Participation.
The first three factors in the list measure Sentiment. They answer the question of which way price is moving and how easily price can move. They measure the sentiment of the intraday participants. Large range and large change signals that sentiment is strong in a certain direction. When the bars are large, there is good trend and limited liquidity blocking that trend. When the bars become small ranged bars which don’t show much change, then either sentiment is lacking or price is sitting in an area of high liquidity and isn’t free to move away from it. The key is to develop an intuition to know when and by how much the bars differ from what has been historically normal. That itself is useful trading information.
The next four factors measure Momentum. What we want to know with these factors is how far away can the market move price from areas of fair value or average price. VWAP is a cumulative intraday measure of all transactions and what we really want to know is how far away is the current price from the average of all transactions for the day? The VWAP deviation is bigger picture momentum. For smaller picture momentum I drop down and use the average price of each 30 minute bar. It’s just a simple 30 minute moving average on a 1 minute chart recorded when each 30 minute bar closes. What I want to know with this is how far was price able to move away from that 30 minute average price? For the XOP specifically, once price moves about 20-25 cents away from the 30 minute average, momentum is extended and the possibility for a snapback to the mean becomes more likely. Knowing this, it helps for trade exits and entries, as well as getting some estimate of the strength of the current trend. I didn’t record it in the above list, but for larger macro timeframe momentum, I also use deviation away from a 3 day moving average (39 bar ma on a 30min chart), 8 day moving average (104 bar ma on 30min bar chart) and a 20 day moving average (260 bar ma on a 30min bar chart).
The last two factors measure Force and Market Participation. These are simply the volume of each 30 minute bar and the cumulative intraday volume of all trading up to the current moment. I want to get a sense of how today’s volume relates to past days volume. I want to know when a certain 30 minute bar has higher or lower volume than usual. For example, if the opening 30 min bar usually has X amount of volume, it is useful information to know when a day has 2X volume or 1/2 X volume. I also want to know who is trading during the day. Is the volume heavy, meaning institutional participation, or is volume light, meaning it’s probably just a bunch of market maker action going on. Volume also verifies the validity of price movement. Price movement on low volume can be suspect, while price movement on high volume is more likely to be trusted.
Once you have the answers to these three measures, you can then develop a trade plan based on how these measures are deviating from the normal XOP action or how price is reacting to certain news or oil numbers/statistics. It takes quite a bit of repetition, but eventually you develop an intuition as to when things seem normal and when things don’t seem quite right. This intuition isn’t a trading system in and of itself, but rather it is a bit of edge that you create for yourself which other market participants may not possess. It sort of helps you recognize when others might be leaning the wrong way, where bull/bear traps might be and when markets might be being temporarily manipulated. We aren’t trying to beat Goldman Sachs here, we are just trying to get an edge over some of the other participants in the market and put ourselves in a position to capitalize on those participants, as well as keep out of the way of the Goldman Sachs type sharks.
I write all the above mostly to commit my own thoughts to paper and to organize them, but also to show that there isn’t only one true Holy Grail way to trade. I see guys sometimes get hung up on absolute rules or indicators or patterns and they think that those things promise riches, which isn’t really right. Trading isn’t a one size fits all proposition or a cookie cutter “follow this rule 100% of the time” deal. Every person’s brain works differently, you just have to find what works for your brain and psychology. Give yourself room to allow the ‘art’ portion of trading to develop rather than limiting yourself to only the ‘science’ part of trading.