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Measuring Price Action within market structure

Yesterday I posted a short article describing how I set up my charts to track market structure. That list of 10 points describes places where liquidity is likely to be and these are the places where I want to trade. The key to knowing whether or not I want to trade at those locations is how price acts as it moves between those levels and how it acts when it approaches and reaches those levels. To accomplish this, I use only three things: Volume, a 30 period moving average on a one minute chart, and envelope channels set at .1, .15 and .2% set around that 30 minute moving average. I don’t use any other indicators to trade, as the 30 ma and bands, combined with the market structure I described yesterday, tell me everything that a set of many different indicators could, and probably more.


I primarily work off a one minute chart, but I also use a 30 minute chart. I divide each day into 13 periods, each of 30 minutes. I track range, change, volume, MFE/MAE and average price for each of those 13 periods. Those stats for each period help describe the volatility, direction and force of the market during each period throughout the market day.


Now, back to the 30 minute moving average and the envelope channels.  I daytrade the IWM, so I’ll describe the settings for that trading instrument. If anyone decides to use this method, you will have to determine your own setting for the envelope bands for your specific trading instrument. The settings for the bands are dependent on the normal volatility of the instrument you are trading. For the IWM, the normal move above or below the 30 minute moving average is about 16 cents (about .1%). This first channel is colored green. The next channel is set at 24 cents (about .15%) and is colored yellow. The third envelope around the 30 ma is set at 32 cents (about .2%) and is colored red.


So how do we use this? One of the most common indicators I see people use is a stochastics indicator. They usually set it at some random interval like 14, which makes absolutely no sense to me. A basic stochastics indicator set like this basically looks back 14 periods and tells you where current price resides within the range of the last 14 periods. The moving average channels do something very similar, and they are easier to read. All you have to do is look where price is within the bands. If price is near a red band, then that is the equivalent of an extreme stochastics reading (oversold/overbought). Once price reaches the outer envelope, there’s a good chance it will reverse. When using stochastics, I’m usually only concerned when price reaches an extreme, so these bands work well for that purpose.


Another stochastics related measure is determined from the points I mentioned yesterday. If we want a rough larger term stochastics reading, then I simply look at where price is in relation to the two light blue bands (last week’s high and low). Then drop down to the intermediate level and see where price is between the red and green lines (yersterday’s high and low). Then we can drop down to an even smaller timeframe and see where price is in relation to the intraday high and low (which I don’t mark on my charts). The shortest timeframe, again, is the location of price in between the two red envelopes. By doing this it is easy, and extremely quick, to look at a single chart and see where you are on four different timeframes of stochastics. That’s something that a single stochastics indicator at the bottom of your chart just can’t do.


The next most common indicator I see people use is Bollinger Bands. I think the moving average envelopes are much more useful than Bollinger Bands for measuring volatility and momentum. When you use Bollinger Bands, you are simply measuring the last 20 periods of price. If for some reason IWM price has been in a five cent range for the last 20 periods and it then moves 10 cents very quickly, then the Bollinger Bands basically explode and tell you that massive volatility has hit. But has it? Is a 10 cent move really massive volatility in IWM? It isn’t. As you may remember, the first envelope channel is set at 16 cents for IWM (this is average volatility). So the 10 cent move which Bollinger Bands show as an explosive move doesn’t even represent average momentum or volatility for IWM. Basically, the moving average envelopes go way back in time, whereas the Bollinger Bands only go back 20 periods (which isn’t much on my one minute chart).


The Bollinger Bands never really let you develop any sense of what a common or average move is for IWM (or whatever you trade). Without a standardized way of looking at something, you can never develop any intuition. The green envelope is at 16 cents, no matter if it’s 20 periods back or 2000 periods back. The envelopes allow you to get an intuitive feel for how the IWM moves over an extended time, not just the past 20 minutes. When it moves 16 cents, it’s an average move, not really much momentum. When it hits the outer envelope at 32 cents, that’s a big momentum move. The Bollinger Bands just can’t give you this information, because they only show you the move in relation to the prior 20 periods, not the past 2000 periods.


The slope of the moving average in the center of the envelopes is also an effective tool for judging momentum. The higher the slope, the stronger the momentum. It was a bit difficult to judge this with the eye at first, but after watching it for a few weeks, it’s easier to develop an intuitive feel for the momentum/slope. You can also get a feel for momentum by noticing how long price stays away from the moving average. I know if I see price stay a good distance above or below the 30 minute ma for say 30-40 minutes in IWM, that’s a strong trend. Normally, it revisits the 30ma in about 20 minutes or less.


I’m not going to dive too much into volume here since I think most people know how to use it pretty well. One resource that I would point out that really helped me learn to use Volume Spread Analysis is Tom Williams’ book “Mastering the Markets” that he has on his site volumespreadanalysis.com. There’s a free copy online here and it’s well worth the couple hours it takes to read it. If you want a new view on how to better use volume, give it a read.


Traders also use other indicators to judge momentum. Things like MACD, RSI, Momentum, etc. The envelopes can pretty much do the same job as all these momentum and overbought/oversold indicators. I’m definitely not saying that what I’m doing is better than what others are doing. Everyone should do their own thing. The point is to pick ONE thing and stick with it. That’s the only way to develop feel and intuition. For me, I picked envelopes because this one indicator can do the job of 3-4 different indicators (stochastics, Bollinger Bands, Momentum, Overbought/Oversold, Trend/ADX) and that’s just easier and quicker for me to use and helps develop intuition on several different levels simultaneously. Simpler is always better.


So now we have market structure and a way to measure price action. There are still two more steps to creating the trading view. For me, an edge situation is defined as price action within market structure within context. For the next post, I’ll explain the context element of the trading plan. Once the context part of the plan is defined, then I’ll follow up with the final piece, which is specific edge price action within this structure/PA/context model. Basically, once I have the right location of market structure, a good handle on the price action characteristics and a handle on the overall market context, I’m then looking for very specific price action which has an edge. I’ll cover that specific price action in an additional article.


I’m out of here on Friday, so the final two parts probably won’t get done until I get back. I’m also going to put together an article on a list of general daytrading rules and ideas that I’ve collected over the years. I know how hard it can be to find real information on daytrading. There are so many fake gurus out there charging for things that just don’t work. Hopefully, these posts will help someone find their way. If you have any questions at all, feel free to contact me, I’m always glad to help. Trading isn’t easy and sometimes just finding one or two good ideas can start a chain reaction to reach profitability.

Merry Christmas and I’ll see you guys in January.

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