How to Read the Market Like a Book

One of the most important factors in trading the US stock indexes is to understand what the trading sessions bias is.

I developed the Daily Directional Forecast for this purpose to offer our subscribers a crystal clear, underlying bias call on the markets each day. Along with this I recommend to traders where I expect the market to get “squeezed” or move against the wrong sided majority of the market participants.

In simple terms this means that if the Daily Directional Forecast’s underlying bias is for example “Neutral/Bearish” or “Bearish” we will generally be watching for an early rise in the market to go short.

In other words we are going to look to “fade into the underlying Market Force bias” for that day. “Fade” is a term which traders use to mean “go against” or “reverse trade into”.

If the underlying bias is “Neutral/Bullish” or “Bullish” for the day then ideally we would get a lower, early move that we could look to potentially “Buy long into the drop” to fade into the underlying Market Force bias.

We use specific numbers also when we look to take a trade which I develop using our proprietary methods.

There are different levels of underlying bias of the market. I consider the Market Force readings in the Daily Directional Forecast to be an “airplane view” of the markets bias.

There is also what I call the “sidewalk view” of the underlying bias which is more of an immediate and right here in the moment view of the markets bias.

Reading the “sidewalk bias” view of the market

To understand the “sidewalk bias” there are two key elements which each are broken down into several components.

The first is what I call the High Five and the other is called Volume Analysis.

Combining these two key elements will allow you to read the market like a book and watch what the real pro traders in the market are watching.

The High Five

I want to share with you a unique approach to staying on the right side of the market when you are day-trading the SP500 futures or the mini S&P (ES), using a special synthesized indicator I’ve dubbed the “High Five.”

The “High Five” consists of the following indicators:

• the NASDAQ Composite Index (the “NAZ”)
• the TRIN
• the Advance/Decline line
• the Dow Jones Industrial average
• the Transportation index

Together, these five indicators can paint a clear picture of the market’s mood and direction for that session. When they all point in the same direction, you are ill-advised to fade them, and when they give a mixed picture you can often save time and money by staying flat.

Using the High Five is a simple way of taking the pulse of the market right now, in real time. It is not the “Holy Grail,” even though I’ve had lots of feedback from traders who think the approach has changed the way they trade for the better.

Synthesizing the High Five takes practice, and involves watching the markets closely every day, learning to read its nuances. It will take a bit of time to gradually incorporate reading of the High 5 each day into your trading. But if you treat S&P500 futures trading as a serious business, success will inevitably follow as you progress in your skill development.

What you usually find with the High Five in day-to-day trading is the market getting ready to “roll over” from a bullish scenario to neutral or all the way to bearish, or vice versa. It can also tell you when a trading day is likely to be “one-way” and when you need to go ahead and sell a market that is breaking down, or buy a market that is breaking out.

The High Five is an incredibly valuable tool to help you make trading decisions during the heat of the action.

Below you’ll find the quick reference table for the High Five, giving you the parameters to look for as well as the definition of each indicator.

Interpreting the High 5 readings for Intra Day trading

The best way to view the High Five is in conjunction with a particular market setup. Let’s use as an example a bullish opening after a previous average-type bullish day, where the Dow closed up about 55 points, the NASDAQ composite index was up around 15 points and the SP500 futures were up 8 handles on the close from the previous session’s closing price.

On the next trading day you perhaps are feeling bearish overall but with a solid close the previous day, and a higher open today, you are concerned about getting short too soon. This is where the High Five come to the rescue.

Remember this is an example only. It takes many trading days to fully learn the nuances of the High Five, and there’s no substitute for watching these indicators in real-time, in all kinds of setups. But don’t worry, with practice you will be able to learn to read the market like a book.

However, if you’re clued in to the High Five, you’ll quickly see what I mean about it being an invaluable tool. Back to our example: The market has now opened with a 5 handle gap up and is rallying, with the Dow up another 40 bucks — but the High Five signals caution!

Here’s why: When you see the TRIN above 1.20, the Nasdaq fading the Dow, the Advance/Decline reading only +500, and the Transportation index weaker not only will it be very difficult for the market to rally much further, but the odds are excellent that getting short under these conditions is where you want to be. Keep in mind that this type of reading must be synthesized to paint an overall picture, and it will take some practice and keen attention watching the movements of the DOW and S&P500 in relation to these indicators.

A Mega Bearish reading looks and feels like this:

The overall market is lower with a heavy feeling of downside pressure. You see the TRIN 1.20 or higher, A/D line down -1500 or more, and the NASDAQ composite index down -30 or more, you can often just get short on any reflex rallies and hold short, because the S&P500 and the rest of the market are almost certainly going down.

On the Mega Bullish side you will usually see the market rallying or starting to rally when you find the NAZ up +30 or more, TRIN below 70, A/D line +1200-1500 or more, and often with the Transportation index leading the market % wise. You should then in most cases be able to get long on any pullbacks because the market is usually going higher with that High 5 setup.

If you take notes on the High Five and keep them on your desk tomorrow, carefully watching the nuances I’ve described, I think you will be impressed, to say the least.

Use a Quote Board from your data vendor to view the High 5

You don’t need to chart each index but just put them in a “quote board” in the upper corner of one of your screens. You will need a regular Data Vendor to build a High 5 quote box as they are not available from broker feeds.

Just set up your quote board and use the Symbol with the last price change, the change amount in points and the percentage change to compare to the other indexes. That’s all you need. Then just shrink it down to a small 5X7 type size and put it up in the corner of one of your screens.

In other words, using just the % change you can see if the Dow is up +1% which is usually a pretty big move but Nasdaq is only up +60% it means the Nasdaq is not being that supportive of the Dow rally.

In this way you can keep a constant eye of the flow of data on the High 5 while you are trading. This is what the pros do. You can often see them on CNBC when being interviewed on the floor about the markets. You will see them looking up while they answer the reporters question staring at the floor’s “big board” screen. I am just showing you how to make a clear and condensed version of what the floor traders are looking at.

For easy reference, here is our table explaining how to use the High Five, complete with the formal definitions of each indicator.

The Art of synthesizing the High 5

I want to elaborate on how to synthesize the indicators in the High Five in order to catch a turnaround in the markets, or hop aboard an early trend. You’ve got to learn how to synthesize the information in a fluid way, because as you know, it is rare to find any indicator or method that works in a completely static way. You will need to learn to “synthesize”.

Using the High Five is a simple way of taking the pulse of the market right now, in real time.

Your hard work, research, skill development and ability to keep your steady Traders Mind set is the real key to trading day in and day out.

I bring up this point, because I care about traders and want to help you succeed. Synthesizing the High Five takes practice, and involves watching the markets closely every day, learning to read its nuances. It’s not really possible to learn this in a few months, so don’t expect miracles right away. But if you treat S&P500 futures trading as a serious business, success will inevitably follow as you progress in your skill development.

What you usually find with the High Five in day-to-day trading is the market getting ready to “roll over” from a bullish scenario to neutral, or to bearish, or vice versa. Here are the setups to watch when you are looking for the market and the High Five to “roll over” and change direction.

Bullish “rolling” to neutral to bearish: Okay, the Dow has rallied for the last two days and the High Five have been consistently bullish following our criteria. Now on the third day, the S&P500 has opened flat to a few handles higher, the Dow is up 30 points or so and you have got a lot of what I call “Johnny come lately” bulls joining the open, not wanting to “miss” the bullish action.

However you notice the NAZ is only up 15 points or so, but the most telling things are the TRIN at 1.20, the Transportation index leading the market lower with a weak A/D line. This is the kind of setup where you want to start looking for a spot to go short very soon. This small continuation rally, after two days up, is about to fizzle out or at least consolidate to a neutral reading on the High Five. In such a scenario — although there are no guarantees — I would be looking for a 5-10 handle pullback off this rally, and maybe more if I can catch the right spot near the high point before the small rally fizzles out.

Bearish “rolling” to neutral to bullish: This is what you see when the Dow has been hit for the last few days. Perhaps it’s been three down days or so totaling 130 Dow points, with the High Five showing bearish readings each day.

Here comes day four and they open the S&P500 4-5 handles lower and naturally many traders think there is more weakness to come. However, as an astute High Five reader, you see that even though the Dow is already down -50 in the first half hour or so of trading the tape is revealing certain things. You notice that the NAZ is only down -10 or flat, the TRIN is 0.80 or less, the A/D line is more Neutral being up +500 or so and the Transportation index is leading higher on a % basis.

This is a tape that is telling you the market is “rolling” to neutral and either a reflex rally is coming or at least a consolidation, which should be good for a 5-10 handle bounce, if you can nail the right price on the lower side.

How to manage a position using the High Five: Let’s say the Daily Directional Forecast says “Market Force: Neutral/Bullish. Look to buy early dips in the market.” Okay, now it’s after the open and the market is dropping nicely as predicted. The Dow is down -70 or so, and you notice that the NAZ is only down -15 points. That’s your first clue. The NAZ is not in trouble like the Dow appears to be, so it could be a fake-out on the downside.

Look at the TRIN, it’s at 1.00. Hmmm, it’s a problem, but not really bearish and that could possibly turn around. The A/D line is more neutral and the Transportation index is leading the market higher which is not too bad but a caution on buying. So what do we do?

Now prices are approaching the Buy Pivot target and it’s after the first hour and a half of trading. You decide you want to try to nail the trade and buy at the exact Buy Pivot. So you put in a limit order, which gets filled. Okay, relax and start watching the price, and the TRIN in particular. The first thing to do is get a stop in there. Now see if the TRIN can start dropping below 1.00 into the 0.80’s. Make sure the A/D line is staying above +500-700 and ideally moving higher, as this is bullish and favors your trade.

Now the most important part…does the price start showing you some proof this is a good trade? A trade proves itself by showing you a profit, moving in the direction you’ve mapped out from the Morning Call, and knowing the proper trading set ups.

Remember this: The best sign of a valid trade is that it moves in your favor right away. Here’s my slight twist on that: You want the trade to move in your favor, but not too fast. When it runs 5 points your way and then comes all the way back, you’ve likely got a problem. We have described these before. I call this +5/-5 and the reversal of that is -5/+5. This type of price activity will usually see the market move in the direction of the recovery.

So let’s get back to our example, the one with the Morning Call saying “Market to rally on early drop.” Even though the High Five are similar to when you entered the trade, you have to
remember that the Headline has my proprietary 18 indicators backing it up. Does that guarantee the call? Heck no! But you’ve got to know that there is a lot of juice on the side of a reversal rally, in the case of this example.

Look to hold out, tighten the stop as the market moves in your favor and try to find a price that may be associated with another one of our areas of support or resistance to watch for further confirmation in your favor.

For example, if the market is pushing up off the Buy Pivot target in a nice and steady way, then ask yourself:

• Where is the Value Area in relation to this move?
• Am I long below the Value Area? This is generally not a good idea because trade below the Value Area is bearish, but do you see it “dipping” into the Value Area and holding there for more than 20 minutes? (That’s a sign it MAY run up and cover 75% of the Value Area to the upside as per our example).
• Does the High Five appear to be rolling to a more bullish position?
• How’s the A/D line doing?
• Is the Transportation index leading the overall Dow on a % basis?
• Is the TRIN pulling back, ideally below .80 as the market moves up?
• Is the Dow improving on the price to the upside?

An anonymous brilliant philosopher once said something like “You control the quality of your life by the quality of the questions you ask yourself each day,” and this was never truer than in trading.

Learn to keep a peaceful but intense dialogue of questions running while you trade. It will keep you from becoming complacent or a victim of wishful thinking so common to us traders. I constantly ask myself:

• What is the price telling me about this trade?
• Is the Dow favoring my position since I entered? What about the NAZ?
• Is the TRIN REALLY moving in my favor or am I in denial and the TRIN is really pushing against my position?
• What has to happen in the next 5 minutes for me to change my mind on this position?
• What does my chart really say? Has there been a retracement of price but an improvement in the appearance of the High Five?

Learn and practice to intelligently “dialogue” with yourself in relation to the position you’ve put on. You will get better and better at this as you do things you could see were “wrong,” like overstaying a position or getting in where you were jamming the trade and really did not have the confirmation you needed. Only then can you learn to correct the behavior.

Trading the S&P500 is a tough gig, yet full of amazing rewards, both external (money) and internal (pride, mental discipline, toughness). I am committed to making my service the best, most informative, no B.S. trading service in the entire industry. I want this service to be the kind I wish I had when I was first learning to trade the markets.

But I’m not going to lie to you — it’s going to take some work on your part. There’s no better time than right now to start studying my Morning Calls, learning the trading setups cold, and figuring out how to synthesize the High Five during the trading day. This is the way to succeed in the “fastest game in town” — trading the S&P 500 futures.

Learning to read the Volume of the market to increase your trading clarity

Learning to read the Volume of the market is going to be one of the most important things you do as a trader along with the High 5.

The Volume is the “life blood of the market” and is the fuel that drives prices to higher and lower levels.

In reading the Volume I have found the 3 essential ingredients are the current volume, the average of the volume over a 4-8 period average and using the ADX.

Below you can learn how to set up a simple volume meter whether on our
recommended Ninja Trader platform or any of the other data/chart vendors in the
industry. Most of them will have the features shown below.

The examples I have used below with the chart are for the Mini Nasdaq (NQ) which I use for trading multiple times during the live markets.

Our Daily Directional Forecast newsletter is a “one trade a day” service to help you get acquainted with the markets and start off slower.

You can use the volume meter for reading the market in any of the stock indexes including of course the Emini S&P500 (ES) which we use for trading with the DDF.

All you have to do is make sure that the ES contract is also loaded in your Volume meter and then adapt to the different levels.

On the ES the early volume will often soar over 2000+ contracts on an 8 period basis. Holding 1500 + is generally normal volume these days down to 1000 contracts on a 4 period basis.

If the volume starts dropping below 500-800 contracts on an 8 period basis then the market is definitely slowing down and caution in trading is urged.

This is why on our “one trade a day method” we usually will look to “fade into” a move Opposite of the underlying Market Force bias EARLY in the trading session. That is when the volume is usually the highest.

The ADX readings and method for watching this indicator are the same for the ES and the NQ.

How to set up the Volume Meter

Volume is the “life blood” of any active trading market. We use the Volume Meter to determine whether there is a normal daily volume flow or if the volume has dropped off sufficiently to cause a possible choppy or range bound market.

To build a Volume Meter open a chart on NinjaTrader with a 1 minute time period. We always look at contract size of the volume coming in on a 1 minute basis.

Then add the VOLMA Indicator (Volume Moving Average) from the Ninja Indicators file to measure the smoothed volume over an 8 period basis.

We then add the ADX indicator which is a valuable tool developed by the brilliant Welles Wilder for determining whether a market may turn choppy or range bound. We use a simplified version of ADX which is suitable for our Volume Meter. If you wish to learn more about the ADX indicator you can go to this link.

To build the Volume Meter just follow these steps:

1. Open a 1 minute NQ chart for use with our Boomerang Day Trader system
2. Add VOLMA indicator, set to 8 period, under “Plots” set to black color, Bar plot style and 3X width
3. Add Volume Up/Down indicator with plots set to Bar and 5X width
4. Add ADX indicator using 14 period and set “plots” to Bar 3X width
5. Add “Constant lines” indicator to the Key levels on VOLMA at 300 and 700 for NQ as shown on the chart above. Adding Constant lines make the line levels permanent on the chart until changed or moved.
6. Add “Constant lines” indicator to ADX at 20 and 12 levels
7. When your chart looks like the example above then click OK to Save and then Save the Chart to Templates so you always have these configurations ready.

*Note: you can erase the labels on each indicator by clicking on that area and backspacing over the label to make it not show up on the chart like the example.

How to use the Volume Meter

All we are doing is glancing at the Volume Meter regularly like any of the other Boomerang Day Trader Indicators. We just want to see that volume is trading at sufficient levels to accommodate our trades.

*Look for regular NQ volume to trade between 700-1000 contracts on an 8 period VOLMA basis. If it drops off below 300 this is an early warning that the market has less participants and may turn a bit choppy or range bound. Compare to individual 1 minute volume. (Note: see the volume levels for ES above)

*Watch for ADX to hold generally above 20 for a regular trending type environment. Below 20 is OK but use Caution. ADX dropping under 12 is a strong caution of a choppy or range bound market.

*If you see the market trading at regular volume levels and then suddenly over a short period of time dropping down under the 300 level this is a caution that the market may stagnate in a range bound area.

Advanced studies in Volume and ADX readings

We will be having on going monthly courses on reading the High 5, Volume and ADX readings.

I sure appreciate your becoming a subscriber and will look forward to seeing you on the webinars that we will be doing.

 

Questions about our services? Send me an email at mohan@daytradersaction.com.