The Foundations of Profitability for Traders (Part 4)

03/13/2008 12:00 am EST

Focus:

Bo Yoder

Publisher and Writer, 5MinuteInvestor.com

In our last Tips for Traders, we looked at a market adrift. On this 5-minute chart of the S&P 500 Index proxy, (Amex:SPY) there was little reason to take a position unless a breakdown, or test of resistance could show itself.  But this "no trade" market environment is exactly what we need to exploit the self-fulfilling prophecy that is behind the magnet trade.

If we could look into the order book and see all the resting orders that exist, we would likely see something like the histogram shows on the chart below. There would be a lot of orders clustered around the lows of the base as traders wait for stop orders to trigger on a break to new lows. There would likely be a cluster of orders near the 200sma as traders hope for a price spike up into resistance. These are the traditional entry zones, and the spots in which order flow will congregate. As a magnet trader, these "ordinary" zones are of little interest. What we are focused on is the area of illiquidity between the highs of the base and the 200sma. If price should happen to break out above the highs of the base, there are very few orders to impede its movement. This offers a very high probability trade to the long side. The markets tend to seek liquidity, and since the nearest order cluster is at the 200sma, this is our profit objective for a long position.

Part 1  |  Part 2  |  Part 3

By Bo Yoder, of BoYoder.com

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