5 Steps to Analyze Any Market

09/13/2012 7:00 am EST

Focus: STRATEGIES

The staff at NetPicks.com explains one way to determine whether a trend is for real or will fizzle out.

We want to run through an example of how to analyze the markets in context to help make sense of daily moves.

We’ll use the move in the E-mini S&P 500 on Thursday, September 6 as an example. We’ve chosen this day because it was a day when many traders we’re having a difficult time understanding why the markets were shooting up in the face of global uncertainty.

Once you realize what is going on, it’s certainly not rocket science to spot this kind of thing. On the other hand, many do understand it, yet fail to incorporate this valuable context into their trading plan.

I’ll explain my thoughts leading into the NYSE open and why we did not fade the move higher. Here’s what we look at:

1. Balance Range
Since August 7, the market had been balancing (with one exception on August 21 where there was a spike higher). This simply means it was moving sideways rather than directionally over the course of several days.

There was a broad perception of value where "unfair" highs and lows were in place, and retests of these brought in opposite trading activity to return price to the main part of the balance. What tends to happen with balances is they build up tension over time, and when they break, price often moves fairly dramatically afterwards.

Specifically in this case, the macro context was that the market was in summer trading mode and was awaiting specific events before committing to a direction. The first event was the ECB rate decision and press conference due on Thursday.

2. Volume
Volume does not always change our views on the market. However, it does sometimes confirm them.

Over the past month, volume had been significantly lower on many days than we had generally seen earlier in the year. Again, summer trading and lack of willingness to commit to a direction before certain unknowns were cleared up.

3. Risk Events
The unknowns which the market was waiting for were basically two things: will Europe be OK, and will the Fed embark on a course of further stimulus?

The first question is yet to be fully answered in that Greece is not out of the woods and Germany has constitutional issues to contend with in its support of Europe. The ECB meeting was an event at which people were anticipating a commitment to support, and this is what happened.

The jobs report on Friday was seen as a possible indicator of whether the Fed might have to act with further stimulus this week at the FOMC meeting. Previously, it had been indicated that they were watching the economic indicators (of which the jobs report is key) for cues to the necessity for a new QE program (Quantitative Easing).

4. Confidence on Open
The next part of the picture was the fact that the market was looking like it would gap up on open. That is, it would open up higher than the prior session’s close and also its high.

Often, gaps are at the very least tested into and possibly closed as the market attempts to verify the validity of the change in price. On Thursday, it was important to monitor for signs of confidence at open. What it did was open and immediately take off without even testing lower.

In turn, this now acts as a good technical reference point if the market were to revisit these price levels again at some point in the future. But the context was that there was high confidence on open, and this tied in with everything else to suggest a breakout from balance and possibly a persistent trend for the day.

5. Small Selling Rotations
The final aspect to reading the market was that any move lower that happened throughout the course of the day was very small indeed.

The biggest move lower happened late in the session and was 3.25 points, or 13 ticks. For those who don’t trade ES, I can tell you that this is pretty small, especially considering it was the biggest move lower! Small counter moves are particularly common on strong trend days.

Given the combination of technical and macro context with the addition of understanding the trading activity within the framework of this context, it should have been quite apparent that Thursday was not a day to try to go short the ES. In fact, rarely is it so clear that when it is, it is crucial to take advantage of such market moves.

This article was written by the staff at NetPicks.com.

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