How a Professional E-Mini Trader Finds Great Trades (Part 2)

08/24/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 1)

Remember, Dr. Andrews and Roger Babson were students of Sir Isaac Newton, who was a well-known mathematician and physicist. But Newton was also the most well-known alchemist of his times, and although the term “alchemist” has fallen in stature these days, most well-schooled scientists know that the alchemists of Newton's days, as well as those who proceeded him, laid the ground work for our most powerful scientific principles. Newton's work, in particular, holds many of the keys to modern physics. His three simple Laws of Motion spurred the work of Albert Einstein and Stephen Hawkins and continue to spur physicists around the world more than 200 years after they were written. And most physicists believe his inspiration came from a treatise written at least several thousand years earlier, The Emerald Tablet. Newton's translation of this simple alchemical work is still used as the best and most useful translation. When we look at its most well-known phrase, “As above, so below,” we may be looking at the inspiration for Newton's best-known Law of Motion, “For every action, there is an equal and opposite reaction.”

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I marked where price interacts with these lines to make it easier for you to see why Shane might use these types of projections, as well as to spur you to ponder how these same lines may come into play later.

Shane measured the distance between the parallel down-sloping lines and then projected that distance forward (or downward, in the probable path of price), then he placed a simple trend line with the same slope at that distance. The original red, down-sloping line was the center line, the line that captured the frequency of price. It was a multi-pivot line as well. The simple trend line above captures the first swing or pivot prior to the center line. This measures the amount of energy price can carry forward from the center line when it “reacts.” And of course, by projecting forward a line with the same slope and the same distance below the center line, Shane now has a first reaction line, where price will have spent an “equal and opposite” amount of energy. As Newton translated, “As above, so below.”

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Still working on his market map, Shane performs the same exercise with the blue, up-sloping simple trend line. He copies the slope of the simple trend line drawn from the low of the gap opening and adds a new simple trend line with the same slope to the high of that day. This will serve as his action line, and the original blue, up-sloping simple trend line—also a multi-pivot line—acts as the center line. Now he simply measures the distance between the two lines and projects it forward (in this case, it projects below price, because that is the probable path of price and the natural path of a reaction) and then adds a new simple trend line at that distance, below the current price structure. This new blue, up-sloping line will act as the reaction line, a measure of where price will have expended its reaction energy off of the center line should it continue lower—and so it is named the “reaction line.” He also adds a second red, down-sloping reaction line (I'll label it R2) in case price continues much lower.

He then adds a horizontal black simple trend line—a multi-pivot line—that connects the high of the open gap and a handful of upper pivots.

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Shane has his market map for the upcoming day and is ready to see the opening action—and ready to look for the high-probability trade setups he uses when he trades this market in this time frame if one begins to develop.

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This chart shows a zoomed-in version of Shane's market map, along with the first five-minute bar of the day session. When this bar closes, it is 8:35 am CST on Monday morning.

I highlighted two particular bars. Both wide range bars and both bars that gapped open quite a bit to the downside. Note that in both cases, once the morning imbalances are smoothed out by the market makers in the US stock market, both in some individual stocks and in some large portfolios, the selling dries up. Then the larger traders, or “whales,” begin buying outright, pushing the stock indices higher. They are trying to drag mid-sized and smaller retail players into having to chase these markets higher in case price does indeed go high enough to fill the open gap. Look at the close on both extremely wide range bars; price closes at or near the bar's highs.

But let's look carefully at Shane's market map. Remember the blue, up-sloping reaction line he added before the market opened? This up-sloping line was based on a multi-pivot line, in this case a center line, and the distance from the center line to the prior high pivot, which he had used to form the Action Line. As Newton would say, “As above, so below.” Look at where price turned after the extremely wide range lower gap: Right at Shane's blue, up-sloping reaction line. And that's why he projected that line forward. “For every action, there is an equal and opposite reaction,” and if price sold off on Monday morning, an equal and opposite reaction from the action line, projected from the center line and its frequency was reflected by the blue, up-sloping reaction line. But that's far from the end of projections contained in Shane's market map.

Continued tomorrow in Part 3…

By Tim Morge of MarketGeometry.com

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