Letting The Market Reveal Its Psychology

I recently posted one of my favorite trading patterns in the broad market that reveals the psychology of market participants.  Here is another favorite trading practice:

I let the opening minutes in the market go by without making any trades.  I'm watching the flows in the NY day session and getting a sense for how the market is moving.  Specifically, I'm looking at:

1)  Breadth and Market Sector Behavior - Is everything going up or down on extreme breadth, or are we seeing a mixed market with rotation among sectors?  The former gets me thinking about a trend day; the latter has me thinking about trading relative strength or weakness with the sectors that are strongest or weakest.  The advance-decline line can also be helpful in this regard.

2)  Relative Volume in the Market - Are we seeing more volume than average come into the general market in opening minutes, same, or less?  Volume tells us about *who* is in the market.  Fewer institutional participants means less movement and greater likelihood of choppy or range trading; more participants leads to greater momentum in the overall market.

3)  Buying and Selling Pressure in the Market - I use the upticks versus the downticks among the stocks in the market averages to tell me how many stocks are attracting buying or selling in real time.  Especially important is the degree to which the buying or selling is capable of moving the market.

So let's put it all together.  If you click on the chart above, you'll see the upticks versus downticks among all Russell 2000 stocks in the top panel, along with a moving average of the ticks (green line).  I've also drawn a yellow line at the zero level so that you can easily see when the short-term moving average of the ticks is above and below zero.  The bottom panel shows the price of IWM on a one-minute basis (Chart and data from Sierra Chart).

The early action in the day, as well as recent days, suggested to me that the smaller cap stocks are showing relative weakness.  Waiting out the first minutes of opening trade, we can see more downticking among the Russell stocks than upticking.  Notice them (yellow arrows) how bounces in the Russell TICK occur at lower price highs, providing nice risk/reward opportunities to sell IWM.

Three matters help me permit the market monitor its psychology:

1)  Looking at all market sectors, not just the overall market or the same stocks that everyone else is trading;

2)  Waiting out the opening minutes of trade to let the market patterns come to me;

3)  Looking at data that the majority of players don't look at, such as upticks/downticks that are sector specific.

As I've stressed in the past, you become a good trader by improving your game.  You become far better when you figure out ways to play different games.

Further Reading:

Looking at the Market Through Different Lenses

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