One Of My Favorite Trading Patterns

If you click on the above, you'll see a screenshot from my trading platform (Sierra Chart).  There are five measures arrayed from top to bottom:  1) ES futures, each bar represents 50,000 contracts traded and lines represent shorter and longer moving averages; 2) amount of volume for each bar that is traded at the offer price (buyers more aggressive) minus the amount of volume traded at the bid price (sellers more aggressive); 3) a 10-period moving average of volume at offer minus bid; 4) a five-period RSI for the ES futures; 5) a five-period detrended oscillator reading for the ES futures.

The idea is that, in a single view, I can see:

1)  Are we overbought or oversold?  (RSI, Detrended Oscillator; Price vs. moving averages)

2)  Have we seen dominant buying or selling pressure? (Volume at offer/bid; moving average of volume at offer/bid)

3)  How much price change are we seeing in response to buying and selling pressure?

The yellow arrows point to occasions in which we are getting short-term selling pressure and oversold levels with very modest downside price change.  These are occasions in which there is meaningful selling pressure, but it's unable to move price meaningfully lower.  These sellers are eventually trapped and help fuel the next leg higher in the uptrend.

The proportion of volume traded at offer vs. bid correlates with actual price change around +.46 over the past 10 months.  That is a significant correlation, but note that the amount of variance in price change accounted for by buyers lifting offers vs. hitting bids is only a little over 20% (.46 squared). It's when we get decent buying and selling pressure that cannot move price significantly that we see reversal opportunities set up.  Many of the best short-term trading opportunities come from occasions in which buyers or sellers become trapped and must run for exits.  We can identify those occasions and anticipate the unwinds.

Reading the psychology of the markets is simply as critical as being privy to your very own psychology.

Further Reading:

Finding Unique Opportunity in the Market

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