TABLE i 6-3 Percentage of Overnight Price Gap Compared with Subsequent Trading Range, for Selected U.S. Markets

% Change Overnit

Price reversals that occur during the day can be plotted using a smaller point-and-figure box size than is common for daily charting. The more frequent reversals due to the combination of more data and smaller box size will define the frend sooner or bring the protective stop closer. Remember, stoploss levels advance only when there are reversals, in this way, day trader improvements are transparent to the point-and-figure users who work only with the daily high, low, and closing prices. In general, when there is a choice of plotting a point-and-figure frend continuation or reversal, the reversal should be plotted. This allows the chart to reflect the reversal sooner and bring the stop-loss closer-both are an improvement over the standard rules.

Moving Averages

The infrinsic dependency on time makes a moving average less adaptable to day frading. To be used properly, a moving average must be recalculated at fixed intervals. Two phdosophic: questions must be answered with regard to infraday moving averages. Do frends exist in this short time interval, and does it make sense to apply a moving average to all intraday prices unevenly spaced with respect to time? In a pre\ious section of this chapter, the conflict between noise and frends was discussed. Martlets with a laige noise component require more time to identifj a frend, or a laiger price move; therefore, it may not be possible to enter a frend frade and still have enough profit potential before the end of the frading session, it is likely that there will not be more than ISo of the daily range remaining after the frend has been identified, making the profit opportunity too small.

The versatility of computers allows all intraday prices to be used in a moving average rather than the traditional 5-minute bar; furthermore, you can create a price bar based on everj 5 or 10 prices, regardless of time. In a liquid maitet, prices might be posted every

FIGURE 16-2 Opening gap as a percentage of daily move.

Opening Gap as a Percent of DaHy Move

Pork bellies Soybeans Crude oil "

Silver " Gold

Biitisti pound Deutschemark (In %)

Japanese bond I German bund Euroyen U.S. Treasury bills U.S. Treasury bonds

Percent reprasenlBd by opening gap

few seconds even though volume may varj. For practical piuposes, prices might be considered equally spaced. But consider an extreme example. The price of a less liquid maitet changes every 15 seconds during more active times then quiets to 5-minute intervals; at one time, there is a lull of 15 minutes followed by a jump in price. Is there a difference in the way we would interpret the following two pattems? is there a difference in the way a moving average would calculate the trend?

Pattern A shows a gradual upward movement over equal time intervals; pattem shows slow rallies and fasi drops. When interjreted by a trader, pattern is often considered toppy; it is a maitet straggling to go higher with anxious sellers. Moving averages of pattem A, taten as shown, and pattem B, interpolated to equal intervals, will have the same trend direction at eadi point. There is not enough information to know which is best but it is clear that the pattems can be interjreted differently.

More on Choosing the Length of the Intraday Bar

While there is no right bar length, traders most often choose 5-, 10-, 15-, 30-minute. and 1-hour periods to chart. Most of the commercial software packages require that the interval be evenly divided into 1 hour; therefore, a 6 1/2-minute interval is not allowed. When using longer bars, such as 1 hour, it is important to consider the length of the last bar of the day. A 1-hour bar will post its first price at the end of the first actual hour, rather than 1 hour after the open; the last bar will be the interval from the last whole hour to the close. In the case of oil, this may only he 10 minutes. When bars are uneven in this way, the price ranges and corresponding volume are no longer comparable with one another.

There is a difference in opinion between analjsts over the choice of intraday intervals. One group prefers to pick a standard number because it conforms to the way others trade, for example, you can expect orders to flow more actively every hour. This approadi may be particularly valuable if you plan to take the opposite position. The other group of traders are constantly seeking their own time interval, avoiding uneven order flow and price distortion caused by most other traders, if you are part of this group, you may choose your interval by dividing the total number of minutes in the trading session by a value that gives you equal-length bars. You may also want to find a bar length, such

as 21 minutes, that represents a Fibonacci number and comes close to dividing the day equally. MARKET PATTERNS

A trade that lasts from 1 to 3 dajs can be improved if short-term pattems or cycles can be found. For , in a frending marfcet there are outstanding weekly and weekend pattems. It is most common to find that the price movements from Thursday to Friday (closeto-close) are in the direction of the major frend and that the movement on Monday is a continuation of that frend. By Tuesday (or sometimes Wednesday), the sfrength of new buyers or sellers has faded, and the marfcet reverses due to lack of activity and some profit talcing. It often stajs in this state through Wednesday or early Thursday when it a- resumes the frend. In a sidewajs marfcet, the Friday and Monday directions differ from the direction during the priorweek and often differ from each other.

Support and Resistance

Support and resistance levels are important to the short-term frader. if prices start to move higher, slow down, and finally reverse, it is natural to consider the top price as a resistance point. Prices are thought to have been stretched to their exfreme at that level. Any subsequent attempt to approach the previous high price will be met with professional selling in anticipation of prices stopping again at the same point. In addition, it is common for the same traders and others to place orders above the pre\ious high prices to take new long positions or close out shorts in the event of a breakout.

This method, very popular among floor fraders and active speculators, tends to create and emphasize the support and resistance price levels until they deflne a clear frading range. Within a Ito 3-day period, these ranges can be narrow and yet effectively contain price movement. During the life of the trading range, it will continue to narrow as the levels become clear to more traders and the anticipation of a reversal at those levels becomes imminent.

To take advantage of the smaller ranges caused in this manner, it is necessarj to enter positions during the middle of a trading session, frequenfly holding that trade until the middle of the next session. An exanple using the Chicago Board of Trade December 75 Silver confract, during August 1975, will help to illustrate this. Prices on 4 consecutive dajs are seen in Table 16-4. The opening and closing prices for the first 3 dajs do not indicate

TABLE 16-4 December 75 CBT Silver

Open tow Oose

August 21 500.S0 505.00 493.00 498.20

22 SO 1.00 504.00 494.50 500.00

25 SOI.OO 594.50 496.00 503 0

26 S02.S0 504.00 483.60 483.80

any opportunity for trading. Prices were generally in the middle of the daily range. By using the high and low of the previous day, this situation can be traded either of two wajs.

Thursday, August 2 I, forms a range of 505 to 493, closing near the center of the range. After the next open, buyjust above 493 and sell just below 505 to be certain of entering and exiting the position. For protection, a stop can be entered at about 506 and 492 to reverse the position on a breakout. Had this procedure been followed, entering 29 (200 points) before the bounds of the range. Table 16-5 shows how trades would have been executed.

In each case, the entry was 200 points before the level at which prices had reversed on the prior day. The Stop-Loss order was placed to limit losses to a 100-point penetration. Although this is an ideal situation, professional traders frequenfly use this method. It can be seen that the support levels did actually rise from 493.00 to 494.50, and then to 496.00. When support was penetrated, prices rapidly broke to new lows of 483.80, down to the permissible limit. Similarly, the resistance level remained intact going from 505.00 to 504.00, 504.50, and finally, 504.00. It is generally accepted that the resistance level represents a more volatile area that must be watched closely for false breakouts.

Support and resistance levels gain importance the more time they remain iniact. The high and low of the prior day are not as significant as the weekly or the monthly range. Each can be traded using the same technique. The major support and resistance levels are confract highs and lows, which rarely allow breakouts with less than one attenpt. Longerterm price objectives can be identified using a continuation chart. This chart plots only the nearest (spot) futures contract of a specific market to allow the location of support and resistance levels when the current contracts are in a