A Favorite Trading Pattern

Brett N. Steenbarger, Ph.D.


Some of my favorite morning trades are based on a reading of strength or weakness in early trading--using such tools as the NYSE TICK and Market Delta--and then handicapping the odds of taking out the previous day's high or low.

Since 2005 in the S&P 500 Index (SPY; N = 588 trading days), we've had 81 inside days. That means that over 85% of the time, the market has either taken out its prior day's high, low, or both.

Those odds are increased when markets trade on above average volume. Because volume correlates well with volatility, it is rare to see a day with above average volume also be an inside day.

For example, we had 329 days since 2005 in which volume in SPY was above the 200 day moving average. Out of those 329 days, only 29 were inside days. That means that over 90% of the time, a high volume day will not be an inside day.

Conversely, out of the 259 days that were below the 200 day moving average of volume, 52 were inside days--about 20%.

When I see a day begin with average or above average volume, I go with the assumption that we'll take out the previous day's high or low and touch either the R1 or S1 pivot level (posted daily to the Weblog). At that point, it's just a matter of following the emerging distribution of market strength or weakness in such indicators as NYSE TICK to place your bet on which extreme will be breached.

A large number of my successful trades are based on this pattern. I will be illustrating in future posts.