How to Handle Midday Swings

This column was originally published on RealMoney on Jan. 10, 2008 at 10:04 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

How do you handle the midday markets? This is an easy question for technically minded investors who focus on closing price to make their decisions. But it's a different story for traders looking for opportunities throughout the session. Their compulsion to overtrade comes into play during this period, and it's capable of ruining a perfectly good day.

I have an Aussie friend who made over a million bucks last year scalping the local futures market. He devised the perfect solution for dealing with the hazardous time between the first and last hours of the trading day: He bought a home near the beach and goes surfing as soon as the midday doldrums hit the Australian Securities Exchange.

That most excellent solution isn't open to most of us, so we need to approach the issue from a different angle. For good or bad, I'm not willing to step away from the trading screen during this time, because the setups that do unfold can be extraordinary.

I'm also a die-hard daytrader who enjoys the choppy swings that translate into midday profits .

Although retail trading activity dominates the first hour of trading, the rest of the day belongs to market professionals . The opening often generates an upward, downward or sideways bias that can persist for the entire day.

Your first job when the tape quiets down is to measure buying and selling pressure with a quick look at the first-hour range . I accomplish this with the Nasdaq 100(NDX Quote) and S&P 500 (SPX Quote) index futures, but you can use their ETF proxies as an alternative (see the SPDR Trust (SPY Quote) and PowerShares QQQ Trust (QQQQ Quote).

The first-hour highs and lows set up short-term support/resistance levels that professionals watch to take initial entry and exit signals. These levels can break early in the day or persist through the closing bell.

S&P 500 E-Mini Futures

Click here for larger image.

Source: eSignal

Next, put those levels into context with larger-scale support and resistance. Without instant recall of the broad pivot points, you can't tell where and when good intraday trades will develop. Note the lines I've marked out, as well as the 20-bar Bollinger Bands and 5-3-3 stochastics. These three elements provide a road map for the entire session.

The vast majority of equities will follow oscillations in the futures markets, so you now have everything you need to read market action between 10:30 a.m. and 3 p.m. Eastern time. During the majority of this period, you'll be tracking a 60- to 90-minute buy/sell oscillation that passes leadership back and forth between buyers and sellers.

Align your equity trades to the wave pattern you see on the stochastics, or else you will risk the consequences. Many stock scalpers keep one eye glued to this oscillation at all times, looking for rapid-fire buy or sell signals. In addition, complex computer algorithms use this natural order flow to execute a wide range of short-term strategies.

The oscillation also helps traders locate low-risk entry or exit prices on larger-scale patterns and setups. Consider Immersion (IMMR Quote), which broke seven-week support on Friday [Jan. 4] and spiraled into a strong decline. Note how every valley posted by the stock this week [Jan. 7-9] matched a related swing low on the S&P 500 futures.

Immersion Corp.

Click here for larger image.

Source: eSignal

No, this isn't a cherry-picked example. Rather, it's a clear statement about how the midday markets work in the year 2008. So I recommend you get these oscillators onto your trading screens and start to use them, or choose to avoid this doldrums period entirely and find another way to occupy your day while you wait for the last hour to arrive.

Practically speaking, this alignment process doesn't always work. For example, trend days upset the apple cart, because they'll ignore the oscillation entirely. For this reason, midday traders need to recognize developing-trend days as they unfold. These directional sessions show up just two or three days per month, on average.