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
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
index futures, but you can use their
ETF proxies as an alternative (see the
PowerShares QQQ Trust
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
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
, 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.
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.
Look for at least one shakeout of the short-term trend during the midday doldrums. Scalpers get bored as the day drags on and can't resist stop-running weak-handed traders out of perfectly good positions initiated by common entry strategies. That's why we see lunch-hour selloffs during strong rallies and late-day
short squeezes during nasty
Realistically, it's hard to stay positioned through a midday shakeout if you bought or sold short at a questionable price and are relying on late follow-through to bail you out. The underlying "science" of the stop-running game ensures that you'll feel just enough pain from the drawdown to make you capitulate.
On the flip side, sidelined traders can find superb second-chance entries when these whippy countertrends grip the midday tape. It works like this. Review the early price action, looking for deep support or resistance. Then set up deep
limit orders, just beyond those prices, that will trigger if the stop-running carries just beyond obvious boundaries.
You'll be amazed how often these orders get filled and capture the final extension of the countertrend. That means your new position snaps into a profit immediately and marks an extreme that lets you manage the trade at a leisurely pace. Meanwhile, all those folks targeted by the shakeout are back on the sidelines, humbly licking their wounds.
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At the time of publication, Farley had no positions in the stock mentioned, although holdings can change at any time.
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