Pinpointing a Shift in the Flow of Opportunity

Take a look at the price action in December Dow futures to evaluate early warnings.
Author:
Publish date:

If you're wondering whether the train left the station without you, here's news: There's another one right behind it. Then another one will follow -- and then another.

If you're fretting because you might've missed or didn't add to positions in this six-day rally, which has added as much as 16% on the basis of

Dow

futures, bear in mind that the market is an endless stream of opportunity.

At any point, you have the opportunity to enter, exit, add to or subtract from a position. At any point, you can do nothing -- sometimes the best action. The important elements in consistently profitable trading are to identify the direction of the flow, to discern when that flow is shifting course, to know how full to load the boat and to plan where you'll disembark.

Let's look at the price action that bleeped on the early-warning radar, alerting us that something was afoot and forewarning a change -- at least a temporary one -- in December

Dow futures

(DJZ2:CBOT), which had been sinking since Aug. 22.

Looking at a two-hour chart of that period, you'll see that pullbacks A-B and C-D were both 540 points (540 and 545, respectively), defining bearish symmetry in this market. Now that 7725 has been resoundingly taken out -- that's 545 up from the 7180 low -- the bear stream has come to a bend. The flow of opportunity has shifted course.

Now that the market has tacked from red to green, now that a trend change has been defined, let's look at price action in Thursday's session to determine a defined-risk port. The market is likely to back and fill gaps left during its six-day burst.

So using the first substantive pullback, marked G-H in the following 60-minute chart, as a measuring stick, we find that an equal or symmetrical pullback from Thursday's high resides at 8069. We also find the coincidence of the 50% and 78.6% retracements of the two most recent hourly swing low-points near this area, yielding a very tight level -- 8061 to 8069 -- from which to test the theory that Dow futures will continue on their northbound journey.

A Breakout or a Fake-Out?

Many commodity funds have systems that define trend on the basis of 20-day or one-month highs or lows. For instance, should a market make a new 20-day high, the funds go long on a breakout of that extreme. If a market makes a new 20-day low, they go short on a breakdown of the low.

Knowing this strategy, contrarian traders will fade breakouts or breakdowns in anticipation of short-term, countertrend gains. Fading 20-day extremes tends to work best in instances where the market has already run up a fair distance, leaving it with insufficient energy to sustain additional gains above the breakout pivot.

November

feeder cattle

(FCX2:CME) futures have a classic setup that make them ripe to fade their recent breakout. Feeders had rallied 4.4% in six recent outings en route to slightly exceed the September high set 19 trading days ago. After breaking out above the high on Oct. 15, the contract closed below the open and below the Sept. 20 high, signs that the breakout would fail.

Then in the last hour of trading Wednesday, feeders left an engulfing bar at the high on the hourly chart, further suggesting this market is likely to correct.

Marc Dupee is an independent trader and co-author of the book

The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to

Marc Dupee.

TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.