Just a short note

Posted on June 18th, 2009
Written by Richard
Posted in: N/A (old archives)

Just a short note today… you know, trading was pretty lame in ES today… stuck in a range since shortly after the open. Still, I traded the last hour and a half pretty well, in my opinion. Because clients ask me about it every week, I’ve been reading about Volume Spread Analysis. Hopefully someday soon I’ll have time to write about it… so far I have only had time to chat about it with my eotprolive folks in our room.

Anyway, I’ve been adapting the vsa concepts to range bars, and I think it’s gone well. The key is our VR4×1 indicator, which tells me which way traders are leaning. That’s 1/2 of the equation (the market order half), and the other 1/2 is identifying liquidity, and whether I think the market pressure will overcome it or not.

So, one example of a change to basic VSA (as I understand it, anyway) is that they will say a low-volume up candle in a downtrend indicates no demand. On a range bar, though, if I get an up candle, it’s because several price levels have been breached… and if that happened on no volume then it actually indicates no supply to me. Funny, huh? So on my range bars, I actually want to see a high volume up candle during a downtrend, because this means it took a lot of buying to break those levels, and that’s not likely to continue since I’d only be short when the volume pressure is predominantly down. You see?

Here are my 4 trades from the end of the session, with interesting points numbered (click to enlarge):

First off… on price we have our channel indicator. I only want to get long in the lower half of the channel, and only short in the upper half of the channel. This gives me an edge right away, because it will be statistically rare for price to give me too much heat after entry.

The first subgraph is our VR4×1 volume trend indicator. This is my trading bias and also helps me see from an overview perspective which way active traders are pushing.

The second subgraph just shows me the raw bid vs ask volume for 1 bar. This, along with the volume histogram, helps me identify liquid areas in the market. The thickness of the histogram indicates how many ticks were in the bar. This can tell you quite a lot, since a low-volume bar with a lot of trades in it would indicate that it’s amateur hour. And that’s just one example.

The bottom subgraph is just plain old volume. I use it with the raw bid vs. ask as I just described above.

See how every indicator on my chart serves a specific purpose? I can’t stress this enough. I have lots of indicators that I love (Alla’s Average, Volume Splitter, Math Lines, etc.), but I only use them when they serve my trading idea. Only use indicators that show you what you need to see for your plan! Read this over and over until you get it.

Anyway, here’s my quick commentary on the numbered items in the chart:

  1. Look at the two candles before my entry… the first had down pressure but it managed to close on its high. To me, this means there was very little ask-side liquidity. The second candle closed on its lows but on lower volume from more ticks (amateur hour). I figured if the next candle caught a bid (it did) then I’d get in. I did cheat a little in that VR4×1 didn’t turn green, but it did go higher than its previous bar so I assumed green bars were coming. Waiting longer would risk a poor fill in the upper half of the channel.
  2. My cat stepped on my mouse and bought a contract. Way to go, kitty.
  3. My exit. Look at the high volume with lots of ticks. Now, I normally might try to see if we’d push through, but lately I have a phobia of prices ending in ‘7′. It’s stupid, I know… I laughed about it in the room (screenshot below). Anyway, it turned out to be about perfect for an exit.
  4. So, at 3 we had established a local top, and you can see that VR4×1 had turned red. So, I was looking to get short. The bar before my entry put in some nice volume, but my entry bar closed on its lows despite up pressure (indicating no liquidity on the bid to me). So, I thought I might have to be nimble if we reversed at support again, but I’d give it a shot.
  5. We did break through, but every candle had less down pressure (you can see this in the second subgraph, but also in the way VR4×1 went flat). I took my exit.
  6. I got long. Upward pressure had been building and price had stalled out, which is why I exited my earlier trade. The two candle before my entry had rising volume, and I was able to get a good fill. Again, VR4×1 hadn’t turned green yet, but I expected it to at any moment. But, it didn’t. As price continued to churn, volume pressure inched back to the down side. The advantage of getting such a good fill is that I had several chances to get out with a tick of profit. For some reason I can’t explain right now, I didn’t do that. Also, I hate to admit it, but I somehow did not notice that VR4×1 remained red until 7…
  7. So, I noticed that things weren’t going my way, and when the fresh decline in VR4×1 caught my attention I reversed short for a small loss. This trade went in my direction right away, making me glad I acted when I did!
  8. My exit candle. We had put in a high-volume candle 3 candles ago, and here we were just a little lower and putting in a high-volume candle again. High volume means that there’s plenty of liquidity we have to eat through to go down, which means demand. As long as selling pressure holds up, it’s no problem, but I didn’t want to press my luck towards the end of the day. I booked my profits and went to run some errands.

Here’s when I noted my exit in our chat:

Hmm… not such a short note, after all!

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