By Dr. Mircea Dologa, MD, CTA*
Posted: Nov 6, 2009
Learning the intuitive approach, true as ever, in the practice of profitable trading, just might catapult the trader's efficiency well ahead of the crowd's, due to the approach's global discernment or perception. The resulting acumen will give the trader the power to see what is not obvious to the average mind. It goes even further, enhancing the implementation of local action, as a result of general observation. It is like an expert guide unlocking the wisdom of the subconscious mind.
I wouldn't completely agree with Einstein's quote, "Imagination is more important than knowledge," because one has to take into account the role of experience. How can a trader imagine anything with "raw", un-cultivated knowledge? I remember one of my students saying that it took him a couple of years, and thousands of charts, to "feel at home" with his trading.
The difficult task is to elaborate an adequate learning module for intraday trading that could effortlessly and efficiently implant this approach in a trader's mind. It is useless to say that this approach is hardly found in any other trading literature. We will propose solutions for this complex and ubiquitous task, carrying in our mind the three main building blocks of the intuitive approach applied to trading, which are:
- The context of the trade
- Pre-open preparation
- Inter-market analysis
We have already discussed, in past articles, the first two elements, so, in this article, we will talk of the third element – inter-market analysis.
Specific Contexts: Inter-Market, Pre-Open Conditions
You are aware, I'm sure, of the great influence Dow Theory can still have, more than 100 years after its creation. In this article, the trader will become more knowledgeable about different specific contexts that will really assist him or her in identifying low-risk, high-probability trades.
The context of inter-market, pre-open conditions is one of those possibilities that presents an optimal opportunity for the trader's pocket, with very little risk.
Market Identification That Has a Positive Correlation Coefficient (near 1), with Regard to Your Traded Vehicle
The first step in accomplishing this task is to verify which markets would behave almost identically to your usual traded vehicle. If we take the German Dax 30 as a traded index, we can count on at least two markets that will behave in almost the same manner: The Eurostoxx 50 and S&P 500. We will also mention the German Bund and the Euro / US dollar currency pair. The difference is that the first two indexes will mostly have the same direction as the German Dax 30, but the last two vehicles won't necessarily behave the same way.
If that's the case, you may say, one question arises…Why should I use the latter two? Well, we've noticed that, in spite of a possible contrary direction, these two trading vehicles have an obvious euphoric or depressive activity when there are at stake financial events that will eventually shake up the operating market. We shouldn't forget that the German Bonds are hyper-sensitive when it comes to European money. The Euro / US dollar pair mimics the same type of phenomenon, but the Euro will inversely fluctuate with respect to the U.S. dollar index.
Pre-Open Identification of the Inter-Active Markets
Once a positive or negative inter-market correlation has been established, the second step is to prepare for the final phase of trade execution. This technique is mostly applied in the pre-open market but can also be implemented at certain hours, at the moment of financial news reports. Trade execution is mostly done right after the opening of the traded instrument, but for some trading vehicles it can also be done in pre-market.
Before getting committed and entering the trade, we should be aware of several elements:
- The open and close of all the implied markets
- Time lapses in the participating futures markets
- Time lapses in the participating cash markets
The possible criss-crossing comparison between the preceding close of the cash market and the close, for the night, of the futures market is especially valid for markets that are not open for 24 hours. For instance, the German Dax 30 Cash Index closes in the afternoon, but its Futures Index closes at 22.00 hours Central European Time (CET). The interval between these two closes finely illustrates the after-market mood of buyers and sellers. If the night isn't rich in news, the acquired after-market mood will really dictate the opening market attitude.
I will now try to describe this technique using real-time cases. I hope this will assist the trader in shortening his or her learning curve. One thing, though...this technique can really augur the best trades...
Real-Time Applications – S&P 500, German Dax 30, EuroStoxx 50 and Euro / US $: A Pre-Open Set-Up
Figure 1. An S&P 500 Chart Showing Preparation of a German Dax 30 Trade in the Pre-Open Period of December 7, 2006.
In Figure 1, we can see a big, 10.5-point up gap. After the close of the S&P 500 and a short pause, the night ES took over. The time is Central European Time (CET) and reflects night activity. As you can see, it exhibits infinitesimal volume. As they say, "Life comes on where the sun rises."
Now...What should you retain from this in order to prepare the German Dax 30 opening? Firstly, we note the strength of the market and, secondly, that the night ES doesn't retrace more than 14.6 percent the whole night. This means that the up gap momentum is there for keeps and that the German Dax 30 will make one heck of an up trend, at least during the morning of December 7. In case you're wondering what caused this high-powered momentum, just read the news clip in Figure 2 (shown below).
Figure 2. Bloomberg News Item for December 7 on Asian Stocks.
It is useless to say that the Asian markets news shown in Figure 2 was responsible for this high-powered momentum provoking the big ES up gap. If you want more detail about this, you can study the charts of the specific Asian markets: Nikkei 225, Hang Seng or S&P / ASX 200 Australian index.
Now that we are convinced of an implied high-powered momentum, which will "spill over" the entire European market, let us observe the pre-open charts of the German Dax 30, EuroStoxx 50 and Euro / US dollar.
Figure 3. A Chart Showing That the Asian Markets Hadn't Yet Influenced the EuroStoxx 50 Index.
As you study Figure 3, remember that the time is expressed in Central European Time units (CET). The 8.00 hours CET opening hour coincides with 16.00 hours Tokyo time when the Nikkei 225 closes. The trend line n° 1 (TL-01) is our landmark informing us of an eventual upsloping, under the "heavy weight of evidence" of the trend line's breakout.
One thing before we go further…This trading vehicle is well known as "the father" of the German Dax 30: It moves more slowly, but it's more reliable in its fluctuations and is mostly followed by the Dax 30. As a positive leading indicator, it tries to calm down the volatile German Dax 30, as much as it can.
Figure 4. A Chart Showing That the Euro / US Dollar Futures Were Slightly Influenced by the High-Powered Momentum of the Asian Markets.
In Figure 4, the chart shows that it is only 07.50 hours CET, still in European pre-open market time. Most of the exchanges in European capitols will open in 10 minutes at exactly 08.00 hours. The elements of our toolbox are applied, and the chart landmarks are drawn: The height of an eventual inceptive rectangle [H(0)] very convenient for future extensions, the two trend lines (TL-01a and T-01b), the Fibonacci ratios applied to the prior pattern correction, the short-term moving averages (8-ema and 13-ema) and the very strong levels of the previous day's gap, located just above the inceptive rectangle.
Figure 5. A Chart Showing That the German Dax 30 Futures Hadn't Been Influenced Yet by the High-Powered Momentum of the Asian Markets.
The chart in Figure 5 is still in European pre-open market time and shows that the German Dax 30 Futures hadn't been influenced yet because it had been closed since the previous day at 22.00 hours CET. The elements of our toolbox are in place, and the chart landmarks are drawn: The median lines of an up-sloping pitchfork, with its warning line n°1 (WL-01), just above the close; the descending channel whose upper border (TL-1a) promptly halted the market, at the close; the Bollinger Bands, whose narrowing is capable of signaling an imminent high-powered momentum and the very strong levels of the old gap, whose upper limit trend line promptly stopped the previous day's market right on it, at the close.
Open Unwinding – On the Watch for the Inter-Market Entry Signal
Figure 6. A EuroStoxx 50 Chart Signaling the German Dax 30 Long Trade Entry.
Trespassing the trend line n°1 (TL-01), the EuroStoxx 50 chart in Figure 6 has signaled the German Dax 30 long trade entry at exactly 9.00 hours CET, one hour after the opening. We will not go into the trade detail here because it is beyond the scope of this article.
Figure 7. A Euro / USD Chart Whose Upper Border of the Inceptive Rectangle [H(0)] Has Signaled the Beginning of Influence from Asian Market.
As shown in Figure 7, at approximately 8.00 hours CET, the Asian market high momentum has begun to influence the European markets. However, this signal is not as reliable as that of the EuroStoxx 50 with respect to direction or reliability. We consider that it should be used, rather, as a confirmation of whatever its direction would be.
However, in its recent behavior, it acts like an opposite leading indicator. Just for the record…given its monetary interaction with the German Bund (currency conversion versus interest rate), I need to point out that the latter has exactly the same characteristics as an opposite leading indicator.
Opening – Trading the German Dax 30
Figure 8. A Chart Showing That the Market Is Aligned Just under the Upper Border of the Descending Channel, a Few Minutes before 9.00 Hours.
In Figure 8, you can see that we are waiting for the EuroStoxx 50's signal to enter – or not – in a long trade. The concomitance of the breakout of TL-1a with preferably expanded volume and the bursting of the EuroStoxx 50 long trade signal, at the same time, will definitely convince us to enter the market.
Once again, we will not go into the trade's detail here, for lack of space.
Figure 9. A EuroStoxx 50 Chart Signaling (also refer to Figure 6) That the Dax 30 Broke the TL-1a Trend Line at Approximately 9.02 Hours CET (also refer to Figure 10).
In Figure 9, once the chart signaled that the Dax 30 broke the TL-la trend line, it showed that it shot straight up, almost to the upper border of the rectangle's n°3 extension [H(+3)]. The momentum confirmed by the expanded volume (not shown in Figure 9) is closing in on the prior pattern 100 percent limit correction. As you can see, the pre-market, inter-market conditions brought to the trader's reach a highly profitable low-risk trade.
Two questions, though… Why did the German Dax 30 break the trend line 62 minutes after the opening bell? Why did it wait more than an hour? Well...This has to do with the time of day. The bulk of traders start their trading activity around 9.00 hours CET, and some German fund managers start making decisions at 10.00 hours CET after they have fully analyzed yesterday's after-market, the night's markets, today's pre-open and the early opening.
The trader can follow the values of the past volumes in order to get the backlog of the entries / exits in the day's market, beautifully illustrated by the waltz of fluctuations!
Figure 10. A 3-Minute Chart That Illustrates the Trading Process from the Entry at the 6364 Level, at Approximately 9.00 Hours until the Last Market Bar at 10.15 Hours.
In Figure 10, the elements of our toolbox used for entry (breakout of the TL-01 trend line and crossover of the two moving averages) and also the trade's development are highly visible. The targeting and the stop trailing are optimally performed through the use of Elliott waves (W3=3.00*W1), gap extensions presently at h(+2) and the two moving averages. The trend is still in effect above both short-term moving averages.
The trader should know that the small time frames (3- and 5-minute) used here have only been selected for teaching. The usual operating time frames are 15, 30 and 60 minutes.
Final Thoughts on the Intuitive Trading Approach
What really intrigued me and caused me to want to know more about the intuitive trading approach was Lee Iacocca's famous sentence, "Think global, but act local."
First, I thought of his statement in terms of the usual trading plan concept, but later I realized that this global concept implies much more than that for trading. And, suddenly it all became clear. The trader must integrate intuition into his or her everyday practice. One should kind of cultivate intuition, day in and day out.
Speaking about the building blocks of the intuitive approach applied to intra-trading…whatever you do, don't neglect the power of the inter-market, pre-open conditions! It might create in your mind a second nature intuition! And, this is vital when it comes to making a profit, day after day!
*Reprinted (and modified) with permission from Dr. Mircea Dologa, MD, CTA, a Commodity Trading Advisor, Stock Investment Advisor (for New York Stock Exchange clients), the founder of a new teaching concept, based mainly on the practical aspects of trading for novice and experienced traders at www.pitchforktrader.com and a well known contributor to international magazines in the U.S., England, Germany, Australia and South East Asia. He can be contacted, for any questions or Excel files, at mircdologa@yahoo.com.
