Today, September 15th, we saw the largest drop in the Dow Jones Industrial Average in six years. At times, a futures market may not have a reference point to help traders determine support and resistance levels. The spike in Wheat earlier this year was one such example. Futures traders should be conditioned to avoid fading strong trends, such as the recent rise in Crude Oil Futures, the rallies in the grain futures markets and the recent sell-off in equities.

One can use the concept of average and extreme trading ranges in order to help determine how much more a move has to offer, in terms of finding a topping or bottoming area and applying the average or extreme range to the market and time frame being observed.

For example, suppose you were wondering how much further we can expect equities to fall this week (you can apply this principle to any time frame). Well, it is absolutely impossible to predict this. No one knows the answer to this question. However, it makes sense to go back and look at weekly charts to measure the largest ranges.

Doing so for Dow Jones Futures, you will see the two largest trading ranges going back to August of 2007 were 770 and 780 points, on a weekly basis. If we were to assume that a) we will come close to that level (let’s round up to 800 points), then if the swoon were to continue, one would expect support in the area of Dow 10,450. This is based on observing the past and applying market behavior to current trading.

It is critical to note that we have no idea how low (or high, for that matter) a market will go. But, we can look at history and know times of extreme volatility produced ranges close to 800 Dow points.

There are trading systems that are built around the concept of average range or extreme range. For example, if the 21 day average range in E-Mini S&P Futures is 24 points, then traders make seek buy or sell opportunity based on that information.

I knew a pit trader that would trade infrequently, but when he did trade, he traded large volume and was usually right instantly after entering the trade. I will refer to this trader as “Trader Y”.

Trader Y stood quietly, for hours on end, in the 30-Yr T-Bond pit, cramped in with 500 locals. Then, seemingly out of nowhere, sometimes even in quiet periods, Trader Y would jump up and scream frantically, something like “I WANT TO BUY 500″. Other traders would look at him like he was crazy.

He did not seem to be crazy when, almost immediately after his purchase of 500 T-Bonds, the market would start to rise considerably. He developed quite a reputation this way - stand quietly, apparently ignoring the action in the pit, as he gazed up at the ticker wallboard. Then suddenly and quite frantically, he would put on a massive position that would usually be an instant winner.

I felt compelled to find out his formula for success. He was an approachable sort of individual - I asked him, “okay, what’s your secret?”.

Interestingly, there was some Technical Analysis involved in his response. He would look at two things: first, he would study the markets that were most strongly inversely correlated with the T-Bond market. Doing this is somewhat art and somewhat science, as markets correlate with other markets and then shift correlations over time.

Secondly, Trader Y would identify critical levels on price charts of the correlated market. For example, if the T-Bonds were trading inversely with the CRB Index, Trader Y would spot critical levels in the CRB Index - levels that if broken, would spark a reaction on the T-Bond market. This trader used weekly pivot points in the CRB. He would simply gaze at the wallboard and watch the CRB Index, looking for something pivotal to happen in that market. When it did happen, he would jump up and put on a large T-Bond trade. That was his secret - combine technical analysis with correlating two markets. In summary, after he confidently identified the inversely correlated market, he would wait for a technical evident in that market, and then put on his position in the T-Bond market.

This approach is different than that of a post I wrote about Trader X - this approach can be used in today’s markets, which are traded almost exclusively electronically (with a few exceptions).

Both Trader X and Trader Y used a technical analysis idea and capitalized on it by combining it with one other component in order to devise a successful trading plan.

Successful futures trading can be accomplished in different ways. In today’s markets, traders will typically use technical analysis, fundamental analysis or a combination of approaches to succeed in futures trading.

What about the “good old days” where trading was conducted via open out-cry in the hectic trading pits? How did traders succeed with no fancy computers in front of them, no technical analysis tools and no access to real-time breaking news?

Discussions with several traders reveal some interesting approaches to making money while trading in the pit. One extremely successful pit trader (I’ll refer to him as Trader X) would gaze into the Treasury Bond futures pit from a different location, set slighter above the pit. He had a very good view of the executing brokers and the market making locals.

Trader X was generally quiet in nature - he did not scream and yell constantly; instead, every now and then, he would simply lean forward and gesture to a broker to sell 100 30-Year Bond futures at the market. Almost immediately after selling, the market would start to deteriorate slightly. Soon after going short, the market would be eight tics lower. The trader would then lean forward and gesture to buy 100 30-Year Bond futures at the market. Typically, his trades would earn him 8 ticks on 100 contracts, which equals $25,000 per trade.

I personally asked Trader X what his secret was. Why do you do nothing for hours and then suddenly go short 100 contracts? What are you looking at? Did you see a special pivot point, moving average level, trend-line approaching? Why does the market usually go in your favor almost immediately after executing your trade?

His answer was simple, yet complex. Trader X believed that the T-Bond market tended to move in 8 tick increments and would “correct” or at least pause at those increments. That’s the easy part of his explanation. I asked why he didn’t sell or buy at every single 8 tick increment (he would only trade at certain 8 tick levels).

The more complicated part of Trader X’s secret was that he combined his observation of 8 tick movements with his assessment of the overall position of the local traders in the pit at each of these 8 tick increments. I asked how he knew what the overall position of the local traders is?

This particular trader would observe volume traded at a particular level and the reaction of the local traders at those levels. For example, the low price of the session for T-Bond futures is 110-08 and the market trades up to 110-16. Bonds begin trading considerably at the offer price. It is common practice for local traders to trade the “turn”, which is when the market turns from “bid at 16, offered at 16″ to “bid at 16, offered at 17″. Local traders will try to buy the “16’s” in hopes that the market turns “16 bid”, thereby gaining the “edge” in the pit.

Trader X went on to explain that sometimes, the locals simply get it wrong. Trader X had a natural ability to spot situations where the local traders got twisted up on the wrong side of the market.

It would usually play out like this: the market is offered heavily on “paper” (non-local offers) at 110-16. Brokers in the pit would begin to buy the offer, sufficiently enough to entice locals to enter long at 110-16, in hopes of trading the turn and becoming long at 110-16 while the market turns soundly bid at 110-16. Sometimes it simply did not work out that way for the local traders. Trader X had a natural ability to spot these situations and he would capitalize on them. In this example, Trader X was able to see locals buying and accumulating long positions up to on 8 tick increment. When the market traded at 110-16 it would briefly turn “16 bid” and then pop back “16 offered”. Well, now we have a bunch of locals long the market while it is once again offered heavily at 110-16. That’s when Trader X would strike and go short.

This is one example of how a simple “technical” idea for Trader X - the T-Bond market tends to move in 8-tick increments - was combined with another factor in order to determine a way to trade profitably. I have to wonder how Trader X applies an “8-tick increment” principle while trading in front of a screen. Perhaps Trader X needs some new tricks in his bag.

The Reversal Bar technique described on our site can be an excellent indicator of trend reversal. We have posted examples for Crude Oil Futures and Wheat Futures that use our reversal bar technique.

The image shown is this post is quite dramatic and shows how effective the reversal bar technique described at ABC Futures would have been, had the sell signal in Euro or Euro FX futures been taken.

Of course, automated futures trading systems must always apply risk management to ensure capital preservation. Combining sound risk management principles with our reversal bar technique can be extremely profitable.

The below image shows Euro or Euro FX Currency Futures and depicts a hugely profitable selling opportunity that would have been realized if the Reversal Bar technique described on our web site was used to enter this market.

Euro FX Futures Reversal Bar

This article exemplifies the profit potential described in ABC Future’s Reversal Bar technique.

The highlighted market is Wheat Futures. Shorting this market on the reversal bar would have resulted in profits in Wheat Futures. Solid risk management is required to help increase long-term success for any futures trading technique, including the Reversal Bar Technique described at ABC Futures.

The below image shows Wheat Futures and the profit potential that would have been realized if the Reversal Bar technique described on our web site was used.

Wheat Futures Reversal Bar

September Crude oil remains weak. Although on August 21st, we saw a price spike. However, from a technical perspective, the rally was meaningless. This was proven in today’s price action - Crude Oil futures made a lower low today, and even more meaningful, Crude Oil futures closed below yesterday’s low. This is bearish from a technical standpoint.

The chart shown below is an image of September Crude Oil Futures, and is an excellent example of the reversal bar technique described here.

Shorting this market on the reversal bar would have resulted in nice profits in crude oil futures. Of course, this technique does not always work out as we hope, however with good risk management, the Reversal Bar technique is an excellent timing tool for futures trading.

Crude Oil Futures Reversal Bar

As mentioned frequently throughout this site, we believe successful futures trading can be achieved through conceiving a solid idea, applying a strong money management principle to the idea and automating (or black boxing) the idea in order to optimize money management general features of the idea.

We are looking at a promising concept that may be able to help identify turning points in futures markets. The concept is simple. The example in this post is associated with a sell signal, however the idea behind it applies to buy signals, as well.

The premise is as follows: We are looking for a new high and then a reversal bar. The high bar and the reversal bar MUST have a proximity relationship - in other words, they must occur within “n” number of bars between one another.

After we experience a new high, we look for price action that creates a reversal bar. This reversal bar must occur within a certain number of bars (”n”) from the bar that the “high” was created. If we wait for too many bars, the “pattern” or technical analysis method becomes irrelevant.

To identify the reversal bar, the high of the reversal bar MUST be lower than the low of the bar on which the new high was established.

This sounds like a brain teaser, however this Technical Analysis Reversal Technique is very straight forward.

A simple example is provided and then supplemented with a screen shot depicting a sell in Crude Oil Futures. In the example, the market is not important. The concept is important.

Example:

New High Bar: High = 200, low = 160.
We must establish a proximity relationship between our new “high” bar and our “reversal” bar. Assume our maximum number of bars allowed between our “high” bar and “reversal” bar is 5 bars.

We are now looking for a bar within the next 5 bars whose high price is below the low established on the bar where the high of 200 was created - we are looking for a bar whose high is below 160. If we find such a bar within 5 bars of our “high” bar, then we refer to that bar as a reversal bar and we establish a position based on that bar.

I want to stress the importance of automation, software programming and black box technical analysis when looking at this technique and other like it: in this example, we don’t know the ideal “maximum” number of bars to use as a “cut-off” point for establishing a relationship between the “high” bar and the “reversal” bar. This is where our programming skills enter the picture. We use inputs to our software programs to help determine this value.

We don’t know the ideal money management principle to apply for our stop loss order - again, this is where we use software programs to automate our ideas and optimize them for maximum profitability and minimal equity draw down.

The following image exemplifies this concept:

Technical Anaylysis - Reversal

You can also visit our Futures Trading Techniques category for several examples depicting this technique in action.

Please note that, regardless of how profitable a futures chart may appear, or how solid a technique may seem, it is critical to always apply money management principles to each and every futures trade. This is true for automated futures trading as well as any other style of futures trading.

Money management principles should be combined with every futures trading technique. Automated futures trading systems go through “slumps”, similar to slumps endured by the greatest athletes of all time.

We all know that Ty Cobb, Michael Jordan and Tiger Woods have each entered “slumping” phases in their respective athletic professions. However, each of these athletes bounced back from their short-term “slumping” periods.

In futures trading, whether trading using an automated trading system or trading by watching a ticker tape, any futures trader will go through a trading “slump”.

What helps keep futures traders reduce their time periods of less profitable trading? The answer is - money management.

Most futures trading techniques presented on this site will be accompanied with a reminder to the reader or futures trader, that solid money management programs must always be applied in conjunction with a futures trading system or technique in order to help maximize results.

A Black Box Approach To Trading The Opening Range In Treasury Bonds

There is a prominence of black box and algorithmic trading in today’s futures markets. Basic black box or algorithmic systems can be effective trading tools. These can also be easy to automate and optimize.

The example in this post uses US Treasury Bond futures, however, the same concept can probably be applied to any futures market. In a different post on this site, we state our belief that technical analysis, if sound in principle, is likely to work in any liquid futures market.

Many investors using technical analysis agree that the Opening Range is considered an important time for a futures market. Note that defining the Opening Range is subjective. The Opening Range can refer to the first hour of trading, the first 10 minutes of trading, or even the first several price quotes. Defining the time frame that is most profitable requires optimization, which is a fundamental feature of black box systems - they can be optimized. By programming our trading idea, we can easily optimize our system.

This technique first defines the opening range by selecting a time frame for the Opening Range (for example, the opening range may be the first hour of the pit-traded session). After defining the Opening Range, the futures trader will wait for the market to “break out” of this predefined range.

Profit potential is based on the follow through of an opening range break out. An important component of the opening break out system is to determine how much follow through will occur. As with man black box trading systems, you need a starting point for optimization. A good starting point for this black box system would be to test to see if the break out doubles the opening range.

For example, suppose we use the first hour of the pit-traded session to define the range. Assume the range is 114-20 to 115-03. This is a 15 tick opening range. Eventually, Treasury Bonds will break out of the opening range either to the upside or to the downside.

If after the first hour of trading, Treasury Bonds break out to the downside and trade below 114-20, then we would expect a 15 tick follow through, down to 114-05. If the break out is to the upside, we would expect a rally up to 115-18.

Another consideration for any black box trading system is stop loss orders. For this system, let’s assume our stop is the other side of the opening range (if you take a buy at 115-03, your stop may be 114-20).

I am not saying this is the best place for a stop for this technique. I use this stop merely to illustrate that you could link your stop price to the opening range in the same way that the entry price is linked to the opening range. You could use a tighter stop, such as just past the half-way point of the opening range.

Although this is a general description of a system, it has great potential for optimization. Through optimization, a simple idea can produce good results (assuming money sound money management is applied).

We are currently developing this system and optimizing it for many different futures markets.

The Opening Price is often times near either the high price or low price for a trading session

There are many price patterns or phenomenon that recur over and over in futures markets. Once a pattern is identified, futures traders need to figure out how to trade that pattern or profit from it. The easy part is identifying the pattern. The hard part is designing a profitable trading methodology around it.

The pattern described below illustrates that a trading bar’s opening price is near that bar’s extreme (the high or low of the bar) a very high percentage of the time. The preferred time frame for assessing this technique is daily bars or 60-minute bars. You will undoubtedly agree that the open price of a bar is near one of its bar’s extremes a high percentage of the time. It is the futures trader’s job to profit from this recurring pattern.

Verify the recurring pattern:

• Using your charting software, pick a futures market. It doesn’t matter whether you choose a market in grains, metals, energies, softs or currencies.
• On each bar, locate the Opening Price and examine its proximity to either the high or low of that bar.
• Use your judgment - you will find that an usually high percentage of a bar’s open prices are within close proximity to one of that bar’s extremes (the high or low of the bar).:

Things to consider:

1. Determine the threshold or level that qualifies an open price as being near one of the bar’s extremes. For example, if a bar trades from a price of 1 to 100, and the open is at 80, then you will need to decide if that bar qualifies as one that has an open price near one of the bar’s extremes (in this case 80 is near the high). The only way to do this is to review many bars (100 or more). You may find that 80 is not considered close enough to the extreme of the bar, and that perhaps 85 to 90, or 10-15 are near the bar’s extremes (high or low, respectively). This is where your judgment comes into play.
2. One way to determine the level that qualifies the bar as having an open price as being near a bar’s extreme (high or low) is to look at 100 bars or more, and use your judgment by simply looking at the bar. Clearly, if the open price is in the middle of a bar’s trading range, then we are not interested in reviewing that bar. We only care about bar’s whose open price is near one of that bar’s extremes.
3. Use the concept of “threshold”. You must determine a threshold in order to translate this technique into a profitable system. Think of the threshold as the distance between the bar’s open price and one of the bar’s extremes.
4. To determine a threshold, examine bars whose open price is near that bar’s extreme (high or low) and then determine how many points, cents, tics, etc the open is from the extreme of the bar (high or low). Do this for as many bars as possible and find an average number to use as the threshold.
5. Each market will be different, as the price formats and trading ranges differ across markets. For example, T-Bond Futures may have a 3-5 tick extreme; E-Mini S&P Futures may have a 3 point extreme; Corn Futures may have a 2.5 cent extreme.
6. Once you determine the threshold from the open, you can devise a trading system based on this concept - a high percentage of time, the open price for a bar is near either the high or low price of that bar.