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Huge double digit gap of almost 30 handles as I sit down to my typewriter (1989 Smith Corona XD 4600) this morning. Needless to say the open is slated to be out of balance and the gap is a true gap. Gap rules are definitely in play.
If that sort of thing matters to you, China said overnight that they would not retaliate further with new tariffs.
Before we look forward as to how today might play out, I want to point out how strong of a signal the poor high from yesterday was. The flat top of ‘M’ and ‘O’ periods with no excess at all create the poor high. Then when the settlement at 4:15pm EST is right up against that level, it increases the odds greatly that futures will trade lower overnight. Note how the ONL is 15 points below the settlement. The way to play this is to initiate a short right about 4:14pm EST if it appears that the settlement will be right up against the RTH high, then cover incrementally (at lower and lower levels) using limit orders overnight. Watch for this pattern, it is relatively rare but not unicorn rare. If that isn’t news you can use, I don’t know what is.
Now, let’s look forward… The gap is obviously enormous. Gap rules are extremely important today. If you are new, then mouse over the tool tip and get yourself very familiar with this framework. I believe it is invaluable when trying to navigate these opens.
Beyond the rules, there is actually little to say here. The strongest potential today is for the gap to just hang at the top (gap rule #4) and digest the overnight activity. That is the most common outcome to gaps that are this large. Novice traders (and I used to do this too!) focus on the size of the gap and believe that shorting it early has excellent risk/reward because their stop is small relative to the their target. While that’s true, it’s also true that the trade itself has low probability of working out. This is am important point that a lot of traders miss. If the expectancy of winning is very low and causes multiple stop outs, then who cares how good the risk reward is?
Your focus this morning should be on market internals more than price. If the tick doesn’t get negative early, then the gap is not going to fill. If the A/D line is pegged at > +1500 after 30 minutes of trade, then the gap is probably not going to fill. If early corrective activity is of the slow grind variety, then that is also a sign that the gap is not going to fill. All of the above usually leads to either very little rebalancing or a partial gap fill. As such I’ve put overnight halfback on the key levels.
If it is a gap and go scenario today, then the ONH is the obvious gateway to higher prices and needs to be taken early on strong tempo and bullish internals. Keep in mind that this trade is also tricky because you are buying after a 30 point move (overnight) has already happened.
Keep in mind that I am telling you only what has strongest probability of occurring from my considerable experience in these matters. Could sellers come in immediately and fill the gap quickly? Without a doubt. BUT and this is a very big but……there will be signals that will confirm this. The tick will plunge right away and advance decline lines will start moving down sharply towards the zero line from the open. This doesn’t have to be a guessing game. You would not drive your car and think “Gee, I wish I knew how fast I was going”, you would just look at the speedometer.
- Given the large gap, my focus this morning will be on the quality of early selling and whether or not there is any meaningful gap fill. I will note all internals readings at open and monitor them constantly to see if any corrective activity is occurring. A common play that I use on these days is to buy the high of the first one minute bar in tech stocks or if there is an early fade, wait to buy when prices cross back through the open with a stop under the LOD. I feel strongly that individual stocks are the better play over futures on these days. FWIW, I generally don’t take the fade trade on these days as the odds don’t favor it.
Have a traderific Thursday,
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